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Puerto Rico fiscal board: Gov’t now unable to pay public debt due to pandemic

By on May 27, 2020

Approves revised fiscal plan that postpones austerity measures for a year; urges commonwealth to reform public services

SAN JUAN – The executive director of the federally established Financial Oversight & Management Board (FOMB) for Puerto Rico, Natalie Jaresko, warned on Wednesday that plunging commonwealth revenues as a result of the “severe economic shock” of the crisis caused by the Covid-19 pandemic will leave the government unable to pay current debt and contractual obligations in upcoming fiscal year 2021.

Jaresko acknowledged the commonwealth government’s precarious fiscal situation during her discussion of the revised 2020 fiscal plan during the FOMB’s 18th public meeting, held via teleconference.

During the live-streamed meeting, oversight board members unanimously approved certification of the revised fiscal plan, which proposes to suspend previously planned budget cuts and austerity measures during upcoming fiscal year 2021, which begins July 1.

Puerto Rico Financial Oversight & Management Board (FOMB) Executive Director Natalie Jaresko (Screen capture)

The revised fiscal plan, the fourth such plan certified by the FOMB since it was created in 2016, would suspend planned cuts to central government funding to the University of Puerto Rico and the island’s municipalities during the next year, while maintaining present levels of funding for commonwealth agencies. Still, Jaresko said austerity measures would resume in fiscal 2022.

The plan, which lays out a roadmap to get the commonwealth’s finances in order and exit the Title III bankruptcy process under the federal Puerto Rico Oversight, Management and Economic Stability Act (Promesa), aims to serve as a framework for the commonwealth budget that goes into effect July 1 and is being discussed by the Legislative Assembly.

Jaresko said that the island’s economy would contract sharply this year because of the Covid-19 pandemic, with the real gross domestic product falling by between 4 percent and 7 percent, and then sputter along with little growth for the next five years as federal disaster aid trickles down to the island.

The fiscal plan takes into account that the island will receive $83 billion in federal hurricane disaster aid in the next 15 years and $595 million in federal earthquake aid, as well as an estimated $14 billion in funding to face the coronavirus outbreak, she said.

As a result, she acknowledged that the government is unlikely to have enough cash to resume paying its bondholders anytime soon, even at reduced levels. The oversight board has been in debt restructuring negotiations with creditors of more than $120 billion in commonwealth debt, including pension funds.

The court-mediated proceedings under Title III of Promesa began in May, 2017, but have since been disrupted by a devastating hurricane, several earthquakes in the island’s southwestern region and now the Covid-19 pandemic. The FOMB reached deals last year that were approved in federal court involving creditors holding shares of Puerto Rico Sales Tax Financing Corp. (Cofina by its Spanish acronym) and Government Development Bank debt. On Feb. 28, the board submitted to the court an amended Plan of Adjustment (POA) to settle $35 billion in central government debt. But as the global markets plunged with the Covid-19 pandemic, the FOMB requested that hearings on the matter be postponed.

In her presentation Wednesday, Jaresko said the 2020 fiscal plan projects a 65 percent decrease in central government revenue surpluses in the next 12 years. Such surpluses, from which funds would be earmarked to pay creditors, are now estimated at $8 billion for fiscal years 2020-2032, down from the $23 billion projected in the 2019 fiscal plan, she said.

This will lead to a central government deficit for fiscal year 2032 onward, six years sooner than the previous fiscal plan projected, she said.

Multiple disasters

While Jaresko urged the government to implement suggested structural reforms to improve education, healthcare and security-related services to citizens in the upcoming fiscal year, she acknowledged that the government would be hard-pressed to pay creditors.

“The effect of multiple unprecedented national disasters on top of 15 years of a poor economy has left Puerto Rico with substantially diminished resources and capacity,” she said. “Even with the implementation of the far-reaching growth-inducing structured reforms I have outlined, this 2020 fiscal plan still projects that the government will be unable to afford to pay public debt as originally contracted.”

Given that “the severity of the duration, possibly the recurrence, of this pandemic is unknown, as well as the extent of federal support,” Jaresko said the oversight board decided as “appropriate and necessary” to “pause discussion and prosecution of the [POA].” While calling the POA deal “an important milestone” that proposed a “sustainable debt burden for the commonwealth at the time,” she hinted that it may have to be renegotiated due to the current circumstances.

