Policy Brief: Possible Consequences of a Default on Puerto Rico General Obligation Bonds
Published on May 17, 2016
Introduction
Puerto Rico faces a serious fiscal and economic crisis. The island is over-indebted: with $70 billion in public debt outstanding and an additional $43 billion in unfunded pension liabilities, Puerto Rico has more debt, in absolute terms, than any U.S. state government except California and New York, while its economy is smaller than Kansas. The following chart compares Puerto Rico’s tax–supported debt (excluding debt issued by state-owned enterprises) and unfunded pension burden with three of the U.S. mainland’s lowest rated states.
Furthermore, since 2006, Puerto Rico’s economy has shrunk by 14% in real terms, its population has declined by 9% and total employment has decreased by approximately 19%. A recent analysis by Barclays concludes that under its base and weak growth scenarios Puerto Rico’s “debt-to-GNP ratio climbs steadily over the forecast horizon, reaching 151% and 166% of GNP in 2025. Both outcomes result in a doubling of the debt ratio over a ten-year horizon, as a combination of weak growth and persistent primary deficits pushes the debt ratio higher.”1 These debt ratios would be comparable to those of Greece.
In simple terms, Puerto Rico owes a significant amount of debt and its economy has been stagnant or contracting since 2006. Therefore, it does not have the ability or financial resources to pay all its obligations as they become due and, under the most realistic scenarios, Puerto Rico is not expected to be able to do so in the near future.
In this policy brief we will (1) provide a succinct summary of the current situation in Puerto Rico and (2) describe some of the possible consequences of a Puerto Rico default on its General Obligation bonds (“GO”) and other government guaranteed debt. Our analysis is based on the following assumptions:
• The government of Puerto Rico decides to prioritize the provision of essential government services over debt payments.
• The Governor utilizes the powers granted to him by the Puerto Rico Emergency Moratorium and Financial Rehabilitation Act (“Act 21 of 2016”).
• The validity of Act 21 is challenged on constitutional grounds, either in Puerto Rico or Federal Courts, and the Court enjoins enforcement of the Act while the case is heard on its merits.
• Congress does not enact any legislation before July 1 granting Puerto Rico the authority to restructure its debt.
• The government of Puerto Rico does not reach a forbearance agreement with its creditors.
• Puerto Rico does not obtain short-term financing to rollover any of the of the July 1st maturities.
1 Barclays, Cross-Asset Research, Puerto Rico’s Debt Sustainability Analysis, 12 May 2016.