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Fiscal board advised to condition payment of Puerto Rico debt to island’s economic recovery

By on January 16, 2018

SAN JUAN – An associate researcher at Columbia University Business School said that in drafting a new fiscal plan for Puerto Rico, the Financial Oversight & Management Board would need to reduce most of the debt and condition any future debt payments to the island’s economic recovery.

Martín Guzmán, who is also an economics professor at University of Buenos Aires, made his remarks while presenting a debt-sustainability study to reporters at a conference organized by Espacios Abiertos and the Center for a New Economy.

The economist acknowledged that while his study does not account for the economic impact of Hurricane Maria’s destruction, his preliminary calculations indicate that after the historic storm, the entire public debt will have to be written off to put the island on a sustainable path. “The only way to pay the creditors, even a small amount in the distant future, would be contingent on an economic recovery,” Guzmán said Tuesday.

An analysis completed before the hurricane found that no matter how creditor losses are distributed, depending on the fiscal policies that are implemented, out of the island’s current debt of $51.9 billion, $36.3 billion to $46.7 billion would have to be forgiven. If the relevant debt were $72.2 billion, the needed reduction increases to $50.5 billion to $65 billion.

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The economist was slated to present the 65-page Debt Sustainability Analysis in a forum at the University of Puerto Rico School of Law. He began the study over a year ago with Pablo Gluzmann, an economics professor at Universidad de la Plata (Buenos Aires) and researcher at the Center for Distributive, Labor & Social Studies (Cedlas by its Spanish acronym) and Argentina’s National Scientific & Technical Research Council (Conicet by its Spanish acronym), as well as Joseph Stiglitz, recipient of the Nobel Prize for Economics.

The analysis, which was commissioned by Espacios Abiertos, was sent to the fiscal board and is slated to be submitted as a friend of the court brief to the U.S. District Court of Puerto Rico, which is overseeing the island’s bankruptcy-like proceedings.

First and foremost, Guzmán said Puerto Rico’s current debt position is “by all means” unsustainable. Assuming the fiscal plan will be respected, and absent a debt restructuring, Puerto Rico would be forced to sustain primary fiscal surpluses of 3.5% to 7.4% of the gross national product from 2027 onward. “But pursuing such a fiscal surplus would lead to a contraction that would make the collection of the necessary tax revenues to achieve it simply untenable, making the fiscal surplus unfeasible,” he said.

The analysis of the fiscal plan detected flaws in its design. For instance, Guzmán said, the plan falls short on presenting a debt restructuring and sustainability analysis. Specifically instead, it simply specifies the amount that must be repaid to creditors during the next decade, without being explicit about the longer-term obligations the island would face as well as their sustainability.

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He said the values of fiscal multipliers used for gross national product (GNP) projections are unjustifiably optimistic. The GNP projects the impact the fall in economic activity would have on fiscal revenues, leading to an underestimation of the contraction in the proposed fiscal policies.

Any spending-reducing reform will more likely deepen the recession in the short term. The plan is silent about how a deeper depression would likely intensify migration, he said.

The plan also assumes the territory will begin to experience a recovery in 2022 entirely because of structural reforms. “This assumption goes against sound macroeconomic theory, because Puerto Rico’s economy is a demand-constrained regime,” the study says.

The study found that:

If the assumptions in the fiscal plan were maintained, Puerto Rico would have to cancel interest payments that are not scheduled to be repaid in the Fiscal Plan, plus reduce 45 percent to 65 percent of the current debt stock of $51.9 billion included in the Fiscal Plan.

However, the relevant universe of the public sector’s debt obligations may go beyond the debts included in the fiscal plan, which increases the relevant stock to $72.2 billion. In that case, the necessary reduction includes cancelling all unpaid interest plus a reduction of 60 percent to 73 percent of the public debt, or up to a $65 billion cut.

“Under a more comprehensive range of assumptions for fiscal multipliers that include both the assumption of the Fiscal Plan and other more realistic scenarios, and dismissing the unjustifiably optimistic effects of the structural reforms on GNP growth for the period 2017-2026, we conclude that if the fiscal plan is implemented, the territory would need full cancellation of interest payments not included in the Fiscal Plan plus a face-value reduction that lies between roughly 50 percent and 80 percent to restore debt sustainability – and again, the necessary reduction is larger if we take $72.2 billion instead of the just $51.9 billion included in the Fiscal Plan as the relevant universe of debt obligations,” he said.

The restructuring proposal must take into account that decisions will be made under uncertainty. To deal with this underlying uncertainty, the restructuring process could be improved by the inclusion of GNP-linked bonds that align debt payments with Puerto Rico’s capacity to pay, he said.

Finally, he stressed that the debt restructuring will not be a sufficient but a necessary condition for economic recovery.


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