Puerto Rico debt plan must be equal parts inspiring, realistic

President Trump quipped — or complained? — that the devastation in Puerto Rico had blown a hole in the United States’ budget. The real fiscal hole, though, is likely to be in Puerto Rico’s own budget.

To have a fighting chance to recover and avoid a new downward spiral, Puerto Rico will need more than short-term disaster aid and protection from its creditors while it restructures its debt. It will need emergency budget funding to cover a pending cash shortfall, generous long-term help as it rebuilds and equal access to federal Medicaid funding.

{mosads}In the short run and likely in the medium run, Puerto Rico cannot make any payment on its debt. In the long run, its debts will need to be significantly reduced. Fortunately, thanks to bipartisan legislation — The Puerto Rico Oversight, Management and Economic Stability Act (PROMESA) — passed in 2016, all Puerto Rican public entities now have access to bankruptcy protection.

With the approval of the PROMESA oversight board, Puerto Rico can zero out all near-term debt service while remaining under court protection.

Rebuilding should take priority over repayment of legacy debt. Market pricing already implies that the long-term recovery on more junior Puerto Rican bonds will be close to zero. But cutting Puerto Rico’s debt service to zero in the short run — and reducing payments on senior bonds substantially in the long-run — will not be enough to break Puerto Rico’s downward economic spiral.

Federal Emergency Management Agency (FEMA) disaster aid is the most obvious source of short-term assistance. But FEMA is designed to reimburse Puerto Rico for the money Puerto Rico spends on disaster response.

The lag in payment, even if the federal government picks up 100 percent of the tab, poses a problem for a government as cash-strapped as Puerto Rico. Puerto Rico effectively needs more, not less, operating cash. The courts should do what they can to free up various funds now held in escrow.

FEMA funding, though, won’t address the collapse in Puerto Rico’s tax base. Puerto Rico’s government, counting all tax-supported public entities, now collects about $1 billion in revenue a month.

That sum will fall substantially in the coming months:

• Sales taxes aren’t being collected;
• the tax on imported crude (sensibly) has been waived;
• income tax collections will fall and
• the interruption in pharmaceutical production will lower the revenue from the “turnover” tax Puerto Rico collects on multinational firms operating in Puerto Rico.

In addition, watch for fiscal skeletons to come out of the closet at inopportune times. For example, I worry that the cost of rescuing small deposits in Puerto Rico’s local credit unions (cooperativas) will exceed current projections; letting these locally-insured credit unions transition into federally-insured credit unions will require first cleaning up their balance sheets.

Congress will need to step in and provide Puerto Rico with funds to cover this year’s revenue shortfall. Forcing Puerto Rico to cut its spending as tax revenue falls will only drive Puerto Rico’s already damaged economy deeper into the ditch.

Filling Puerto Rico’s short-term budget hole though is complicated by fact that Puerto Rico is likely to see a long-term fall in its tax revenues. Two percent of the Puerto Rican population was leaving every year before Hurricane Maria. Many more will leave now rather than wait a year for the resumption of electricity and economic life, and few will return.  

The pharmaceutical sector may slowly move to locations that offer the same tax advantages but a smaller risk of hurricanes. Future tax revenues are likely to be substantially lower than the oversight board projected.

This implies that Puerto Rico either needs a grant or a long-term loan — it won’t just be a short-term bridge loan — at a concessional interest rate that avoids adding to the burden on an already overburdened budget. Such a loan needs congressional authorization, and, so long as it is outstanding, Puerto Rico shouldn’t be making payments on any of its legacy bonds.

Federal budget support should be provided in a form that strengthens Puerto Rico’s long-term budget planning. Thus, it should only cover recognized funding gaps in a fiscal plan approved by the oversight board.

The immediate need for emergency funds, though, should not crowd out long-term help. Puerto Rico needs access to generous federal funding to harden its core infrastructure — a future hit from a category 4 or 5 hurricane hardly can be ruled out.

Puerto Rico needs access to more community development block grants to fund projects that go beyond those typically funded by FEMA. The existing inequities in Puerto Rico’s fiscal treatment, notably, the cap on Medicaid funding, need to be removed.

If Puerto Rico continues to get less federal funding to cover its population’s medical expenses than it would receive if it were a state, Puerto Rico’s population will have no choice but to move to the 50 states.

Puerto Rico’s economy was in decline before Maria: Output is 15-percent below where it was a decade ago. Its fiscal and financial rescue needs to be built around hard-headed analysis of where its economy is likely to go.

Ten years out, the odds are that Puerto Rico’s economy and population will be substantially smaller, with a smaller revenue base and less capacity to repay legacy debts.

But it is equally important to provide hope that Puerto Rico can eventually emerge from its current crisis — and to guarantee that Puerto Ricans, especially low-income Puerto Ricans, can access the same federal benefits inside Puerto Rico as they can outside of Puerto Rico.

Brad W. Setser is a senior fellow at the Council on Foreign Relations. He served as the deputy assistant secretary for international economic analysis in the U.S. Treasury from 2011 to 2015, where he worked on Europe’s financial crisis, currency policy, financial sanctions, commodity shocks and Puerto Rico’s debt crisis.