Puerto Rico Governor Rebukes Default Talk

Puerto Rico Gov. Alejandro García Padilla, stung by the defeat of his plan to increase revenue with a value added tax, ridiculed the idea of defaulting on the island's debt. At the same time, he called for talks with creditors.

In his annual state of the commonwealth speech Thursday, García Padilla laid out an eight point agenda that included talks with the government's creditors similar to those already underway between the Puerto Rico Electric Power Authority and its creditors.

"Sometimes there is talk about the possibility of not paying [the debt] because people don't want to. That is ridiculous," he said. "You have not only contracted debt with wealthy and foreign investors. Our debt is also with Puerto Ricans who have put their savings in our bonds. It is with the pensioners working here. It is with our credit, which is the future of our infrastructure of roads, ports, schools and hospitals, which we have to lift the country.

"The issue is not painted in black and white; it has many shades," García Padilla continued. "Demagoguery provides little help to understand it."

Some municipal analysts were skeptical the governor could meet his commitments, especially after his political position was weakened by the defeat of his tax plan.

"We applaud the governor's steadfast refusal to even consider defaulting on the general obligation and GO-related debt such as COFINA [sales tax backed bonds]," said Triet Nguyen, managing partner at Axios Advisors. "However, one has to wonder how much damage the latest tax reform fiasco has done to his re-election prospects. Furthermore, investors should worry about whether or not the failed attempt to shift to a Value Added Tax structure has opened the door to future legal challenges of the entire COFINA security structure."

Puerto Rico, which has an estimated $38 billion to $54 billion of tax supported debt, lost its investment grade ratings last year. The governor said that the commonwealth is facing the greatest fiscal and economic crisis of its modern history.

As a result of the Puerto Rico House of Representative's vote against the proposed tax reform that morning, he said, recovery "will be an even harder, longer and a more difficult road."

He called for sacrifice, responsibility, and austerity and "the transformation of the state apparatus and the establishment of a fine balance between fulfilling our responsibilities to the people and those undertaken by other governments, on behalf of the people, to the market."

García Padilla said his priority would be "to protect the public welfare, the health of Puerto Ricans and public safety during a transition period in which all of the commonwealth's revenues very likely will be insufficient to meet all of our obligations."

The governor said he would present a budget and a five year fiscal adjustment plan in the coming weeks. He said part of his agenda will be spending cuts in all government branches without layoffs.

García Padilla said he would be open to reaching a consensus on the way forward with the legislature.

He said he would set up two groups to address the commonwealth's crisis. One would be a group of experts focused on maintaining enough liquidity. A second group would be in charge of reorganizing the government to maintain essential services to citizens, smooth the functioning of the state, promote government efficiency, and stimulate economic growth. Chief of staff Victor Suárez Meléndez and secretary of state David Bernier Rivera will co-chair the committees.

García Padilla lambasted the "selfishness and disloyalty" that led the opposition New Progressive Party legislators and six legislators from his own party to vote against the tax reform.

Pedro Pierluisi, the leader of the NPP and Puerto Rico's nonvoting representative in the U.S. Congress, hailed the vote against the tax reform. "From day one, I have argued that this was the wrong bill at the wrong time, and that it would hurt, not help the economic and fiscal situation in Puerto Rico. So I am heartened that the Puerto Rico House of Representatives voted to reject the bill.

"Now, the governor and the legislative assembly need to move forward and prepare a balanced, realistic and responsible budget for the upcoming fiscal year," Pierluisi said. "There is no time to waste."

Thursday night's speech was more a reaction to the vote against the governor's tax reform that had taken less than 14 hours earlier, than a concrete plan for the way forward, said Advantage Business Consulting president Vicente Feliciano.

In a week or so the governor will present more about his proposals, Feliciano said. The government will be more forceful about making spending cuts. In the current fiscal year's budget 200 schools were supposed to be closed but the government has only closed 70 of them. The rest may soon be shuttered.

There was heavy trading of Puerto Rico's 2035 general obligation bonds Tuesday through Friday on the secondary market. However, it was only after the legislature's rejection of the tax reform that there was significant movement.

"Thursday's decline was absolutely breathtaking, but now levels have hit an equilibrium," Municipal Market Data senior municipal strategist Daniel Berger said. The bonds yield jumped to 10.613% at the end of trading on Thursday from 10.336% at the end of Wednesday.

Trading through mid-day on Friday, after the governor made his speech, was near to Thursday's levels, Berger reported.

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