Pity Puerto Rico: Island’s debt crisis to reach Greece-like lows

One has to pity Puerto Rico. With the temporary protection that Congress last year provided the island from its creditors due to expire on May 1, Puerto Rico is now headed for a spate of costly and disruptive creditor lawsuits.

Worse yet, with the changing of the guard in Washington and San Juan, there is every prospect that economic policies in both the United States and in Puerto Rico will only deepen the island’s already very sorry economic plight.

{mosads}This is bound to exacerbate the island’s 10-year economic slump and to accelerate the flow of Puerto Ricans leaving the island for the mainland. It is also likely to aggravate the island’s humanitarian crisis and make it all the more difficult for the island to service its public-debt mountain. 

Since 2005, with the ending of U.S. corporate tax breaks favoring investment in the island, Puerto Rico has been in an economic slump. Over the past decade, a period during which the U.S. economy expanded by almost 15 percent, the island’s economy contracted by around 10 percent.

This led to more than 10 percent of Puerto Rico’s population leaving the island for the mainland in search of better economic opportunities. It also contributed to an increase in the number of those living in poverty to over 40 percent of the island’s population and to a rise in the island’s public-debt burden to more than 100 percent of its output.

The last thing that an economy in as deep a slump as Puerto Rico now needs is a tightening in aggregate demand policies that could further depress its very troubled economy. Yet that is precisely what Puerto Rico must expect in the year ahead, judging by the economic policies being advanced by both President Trump and Ricardo Rossello, Puerto Rico’s newly elected governor.

For his part, Trump is proposing for the United States large cuts in corporate and household income tax rates at the same time that he is advocating large increases in public infrastructure and defense spending. He is doing so despite the fact that the U.S. economy is very close to full employment and that wage inflation is now picking up. 

This expansionary fiscal policy stance will almost certainly force the Federal Reserve to raise interest rates further to contain inflationary pressure, which is all too likely to lead to a further strengthening in an already strong dollar.

Not having its own currency, but sharing that of the United States, means that Puerto Rico must expect to face higher interest rates and a stronger currency in the year ahead. This will be unfortunate for the island since its moribund economy, and especially its struggling tourist industry, could now benefit from low interest rates and a weak currency.

Further darkening the island’s economic outlook is the economic program of draconian budget belt-tightening that Governor Rossello has agreed to at the behest of the Financial Oversight Board that Congress imposed on the island last year. That program involves budget-tightening measures amounting to as much as 6 percent of the island’s GDP over the next four years.

Governor Rossello is hoping that these budget efforts, unaccompanied by meaningful economic reform, will somehow allow the island to meet its debt service payments without a forced debt restructuring.

In framing this policy approach, both Governor Rossello and the Financial Oversight Board seem to be oblivious to Greece’s recent dismal experience with such policies under very similar circumstances. Even the International Monetary Fund now acknowledges that it was a big mistake in 2010 to have delayed Greece’s debt restructuring and to have insisted instead on excessive budget tightening within a euro straitjacket without adequate structural reform. 

Far from promoting economic growth and improving Greece’s debt position, those policies drove the Greek economy into an economic depression on a scale of that experienced by the U.S. in the 1930s. It also substantially led to the largest sovereign debt default on record.

Sadly, lacking any semblance of meaningful economic reform policies or a debt-restructuring plan, Puerto Rico now seems to be heading for the same dismal fate as Greece and for a worsening in its humanitarian crisis. It hardly helps matters that as the island inexorably drifts towards a messy debt restructuring, it does not rank high on President Trump’s list of economic policy priorities.

It also does not help matters that with the 2016 elections out of the way, the U.S. Congress does not appear to have the appetite for once again extending the island the helping hand that it now desperately needs.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

The views expressed by contributors are their own and not the views of The Hill.