Thursday, November 23, 2017

[Column] The Cat Is Out of the Bag

By on August 4, 2016

BY RAFAEL M. ARRILLAGA-ROMANY

Puerto Rico is stuck with a model for a federal oversight board whereby public-policy objectives will be pursued through an unelected control mechanism of limited duration, and whose performance will primarily be measured based on short-term benchmarks. Our principal challenge within this context will be whether it is possible to develop a successful and relevant fiscal plan notwithstanding the seemingly unavoidable future changes to the political relationship between Puerto Rico and the United States.

Status is a meaningful credit risk
With debt sustainability front and center, the “cat is out of the bag.” Traditional investors and credit-rating agencies will pay careful attention to this experiment. The decision by Congress not to bail out the commonwealth revealed the “status question” as a meaningful credit risk. It is a clear message to investors that, at least for now, they must account for the risk associated with Puerto Rico’s territorial status.

Puerto Rico must also be cognizant of this message. By enacting a federal bankruptcy regime for the territories, the commonwealth will now arguably have to revisit how much of this risk it is willing to assume, with an assumption of risk manifesting itself by the granting of debt-security packages designed to be “bankruptcy remote.” Conversely, if the commonwealth is to retain flexibility with respect to the short- and midterm economic consequences that may result from the resolution of the status question, then insisting that future payments on a portion of its debt be conditioned on the occurrence of certain contingencies seems suitable.

Rafael Arrillaga-RomanyThe unresolved status question requires that fiscal projections incorporate a higher degree of readily identifiable contingencies that will have to be settled based on assumptions. Until the status question is addressed, traditional investors will be justified in demanding higher premiums for long-term debt, not because Puerto Rico turned to debt restructuring as a short-term solution for its fiscal crisis, but because a successful return to capital markets will depend primarily on the ability to pay. The presence of these assumptions not only makes it more difficult to restructure the commonwealth’s tax-supported debt, but also obstructs Puerto Rico’s ability to achieve the paramount objective of restoring “adequate market access” through debt sustainability.

Some of the most obvious contingencies seem manageable. While some may argue that a debt-restructuring scenario opens up the possibility of negotiating risk allocation between the commonwealth and investors regarding the level of future federal transfer payments, all restructuring proposals to date by the commonwealth have been premised on the continuance of such benefits. At the core of the U.S.’ political foundation is a set of values that preclude, for the foreseeable future, transfer payments protecting and promoting the common welfare of U.S. citizens in Puerto Rico be withdrawn due to a change in political status.

Status-neutral fiscal plan essential
But if the interim period—prior to a change in status—is to be relevant in boosting the prospects for a sustained economic recovery, a status-neutral fiscal plan will be essential. While I have long been highly skeptical of the relevance and efficacy of post-industrialization “economic development plans” in a globalized model, and openly advocate against state involvement in lieu of reliance on the market’s competitive process to best allocate resources, such rejection does not minimize the role of fiscal policy in maximizing the prospect for sustained economic growth.

Well-designed tax and spending policies can positively impact employment, investment and productivity in the long term. Such policies, however, are most powerful when they elicit genuine long-term responses from economic agents. If the policies adopted are perceived as too linked to a particular resolution of the status question, their permanence is exposed and their efficacy diminished. In fact, my biggest fear is that even if we are successful in identifying a mix of fiscal policies that are status-neutral, such an exercise will further underscore how our current political status limits our ability to achieve long-term growth by having an impact on labor supply, investment in physical and human capital, and total factor productivity.

Perhaps even more troubling for some—depending on the allocation of risk between the commonwealth and investors—the adoption of policies associated with a particular status may also predetermine our future political relationship with the U.S.

The “status question” can no longer be ignored. The quicker it is resolved, the better. Will Rogers was right: “Lettin’ the cat outta the bag is a whole lot easier than puttin’ it back in.”

—Rafael M. Arrillaga-Romany is the managing member of RAR Consulting Group LLC. In this role, he has advised Puerto Rico Senate President Eduardo Bhatia Gautier on fiscal policy matters. Before founding RAR, he served as executive director of the Puerto Rico Tourism Development Fund and as special adviser to the Government Development Bank president. Arrillaga-Romany earned a bachelor’s degree in economics & political science from University of Michigan, Ann Arbor, and a J.D. from Fordham University School of Law.

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