“The focus now will be on budgeting and getting the commonwealth to the end of the fiscal year on June 30. We will, of course, on the basis of the new fiscal plan, work with the government, the mediators and the creditors to determine the next steps,” she said when asked during the citizen Q&A section of the meeting whether the POA would have to be renegotiated.

However, in his presentation, board member David Skeel stressed it was imperative for the commonwealth government to reach settlements with its creditors and emerge from Title III bankruptcy, otherwise, he said, “Puerto Rico will not truly begin to recover and begin to see the glimmer of economic prosperity.”

Skeel said that most of the island’s creditors have not been paid in four years, and that “at some point it is only fair that they get paid part of what they were owed.” He reminded the government that the oversight board’s mission will not end until it achieves four consecutive years of balanced budgets.

Skeel said that the amended Plan Support Agreement (PSA), which the FOMB submitted in February to the federal court and proposes a global settlement on certain central government debt, “was far from perfect, but has widespread creditor support.”

“I believe the framework for the PSA is still likely to be the best starting point for a confirmable plan of adjustment,” he said. “We need to turn back to it as soon as the current crisis eases.”

Board insists on structural reforms

In fact, Jaresko credited the board’s oversight of the commonwealth’s finances during the past three years with providing Puerto Rico with “an emergency reserve and a financial cushion” to face the impact of the Covid-19 crisis, which she noted was absent in the aftermath of Hurricane Maria in 2017.  She said such a reserve allowed Puerto Rico “to help itself,” in contrast to other U.S. jurisdictions.

Jaresko said that “despite this real progress,” the government has failed to implement key reforms that would allow economic growth and improve its delivery of services. She stressed that the board will press on with “government rightsizing” measures, including government pension cuts, in fiscal 2022.

“There continues to be insufficient political appetite to drive the types of structural reforms that are needed to create sustainable economic growth, and an inability to implement even the reforms that have been nominally agreed upon,” she said, noting that such key reforms involve “improving the private labor market to make it more flexible by repealing restrictive laws and creating labor conditions more like the [U.S.] mainland,” as well as “meaningful tax reform to broaden the base of collection in lower rates.”

In fact, attorney Jaime A. El Koury, general counsel to the board, noted during his presentation that the administration of Gov. Wanda Vázquez had failed to fully comply with the board’s contract-revision policy and its own executive order on the submission of contracts regarding the procurement of services during the Covid-19 emergency, particularly pertaining to the expedited purchase of coronavirus test kits.

“Despite the oversight board’s efforts, the information received so far does not provide a complete picture,” he said, noting that after sending out several notices only one agency, the Office of Management and Budget, had complied with information requests, and that after cross-checking with the Puerto Rico Comptroller’s Office it was found that the government was not submitting all the contracts issued during the period.

The attorney noted that many of the contracts that had been submitted to the board failed to adhere to the requirements of the governor’s executive order (2020-24), particularly the maximum duration limit of 60 days, and a disclosure of campaign contributions by contracting parties.

But in the current 2020 fiscal plan, in contrast to previous plans, the board is proposing “prudent and integrated actions to restore fiscal balance in the short term, while “outlining opportunities for more ambitious reforms that would enable the conditions for a long-term fiscal balance,” Jaresko said.

The revised fiscal plan calls for the immediate implementation of restructuring measures at the Education, Health and Public Safety departments to control spending, increase accounting and improve services.

At the Economic Development and Commerce Department (DDEC by its Spanish initials), the plan calls for the completion of the merger of the Puerto Rico Tourism Co. and the Planning Board under the agency, as well as the renegotiation of contracts and the publishing of quarterly reports on incentives issued.

The fiscal plan suggests that the government set aside $6.6 billion between fiscal years 2020 and 2025 for key investments in the island’s health, education and technology infrastructure. It calls for hiring of nurses in public schools as well as establishing a scholarship fund to encourage medical graduates to deliver services in rural areas. Proposed investments include the expansion of broadband internet into rural areas to improve teaching and increase work and business opportunities for islanders.  

