Puerto Rico Likely To Default Despite Initiatives to Reduce Deficit

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Puerto Rico, the unincorporated territory of the United States, is likely to default despite the initiatives of its governor, Alejandro Garcia Padilla in reducing deficits and raising taxes. Early this month, the governor stated that the territory’s fiscal year 2014 deficit is expected to be reduced by 62% compared to the previous year.

The majority of municipal credit analysts consider Padilla’s achievement in reducing Puerto Rico’s debt as remarkable, but they believe that the territory is still facing challenges due to weak economy and high unemployment rate.

Today, the Financial Times reported that creditors to Puerto Rico are engaged in debt moratorium talks with lawyers and restructuring specialists in New York. Debt restructuring specialists have perceived an increasing possibility of payment suspensions on the territory’s $70 billion public sector debt and another $40 billion of unfunded pension liabilities.

Puerto Rico’s numbers unsustainable

“The numbers are untenable. To issue new debt the yield would have to rise and where they can’t raise new money and they will have to stop paying,” according to one of the restructuring advisers.

According to the Financial Times, any decision such as suspending payments would represent further legal difficulties given Puerto Rico’s uncertain situation, and noted that filing for Chapter 9 bankruptcy protection, similar to the action of Detroit in July, is impossible. The report also noted that the debt service problem is approximately $3.4 billion to $3.8 billion over the next four year, which is expected to increase because of uncertainties regarding Puerto Rico’s ability to service the debt.

The effect of a debt moratorium may swell through the $4 trillion municipal bond market if Puerto Rico is compelled to take such a step. It is also impossible for Puerto Rico to raise taxes further because its debt capital is more than $14,000, while its income per capita is nearly $17,000— a ratio of 83%.  The unemployment rate in the territory is 14%, twice the national average.  The local government rejects considering any radical steps such as legal process.

Congress could create insolvency regime

According to lawyers, the U.S. Congress could intervene and establish an insolvency administration for Puerto Rico because it has comprehensive authority over it. However, such move could also create arguments between the Democrats and Republicans. The Democrats might argue that the pension claims should be prioritized while the Republicans could push the payment to bond holders first due to the constitutional sanctity of contracts

Data from Morningstar showed that $14 billion of the $70 billion debt of Puerto Rico were held by funds. Puerto Rico debt earned 2.3% this year, higher than the 27 U.S. states monitored by the Standard & Poor’s.

According to Bloomberg, Puerto Rico intends to sell a tranche long-term securities this month or in February. Officials said increasing interest rates prevented the issuance of almost $1.2 billion of sales-tax debt.

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