Daily Management Review

Will Puerto Rico's bankruptcy result in exit from the United States?


05/10/2017


The Government of Puerto Rico announced in 2015 that the island was unable to service its debts. On May 3, 2017, it launched the bankruptcy procedure, the largest in the history of America. The total national debt is almost $ 74 billion, or 100% of GNP.



pixabay
pixabay
The prolonged fiscal crisis adversely affects both the economy of Puerto Rico and the island’s political life.

The bankruptcy became possible due to the federal law adopted in 2016. Prior to this, the island’s legal status as an "unincorporated organized territory" did not allow to avoid paying debts. If Puerto Rico were an independent state, then its utilities could have declared bankruptcy.

The new law requires creation of a "financial oversight committee", formed by Washington, which main goal is to reach an agreement with bondholders. At that, it also allows for bankruptcy proceedings in the event of a failure of negotiations.

A two-thirds majority would force all bondholders to accept a decline in the debt’s value, but the agreement always seemed unlikely.

Under the Puerto Rican constitution, payments to holders of so-called "common obligations" bonds have an advantage over all other items of expenditure.

However, another group of creditors has preferential rights to income from sales tax. It seems that this ambiguous situation requires a trial.

Both groups of lenders have recently rejected a proposal of 50 cents for every dollar, British magazine The Economist said.

Meanwhile, Puerto Rico continues to experience serious problems. The government’s latest fiscal plan, approved by the supervisory committee in March, includes mandatory balancing of the budget in the next three years. Achieving this goal will require a reduction of about 10% of GNP by 2020.

The latest agreement on the federal budget gives a little extra time and allows getting money for the Medicaid program, which provides health insurance for low-income citizens. This social stratum makes up about half of Puerto Rico’s three million-population.

This money, however, could not prevent a mass demonstration on May 1 against severe austerity measures.

Due to the fact that Puerto Ricans are citizens of the United States, island taxpayers can avoid austerity by moving to mainland America, which means fewer people will have to pay the national debt.

The population of Puerto Rico has already declined by 8% compared with 2010, and the economy has practically not come out of the recession since 2006.

It's no wonder that all this is stirring up the territory’s political life. Governor Ricardo Rossello promises to hold a referendum on the island’s status in June. According to the March poll of public opinion, 57% support this initiative, but the plebiscite’s opponents want to boycott the vote.

However, whatever the outcome of the referendum will be, it is unlikely to be approved by the US Congress. Traditionally, it is believed that it is beneficial for Puerto Rico to maintain its current status, as it allows the island to take advantage from two worlds: Puerto Ricans use the dollar, have American passports and can pursue a relatively independent policy from Washington. However, the last argument is no longer true after the creation of the financial supervisory committee. 

source: economist.com






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