A question of austerity

For his part, Omar Marrero, the executive director of Puerto Rico’s Fiscal Agency and Financial Advisory Authority, said it was unclear when the reforms sought by the board could be implemented because of the ongoing economic uncertainty, adding that a one-year austerity hiatus would be insufficient. Marrero, who is also the government’s representative to the board, raised concerns about pending debt obligations as well.

“The debt repayment solution cannot rest solely on austerity,” he said during his turn at the meeting. “It would offer no hope for Puerto Rico.”

The modified fiscal plan comes less than a week after Rep. Raúl Grijalva (D-Ariz.), chairman of the House Natural Resources Committee, which oversees Puerto Rico matters in Congress, introduced a bill to amend Promesa.

The proposed legislation calls for an audit of Puerto Rico’s debt and declares public health, education, safety and pensions as essential public services, which could protect them from funding cuts. In addition, the measure would guarantee funding for the University of Puerto Rico and allow the local government to shed certain debt. The bill was submitted amid criticism that the board was not protecting Puerto Ricans and has not done enough to improve the island’s situation.

“The crushing fiscal austerity imposed by the original … law has failed to improve economic development or fix chronic poverty in Puerto Rico, so it’s time for a more people-focused approach,” Grijalva said in a statement late last week.

In accordance with the revised fiscal plan, the FOMB will proceed to send “budget targets” to the government “with the expectation” it will send back a revised budget by June 5, Jaresko said, noting that the oversight board will send back a “compliant budget” on June 10 to be “analyzed” by the Puerto Rico Legislative Assembly and again reviewed by the board before June 24. She said the process will ensure that the fiscal 2021 budget will be approved before June 30.

After Wednesday’s meeting, the economist Daniel Santamaría Ots, senior public policy analyst at nonprofit citizens’ advocate Espacios Abiertos (Open Spaces), said in a statement that the board must provide debt relief measures through the implementation of a moratorium beyond 2021 and “update as soon as possible the already unfeasible central government debt adjustment plan proposed last February.”

For Puerto Rico to “move towards sustainable and inclusive economic growth and to access the capital markets, the plan needs to incorporate two areas that are barely present in the plan certified today: A realistic and plausible macroeconomic plan; and [a] new proposal on the central government debt adjustment plan that contributes to a sustainable public debt payment and that incorporates the effects of the current COVID-19 crisis.”

He assured that “Focusing all efforts of the fiscal plan on failed policies—both in Puerto Rico and internationally—such as austerity, and on policies that are difficult for the government to implement, such as structural reforms, only buy time towards eventual financial and economic unsustainability at the cost of the suffering of the most vulnerable populations. All of this—as the plan recognizes and anticipates—will contribute to the acceleration of migratory flows (2.8 million inhabitants in Puerto Rico by 2025), which will lead to an ever-heavier burden for the rest of the inhabitants, and an inevitable fiscal deficit situation from 2032 onwards.”

The economist argued that even if austerity measures are postponed, “they will restart again at the end of fiscal year 2021,” adding that while the “plan criticizes and highlights the inability of the government” to implement the board’s recommendations,” it nonetheless “urges the government itself not to delay” their implementation.

“In its macroeconomic projections, the Board foresees in its base scenario a drop in real Gross National Product of 4% for fiscal year 2020 and a slight rise of 0.5% for 2021. This is a more optimistic scenario than the one projected by the government, of minus-3.8% for 2020 and minus-7.8% for 2021. Despite these divergences in short-term projections, their estimates are closer to the year in which Puerto Rico will present primary fiscal deficits once the reforms approved today are implemented: the Board projects deficits from 2032 onwards and the government from 2030. Both conclusions reinforce the unsustainability of the debt’s payment and the consequent infeasibility of the central government debt adjustment plan presented in February this year.

“The economic effects of the pandemic are difficult to predict given the changing scenarios of its evolution. [T]he government projected a deficit of $708 million for 2021 and the Board a surplus of $440 million in their respective base scenarios. We do not know who will end up projecting better, but we are certain that we must meet a COFINA payment of $454.5 million. If the worst-case scenario is confirmed, wouldn’t it be reasonable to be prepared to deal with the most important economic and health crisis since the 1930 depression? Who will end up paying for the broken dishes if the optimistic projections of the Board do not materialize?” Santamaría Ots questioned.

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