What can Puerto Rico do about its debt?
Puerto Rico’s debt burden is unsustainable. It’s over 100% of their economy. By contrast, the most indebted states—Connecticut and Illinois—have debt-to-GDP ratios that are a little less than 30% of their gross state product. And this doesn’t even include PR’s unfunded pension obligations, which total another 65% of GDP. Lately, the size of their debt has stabilized, but that’s only because they’ve been selling assets and delaying debt payments—something that clearly can’t continue. What’s to be done?
Source: T Rowe Price
Some have said that Puerto Rico’s problems are the US Congress’s creation, so Congress should fix them. There is some truth in this. Up until the mid-1990s US corporations got special tax breaks for locating manufacturing facilities on the island. When those rules expired in the 1990s, companies started pulling out, the island’s economy went into a long, slow decline. In June, their debt was downgraded to junk status.
But however the island got to this juncture, they’ve had almost 20 years to adjust to their current economic and financial situation. The US taxpayer is not going to assume Puerto Rico’s obligations. So what can Puerto Rico do? Currently they’re in a vicious cycle: high tax burdens encourages out-migration, which increases the debt-burden on the remaining population, which requires higher taxes. Since Puerto Ricans are US citizens by birth, it’s relatively easy for them to move.
Source: Liberty Street Economics
Last year, the Commonwealth passed its own legal framework to help it reorganize its debts, but a federal Appeals Court held that this was unconstitutional. Congress has the sole authority to set the rules of bankruptcy, and they have reserved for themselves plenary powers over the unincorporated territory.
So for good or ill, Puerto Rico’s debt problem is Congress’s problem. The US has an orderly bankruptcy system that allows individuals and corporations to start fresh. In many ways, this has been a distinctive strength of the US economy—to treat bankruptcy as a financial problem, not a moral failure.
In the end, Puerto Rico has some tremendous assets—a Caribbean location, access to the mainland, modern infrastructure, and strong democratic institutions. There’s no reason it should rank behind Cyprus or Slovenia economically. But they can only grow if their credit is reestablished. A junk-bond rating leads to a junky economy.
Douglas R. Tengdin, CFA
Chief Investment Officer