On February 12, Governor Ricardo Roselló presented the third iteration of his Fiscal Plan for Puerto Rico. In general terms, this version of the Plan has three main components: (1) a revision of the base economic scenario taking into consideration the appropriation of federal funds for the reconstruction of the infrastructure destroyed by Hurricane Maria; (2) an austerity plan; and (3) a structural reform program.
The Plan’s basic assumption is that Puerto Rico will receive at least $49.1 billion in federal disaster aid and another $21 billion to be paid out by private insurance companies, for a total of $70.1 billion, a sum equivalent to the Gross National Product of Puerto Rico in 2017. This influx of funds is the basis for the governor’s radical revision of the base economic scenario. The Plan projects a contraction of 11% in the current fiscal year due to the impact of Maria, and then real growth of 8.4%, 3.5%, 2.3%, 1.8%, and 2.1% during fiscal years 2019 to 2023, respectively.
The growth forecast for 2019 has generated a great deal of discussion, but in our opinion that growth rate is feasible if the projected influx of funds actually occurs. In fact, even if we assume that the Plan’s projections are on point, at the end of fiscal year 2019 the island’s real GNP will still be below the pre-Maria level. Let me explain. If we assume that Puerto Rico’s GNP as of September 19, 2017, was equal to 100, and the economy contracts 11% in FY2018 and then grows 8.4% during the next fiscal year, simple arithmetic tells us that at the end of FY2019 we will still be below the pre-Maria level.
Beyond 2019, however, it is hard to defend the modification of the base scenario in its entirety, since it is inconsistent with other elements of the Plan. The combination of the effects of federal aid with a modest fiscal consolidation at the beginning of the projection period has consequences that are not consistent with the consequences of the second phase, after the first few years, when the federal aid dries up and the economic contraction is greater.
It appears that the architects of the Plan are assuming that the reconstruction of the capital stock destroyed by Maria will generate a permanent increase in both the level and rate of growth of the GNP. But there is no reason to assume that we will grow faster simply because we attain the same level of infrastructure that existed the day before Maria. In fact, before the hurricane the growth rate of the real GNP was negative. Yet the government is forecasting that the impact of federal spending will be of such magnitude that it will permanently accelerate the growth rate of the real GNP well above the prevailing trend pre-2019.
In terms of revenues, the Plan assumes that beginning in FY2019, government revenues will increase at the same rate as the growth of the nominal GNP, despite the fact that during the projection period the Plan assumes the following: (1) a tax reform that will reduce income tax revenues, eliminate the business-to-business tax, and reduce the tax rate on prepared foods; (2) a reduction of 42% in revenues generated by the Law 154 excise tax; and (3) a reduction of 20% in the population over the six years covered by the Plan. Yet government revenues are projected to rise significantly during the projection period. In our opinion, this forecast is the product of inexplicable wishful thinking.
The second component of the Plan consists of a fiscal consolidation, including, among other measures, cuts in government spending in the areas of education and health, as well as reductions in appropriations to the UPR and municipalities that will begin in 2018 but will intensify beginning in FY2020, just when the economic stimulus resulting from the reconstruction begins to taper off.
The administration estimates these measures will generate net annual savings of $2.462 billion in fiscal year 2023. According to an analysis carried out by Brad W. Setser, of the Council on Foreign Relations, that number is equivalent to a little more than 3% of the GNP projected for that year—without taking into account the negative multiplier effect resulting from a reduction in public spending, which the Financial Control Board estimates to be 1.3. Therefore, the contraction in the GNP could be a little over 4%. Yet at no time during the fiscal consolidation period does the rate of growth in the GNP turn negative, even during the years when the federal stimulus declines and austerity measures intensify.
The government, then, tries to square the circle by assuming a positive, swift, and significant economic stimulus generated by a series of structural reforms—tax reform, energy reform, regulatory reform, and so on—that are slated to begin in 2018 and will stimulate growth to such an extent that they will completely offset the negative effects from the end of the federal stimulus and the implementation of austerity measures.
This scenario is hard to justify, as the Plan identifies no local, endogenous source of growth and appears not to take into account a series of downside risks to the projection. Among these risks, we might note that (1) federal appropriations may be lower than estimated; (2) revenues may rise at a lower rate than projected or even decline after 2020, so that the government will be forced to implement additional fiscal-consolidation measures; (3) the impact of emigration on economic activity could be more severe than anticipated; (4) the multiplier effect (negative) of the austerity measures may be underestimated; and (5) the positive effect of the structural reforms may be overestimated.
At the end of the day, however, the greatest risk is that the calculation of the amount of the needed debt relief may be based on a foolishlyoptimistic Fiscal Plan, resulting in a debt adjustment that is less than what Puerto Rico really needs to make its debt service sustainable. In fact, in over fifty percent of all sovereign-debt adjustment cases since 1970, the debtor has defaulted again within five years of the restructuring—due, in many cases, to over-optimistic economic projections. That would be the worst-case scenario for Puerto Rico. Just ask Greece.
The original Spanish version was published in El Nuevo Día on March 11, 2018.