Panel Highlights Options to Pull Puerto Rico Out of Fiscal/Economic Hole
SAN JUAN—A group of panelists debated Thursday the merits of the alternatives available to Puerto Rico to alleviate its financial woes, at a time when it must tackle fiscal and debt restructuring and economic development simultaneously.
Jorge L. San Miguel, a lawyer at Ferraiuoli LLC, who represented AMBAC, a monoline insurance company that insures $2.2 billion in municipal bonds and recently sued the government over the clawbacking of payments, criticized some of the myths that the government appears to perpetuate during the crisis.
For instance, he said that not all of the debt could be restructured through Chapter 9, which means the bankruptcy process will not guarantee an orderly discussion of the debt. He also disputed government claims that the $72 billion debt is unpayable, noting that the Treasury Department reports more revenues each year and the government has said it has cut expenses.
San Miguel spoke at a debate dubbed “Debate: Default vs Restructuring vs. Other Alternatives,” organized by the Latin America Entrepreneurship Council (Consejo Empresarial de América Latina or CEAL) at a hotel in Condado.
Regarding the government’s assertion that the debt service as a percentage of revenues is unsustainable, he said, “True, when you use 92% of the debt and only 34% of revenues to calculate, using the government’s own data. When using complete data, the ratio is 16%, in line with other jurisdictions, and sustainable.”
San Miguel also challenged the government’s use of the Krueger Report to back its claims of unsustainability because of remarks in the report’s disclaimer that state the report is “for discussion purposes only”, “prepared at request of counsel”, and that it is based on public information that has not been reviewed or consulted with auditors.
“Unfortunately, recent events of default and moratoriums distract from the real and viable solution,” he said.
San Miguel said the island could take a number of initiatives that do not require restructuring or help from the U.S. Congress. These include improving tax collections, implementing an efficient permitting process, reactivating private public partnerships, implementing government procurement reform by centralizing purchases—which the government has already done—and completing the revitalization of the Puerto Rico Electric Power Authority (Prepa).
José Sosa Lloréns, a lawyer who spoke on behalf of the credit unions or “cooperativas,” noted that the interest of the Government Development Bank (GDB) in achieving debt reduction is evident. However, to the extent that said reduction impairs the capital of the Puerto Rican investors, the social benefit of reducing government debt will be offset by the damage to the economy.
“The decapitalization that our economy would suffer due to the principal haircuts will impair our prospects for economic recovery, which is an essential pre-condition for a definitive solution to Puerto Rico’s fiscal crisis,” he said. “It is for this reason that the principal ‘haircuts’ that the government proposals contemplate—which deliver their greatest damage upon Puerto Rico’s investors—end up laying the foundation for the trauma of a future default.”
“This risk of future financial failure is especially dangerous when we consider that debt restructuring is just but one piece of a decisive solution, which requires: adopting economic development policies that lead to growth (thus increasing government revenues), and reforming governmental structure and operations to ensure sustainable levels of spending and increase public productivity and effectiveness,” he added.
Sosa LLoréns, on the other hand, criticized the preliminary terms of a possible agreement to restructure the GDB’s debt. The terms, which a group of hedge funds agreed upon, contemplate a bond exchange with a principal “haircut” of 47%. The GDB’s press release points out that the proposal contemplates the issuance of other “par value” instruments, the specific terms of which have not been defined, he said.
“The GDB’s disclosure acknowledges that the bank’s restructuring will require the consent of the entirety of the bank’s bondholders, including the state chartered credit unions. Additionally, it recognizes that the hedge funds Ad-Hoc group represents only 25% of the GDB’s debt,” he said.
“The terms disclosed by the GDB aiming to make principal ‘haircuts’ correspond to the proposals and financial expectations of hedge funds, for whom said haircuts do not imply capital losses on account of them having acquired their bonds at a discount price in the secondary market. This is in contrast with the situation that traditional investors confront. To traditional investors, who typically bought their bonds at par in their original issuance, principal haircuts represent material losses, both of capital and of current income. This is the same situation that state chartered credit unions share with the rest of the Puerto Rican bondholders and traditional investors in the United States,” he said.
“The G25’s position on this matter has been clear: (a) the restructuring of the bonds held by state chartered credit unions and the other Puerto Rican investors cannot be subordinated nor be conditioned to the hedge funds’ negotiation perspective; and (b) debt reduction cannot be achieved blindly, without acknowledging the full financial realities of each group of bondholders, especially those comprising a majority,” he said.
Claudio Loser, director of Centennial Group and chief executive officer for Centennial Group Latin America, said the current government strategy, as set up, envisages a comprehensive set of budget and structural reforms that would be supported by federal policy changes and by concessions made by public sector creditors.
He said studies have shown that, contrary to conventional wisdom, fiscal adjustment and reforms in other countries have helped reverse an economic decline by reestablishing confidence in the future and access to financing at lower costs, both of which are critical in promoting domestic investment. “For instance, the Independent Evaluation Office of the International Monetary Fund conducted a review of 133 programs in high- and middle-income countries, with an average targeted fiscal adjustment of about 2% of gross domestic product over two years. It found that economic growth in the first program year improved over the previous year, and that it improved further in the second year,” he said.
The Puerto Rico Fiscal and Economic Growth Plan, he said, does not stabilize the commonwealth’s finances, given that the central government overall deficit and corresponding financing need will still be sizable in fiscal 2020 and beyond. The plan does not fundamentally address the financial problems of the public pension funds and, given that it requires passage of constitutional amendments and various legislative changes, its implementation as envisaged could be uncertain for an extended period. The creation of the proposed control board would require the island to relinquish oversight over the budget and taxation, he noted.
Local officials are seeking a broad-based restructuring/default of government debt to cover an estimated financing gap of $14 billion. Puerto Rico’s public debt is not monolithic, as there are 18 major issuers of debt, and it is recognized that the entities that have issued debt have different circumstances than those of the government and, therefore, a restructuring of their debts may need to be considered.
He said the markets view such a default and unilateral restructuring as a sign of Puerto Rico’s unwillingness to pay, rather than a compelling need.
The objective of Puerto Rico’s economic policy framework should be the restoration of the conditions for sustainable economic growth through orderly fiscal adjustment combined with growth- and competitiveness-enhancing structural reforms, Loser said. The plan, he added, is a strong basis toward achieving this objective, but it needs to be strengthened under a reinforced plan.
The adjustment and reform effort in Fiscal Year 2016-17 should focus on achieving a central government deficit of half a percent of gross national product (GNP) in fiscal 2017, and a small surplus in fiscal 2018. This would help prevent a liquidity/credit crunch and a possible systemic crisis; restructuring the large public enterprises in ways that ensure continuing and more efficient service delivery at a lower cost; and putting in place public-private partnerships to play a key role in such restructuring and boost infrastructure spending without unduly burdening government finances.
In fiscal years 2018-20, efforts should focus on finalizing negotiations for adequate federal government support of health care programs and expenditure restraint to help maintain an overall balance in the central government finances, while channeling more government resources to high priority investment projects and social spending, as well as deepening pro-growth structural reforms.
In this context, he said, the key modifications of the plan would include a medium-term debt sustainability analysis for the proposal that suggests that government debt would come down from the equivalent of 68% of GNP in fiscal 2016 to 61% in 2020, and to 51% in 2025.