Puerto Rico bonds have been the best-performing fixed income investment thus far in 2018. Following the devastation of last year’s Hurricanes Maria and Irma, and the expected migration to the mainland of more than 10 percent of the island’s population, how can this be?
The answer lies in the tens of billions of emergency-reconstruction dollars appropriated by Congress, including $18 billion in housing grants alone, and in the dangerously optimistic forecasts of Puerto Rico’s own government.
Prior to the hurricanes, the government’s fiscal plan, certified by the Financial Oversight and Management Board for Puerto Rico established by Congress in 2016, assumed Puerto Rico could make debt service payments equal to 25 cents on the dollar.
Now, notwithstanding the virtual destruction of its electrical grid, serious damage to other productive infrastructure, the shuttering of many of its businesses and the exodus of many workers and taxpayers, the government is happily forecasting that it could make payments up to 40 cents on the dollar.
It’s doing so by unrealistically assuming that increased health-care and reconstruction funds being appropriated by Congress will spur the kind of economic growth not seen on the island in more than a decade, even as it proposes steep cuts to government services and agencies that employ about one-quarter of its formal workforce.
In making its latest economic forecast, the Puerto Rican government seems to be turning a blind eye not just to the island’s devastation but also to its dismal economic track record over the past decade, when its economy declined by 15 percent.
A year ago, Puerto Rico’s certified forecast that a prolonged period of budget austerity would cause the island’s economy to decline by more than 10 percent. Now it is predicting an output level by 2023 that is 10 percent higher than in the previous plan.
The island’s infrastructure can be rebuilt with large-scale funding from Washington, but at best its productive capacity would only be restored to its pre-hurricane level. The influx of federal reconstruction dollars certainly could temporarily raise the rate of growth and pull up the level of output. Yet once recovery spending wanes, that effect should largely go into reverse — leaving in place long-standing problems like high unemployment and the highest poverty rate in the United States.
Importantly, structural reforms such as changes to “ease of doing business” and labor laws cannot by any reasonable economic analysis be powerful enough in themselves to offset the loss of federal Medicaid funding, the potential drag from recent changes to the corporate income tax code and the eventual withdrawal of disaster aid.
Yet both the government and oversight board rely on a range of controversial structural reforms to produce decades of sustained growth — a perilous projection.
Yet another factor that would make Puerto Rico’s rosy economic scenario appear highly implausible is population flight to the mainland. The government itself is estimating that as a result of the hurricane, the island will lose more than 10 percent of its people over the next few years.
The loss of that large a part of its economically active population is likely to result in a permanent downward shift in the island’s productive capacity.
It’s our view that the public-sector debt, which consumes roughly 30 percent of the island’s tax revenues annually, must be written down to the maximum extent allowable under the law. This should be done in the interest of getting the island back onto its feet and of avoiding a second debt restructuring.
This week, the oversight board appointed by Congress meets to review the new fiscal plan. For the sake of the island and all US taxpayers, let us hope that its approach to the island’s daunting economic challenges is more prudent than that of the Puerto Rican government.
Desmond Lachman is a resident fellow at the American Enterprise Institute. Brad W. Setser is the Steven A. Tananbaum senior fellow for international economics at the Council on Foreign Relations. Antonio Weiss, served as counselor to the secretary of the Treasury until January 2017.
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