Puerto Rico: Debt Crisis with Caribbean Taste

8 February 2014 by Daniel Munevar

When we mention the debt crisis the first images that come to mind are the marches and protests in the streets of Madrid or Athens. But the negative impact of the debt system on the lives of the people is felt all over the world. Not even the sunny and placid lands of the Caribbean are immune to the destabilizing power of that system. In this case the victim is the island of Puerto Rico, where the uncontrolled increase of the debt has placed it on the edge of bankruptcy.

The history of how the island has reached this point is relatively simple. Given its status as a territory occupied by the United States, Puerto Rico has access to a series of fiscal benefits and exemptions which are very attractive to U.S. investors. Although it is not a state of the Union, bonds issued by the government of Puerto Rico have the same legal standing as U.S. state and municipal bonds. In order to facilitate access to funds at preferential rates, interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. payments on these bonds is tax-exempt. In that sense the key difference between Puerto Rico and the states of the Union is the interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
that they pay. Thus, while a state with fiscal problems such as California issues debt at 2.37 % interest, Puerto Rico does so at 8 or 10 %. [1] In a context characterized by low interest rates on a global level, this yield Yield The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value. is very attractive to investors. There are two further benefits. First, according to the laws of Puerto Rico, interest payments must be considered a priority over any other government expenditure. Secondly, there was an implicit understanding that the government of Puerto Rico could count on the support of the U.S. federal government. Given these features, financial markets came to see the island as good and secure opportunity to increase their profits.

From the perspective of Puerto Rico, the availability of external funds made it possible to temporarily mask the fiscal problems, thus postponing difficult decisions. Between the 2007 and 2012 the economy contracted year after year. [2] The shrinking of the economy reduced government earnings and accentuated the need for external financing. At its worst moment, in 2009, the state budget deficit reached 6% of the GDP GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
. [3] This risky balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. lasted until 2013.

In July of 2013 the declaration of bankruptcy by the city of Detroit changed everything. Investor’s trust on state and municipal bonds vanished. When markets began to shed Puerto Rico´s bonds the island’s debt had already reached $70 billion (102% of GNP Gross National Product
The GNP represents the wealth produced by a nation, as opposed to a given territory. It includes the revenue of citizens of the nation living abroad.
). [4] Given the incapacity of issuing new bonds since July 2013, Puerto Rico has been forced to seek short term financing from banks that charge higher interest rates, given the possibility of a default. This has only increased the doubts regarding the government’s capacity to come out of the crisis without a default and an eventual restructuring of its debt.

Given this difficult situation, the government of Puerto Rico has presented a series of austerity measures as an original and innovative way to deal with the crisis. As may be expected, austerity in its Caribbean version does not differ much from its European version. Placing the payment of the debt above all else, the government has frozen state pensions, increased taxes and tariffs for public services. [5] Given the negative impact on future economic perspectives, financial markets retain a skeptical attitude regarding Puerto Rico’s fiscal health. This has increased the rumors regarding the need of a federal rescue of the island territory, coordinated by the U.S. Congress.

While the investors wait, Puerto Ricans suffer the consequences of the austerity measures. The unemployment rate is now 15 % and an estimated 45 % of the population lives under the poverty level. [6] Around 50% of the population receives some sort of federal government aid. [7] It is estimated that during the last five years 65 thousand persons have emigrated each year in search of better opportunities in the continent. [8] The population that stays behind includes older people and those with least qualifications, a fact which further darkens future prospects for the island.

To conclude, it should be pointed out that the country can hardly find a solution to its problems within the logic of financial markets. In the specific case of Puerto Rico the relation between sovereignty and debt obligations must be taken into account. It is possible to argue that given Puerto Rico’s condition as an occupied territory the debt has an illegitimate character. Thus, the people of Puerto Rico have no obligation to pay it. Ironically, the United States established this legal principle in another Caribbean island in 1898. After the Spanish American War, the United States argued that due to its colonial status, Cuba was not bound to pay its debt to Spain. It would be a lovely turn of fate for the oppressed to now wield this argument against their oppressors in order to cancel their debt. In that sense the struggle for a free and independent Puerto Rico, both from the debt and from the U.S. occupation is one and the same struggle for justice.

Translated by Rafael Barnabe

Daniel Munevar, economist, is member of CADTM Latin America Caribbean network (CADTM Abya-Yala Nuestra America).

Daniel Munevar

is a post-Keynesian economist from Bogotá, Colombia. From March to July 2015, he worked as an assistant to former Greek Finance Minister Yanis Varoufakis, advising him on fiscal policy and debt sustainability.
Previously, he was an advisor to the Colombian Ministry of Finance. He has also worked at UNCTAD.
He is one of the leading figures in the study of public debt at the international level. He is a researcher at Eurodad.



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