Yesterday, the Government Development Bank made public a letter to Governor Alejandro García Padilla, Sen. Eduardo Bhatia and House Speaker Jaime Perelló. To some, the letter is simply a way to put pressure on the Legislature for the swift approval of a VAT and a new version of the “wolf is coming” tale. The letter, however, highlights a lot more than the Government’s economic situation.

In its second paragraph, the letter asserts that the financial situation of the Commonwealth is “extremely precarious.” It continues saying that a “government closing in the next three months is very probable due to lack of liquidity to operate.” The way it reads in Spanish, it is NOT saying that in three months there will be a government closing but rather during this three-month period. Although this may simply be a tactic to pressure the Legislature, nevertheless it is a serious admission. Governor García Padilla tooted his horn when the present budget was approved that this was the first balanced budget in many, many years, although many analysts, including yours truly, mentioned that it was not since part of the debt service was from capitalized funds of the March 2014 bond issue. Reality, however, is even grimmer. The Government overestimated the funds it would recover due to over 85 new taxes and has a deficit of between $200 and $500 million for this fiscal year. Since the Government Development Bank lacks funds, a loan from this agency is out.

Another important admission by the Government Development Bank is that the $2.95 billion bond issue is highly improbable as confirmed by banks and potential buyers, allegedly due to the “growing uncertainty about the Government’s fiscal initiatives, especially the tax reform and the 2016 budget.” At this time, the 2016 proposed budget has not been presented to the Legislature since there is no final decision on the VAT.

The letter insists that there is an immediate need to establish expense reduction measures. This, although Law 66 was supposed to reduce expenses in 10%. The letter adds three indispensable measures; “(1) development and approval of by the Executive and the Legislature of a 5 years fiscal adjustment plan that eliminates the historical practice of financing recurring expenses with long term debt and that achieves the sustainability of the Government through a radical transformation of the governmental structure; (2) the approval of a Tax Reform whose recurring income satisfies the recurring expenses of the central Government; (3) the approval of a budget for the next fiscal year of a budget that adjusts, in an intelligent manner, public spending to the fiscal reality of the country (país).”

These statements have several problems. The letter does not explain what a “fiscal adjustment plan” is. Is it restructuring or simply is a legal framework in which to prohibit borrowing to balance a budget? If it is restructuring, no details are provided and given previous statements by the island’s executive, this will not happen but of course it can always be another lie. As to legal framework, the Puerto Rico Constitution makes clear that all budgets must be balanced but both parties have ignored this requirement and not challenges of the practice has been attempted in Court. Hence, we have no idea what this means.

The second measure is clearly geared to convince legislators to approve a VAT, which all sectors in the island have rejected, except the Government. Moreover, if we look back in history, in 2006, Governor Aníbal Acevedo Vilá closed the government in order to blackmail the legislature into approving a sales tax. The legislature quickly approved it and the island has never recuperated. Now, the Government wants more revenue with no guaranty there will be any control of its spending, which is the real fiscal problem. Moreover, until this issue is resolved, the Governor will not present the budget and when he does, the process will be thoughtless, hasty and counterproductive.

The third measure is another joke. As stated before, the present budget was supposed to be balanced but it was not and worse, collections were overstated. Politicians are very adept at lying through their teeth and they will continue to do it in order to get reelected.

The letter also mentions that the Government Development Bank, with the “help of economists and external consultants (i.e. Milco and Cleary Gottlieb) are coordinating the development of the plan for fiscal adjustment.” It admits that the Executive and the Legislature are needed in order to put the plan into effect. The problem is that there is no timetable for the plan and next year is election year. Good luck with that one.

What is lacking in the letter is any mention of an ECONOMIC development plan. Actually, this administration has never mentioned it has any plan for economic growth. It is important to note that the letter is signed by, among others, Alberto Bacó, Secretary of Economic Development and Commerce of Puerto Rico. For over two years he has been telling us how everything was going so well, how the economy was strong, vibrant and in clear recovery. I refer to him as the administration’s buffoon and his signing of the letter demonstrates that it has all been smoke and mirrors.

Why would any investor buy Puerto Rico’s debt with these admissions is beyond me. It is tantamount to throwing good money after bad.


One comment

  1. John, I’d like to ask you and your readers a few questions. Always hard to form opinions on subjects from such a distance.

    1) I think Puerto Rico is a low taxed jurisdiction. Largely basing that on the KPMG report provided as part of the review of the tax system. It fits with my bias too as I know property taxes are extremely low, no Federal income (there are payroll taxes). Do you agree with this?

    2) Opposition to VAT. I can completely understand not wanting to see this tax passed into law. It will cause living standards to decline and hurt the service sector badly but I am not understanding the alternatives as people see it. PR could default on all its debt and make cut-backs necessary to fund operations, not unlike what Greece is talking about doing. I get the perception that this is what most people want to do. Is this right?

    I definitely get the impression no one is expecting a Federal bailout with the possible exception of those really pushing the statehood issue.

    3) PREPA. When I look at the numbers it looks like servicing the debt should be fairly simple just by increasing rates to something approaching those charged in Hawaii, Jamaica and other islands. This seemed pretty obvious to me even before it was pointed out by the bond holders group. My recollection is that the indenture says rates have to cover debt unless the rates are unreasonable.

    Now one can argue over what is reasonable but I would literally laugh at someone who said rates should be as low as on the mainland. I can see maybe a lower level than Hawaii but my point is that unless the Federal government comes riding to the rescue by passing HR 870 the courts are almost clearly going to force an increase in rates at some point in time. The political system can fight and delay but it sure looks like a losing cause to me.

    Do you disagree with anything I said above with regard to PREPA?

    Know these are tough issues and books could be written about each topic. Just trying to get the opinions of someone who I respect. If there are good business reasons for you to not respond to my questions, feel free to ignore them but I hope some of your other readers might respond.


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