Puerto Rico fiscal plan may be too optimistic, economists say

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Puerto Rico Gov. Ricardo Rosselló’s proposed fiscal plan, which leaves room to pay as little as 8% of debt service, is too optimistic in its economic assumptions, two economists said this week.

In a paper posted to the web site of Puerto Rico’s Center for a New Economy on Monday, CNE Public Policy Director Sergio Marxuach said he was skeptical of the plan’s optimism about economic growth and government revenues in the next five fiscal years. He pointed out several risks to the plan’s projections.

“At the end of the day, however, the greatest risk is that the calculation of the amount of the needed debt relief may be based on a foolishly optimistic fiscal plan, resulting in a debt adjustment that is less than what Puerto Rico really needs to make its debt service sustainable,” Marxuach said. He said in more than half of all sovereign-debt adjustments since 1970 the debtor has defaulted within five years from the restructuring. This is frequently due to over-optimistic economic projections.

“That would be the worst-case scenario for Puerto Rico,” Marxuach said. “Just ask Greece.”

The fiscal plan is a key to determining how much of of more than $50 billion of public bond debt will be repaid as the territory undergoes the biggest municipal debt restructuring to date. The Puerto Rico Oversight Board, which had approved a ten-year plan that envisioned repayment of 24 cents of debt due, ordered a revised plan after Hurricane Maria devastated the island in September.

The Feb. 13 version of the fiscal plan projected that there would be enough money to pay 8% to 17% of Puerto Rico debt in the next five fiscal years. This was an improvement from the governor’s Jan. 25 version that assumed there would be no money to pay the debt in the period.

Brad Setser, senior fellow at the Council on Foreign Relations in New York, expressed similar views to Marxauch.

“The governor’s [Feb. 13] plan was far too optimistic," he said in an email. "There will be a rebound from Maria next year, but it isn’t clear that a few years of federal recovery spending alone will be enough to jolt Puerto Rico’s economy onto a path of sustained growth, or fully offset future austerity measures.”

Whereas Rosselló’s Jan. 25 plan assumed an average 0.42% real gross national product annual growth rate, the Feb. 13 plan assumed an average 1.06% real GNP annual growth rate.

Marxuach said that the fiscal year 2019 economic real GNP growth of 8.4% was “feasible” if the island received $49.1 billion in federal disaster aid and $21 billion from private insurance companies. However, beyond fiscal year 2019 Marxuach thinks the governor’s economic projections may be too rosy.

He also said that government revenues may come in lower than projected. He points out that a planned tax reform will reduce income tax revenues, eliminate business-to-business taxes, and reduce prepared food taxes. The plan also assume a 42% cut in Law 154 (foreign corporate profit) tax revenue.

The plan doesn’t factor in a negative multiplier effect on the economy of planned reductions in government spending, Marxuach said.
Among other concerns with the plan, Marxuach said that federal appropriations may be lower than estimated and the impact of a projected 20% decline in population may be greater than expected.
The Puerto Rico Oversight Board is working on creating a final “certified” version of the fiscal plan and currently anticipates releasing this on March 30.

After Rosselló submitted his plan on Feb. 13 several Puerto Rico bond insurers and bond holder groups released a critique from a different perspective than that of Marxuach and Setser.

The plan failed to provide transparency about the assumptions used to create it and didn’t clearly outline essential services, they said. It failed to provide a “vision for igniting growth.”

“Reductions in government expenses under the plan are minimal, with government payroll figures growing by 1.2% annually, even as population is projected to decline by 20% during the fiscal plan period.”

The plan’s debt sustainability analysis, based on a comparison of Puerto Rico the U.S. states, “overlooks the fact that citizens of Puerto Rico do not pay federal income taxes,” the bond holder groups and insurers said. Whereas the World Bank and the International Monetary Fund have said that 18% to 22% of government revenues is a sustainable level of debt service for low-income countries, the plan suggests 8% of revenues is an appropriate target.

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