On 3 May, Puerto Rico pulled the trigger on a bankruptcy-like filing after years of economic hardship. The island is not a US local government or public corporation so it does not have access to typical bankruptcy protection (Chapter 9). However, since last year Puerto Rico has access to rescue legislation PROMESA, a federal law for insolvent territorial governments. Under the quasi-bankruptcy procedure, the government is expected to restructure USD 73 billion in debt and USD 50 billion in unfunded pension liabilities, making it the largest municipal bankruptcy in US history. 

Impact on country risk

The quasi-bankruptcy procedure does not come as a surprise. Storm clouds have been gathering over Puerto Rico since 2006, when federal tax breaks that were crucial to the island’s competitiveness as a manufacturing hub were completely phased out. Indeed, attracted by unrestricted access to the mainland market and fiscal advantages, US firms invested heavily in Puerto Rico as of the 1950s. As a result, Puerto Rico became a manufacturing outpost of the US, with goods exports the equivalent of more than 70% of GDP. But fading tax breaks along with a host of other negative fundamentals (high minimum wages and utility costs, for example) undermined Puerto Rican competitiveness, leading to economic decline in the past decade. By undermining tax collection and fostering expansionary spending, the recession has, in turn, seen increasing public debt reach an unsustainable level. The use of the rescue legislation PROMESA could lead to years of litigation with bondholders and pensioners.
As a result, economic activity is likely to remain depressed (negative economic growth of -3% is expected in 2017). The high level of unemployment is expected to increase in the coming years, accelerating a further exodus to the US (the population has fallen more than 8% over the past six years). Furthermore, harsh austerity measures will be necessary to find a path out of the public debt crisis, further weakening the economy. In addition, the liquidity shortage of the Puerto Rican government may also affect its timely payments to goods and service providers in the private sector. In particular, given the likelihood of lengthy negotiations, the ability of the Puerto Rican state to access future debt funding will most likely be severely reduced, further impacting its liquidity.
Credendo keeps its risk categories unchanged for now. Short-term political risk classification in category 2 remains relevant for private debtors. Their access to hard currency is safeguarded by the full dollarisation of the Puerto Rican economy, and the imposition of capital controls that would affect their international payments remains highly unlikely.

Analyst: Jolyn Debuysscher, j.debuysscher@credendo.com