Steps Needed to Address Puerto Rico’s Fiscal Stress

by James Orr – Liberty Street Economics, Federal Reserve Bank of New York

An Update on the Competitiveness of Puerto Rico’s Economy, released today, offers six steps that the Island’s government should consider taking to restore its fiscal health. Puerto Rico faces interrelated economic and fiscal challenges. The report characterizes economic activity in Puerto Rico as flat at a depressed level and shows that public debt has risen to about 100 percent of GNP, a high ratio compared with the ratios for U.S. mainland states and a number of foreign economies.

Besides the weak economy, the main sources of the debt buildup have been increasing general government deficits; debt incurred by COFINA, a special-purpose bond issuing entity; and rising deficits in a group of public-sector corporations that provide a variety of services on the Island, including electricity, water, and transportation. A series of ratings downgrades eventually pushed the credit ratings on the Island’s debt below investment grade in early 2014, and it has become increasingly evident that fiscal and economic reforms will be needed in order to maintain access to capital markets on a sustainable basis.

The report notes that Puerto Rico is not alone in facing daunting fiscal problems. Within the United States, New York City experienced major fiscal stresses and serious concerns about market access in the 1970s. Faced with the need to act, the city summoned the strong leadership and political will required to tackle these issues head-on and, over time, emerged stronger. Puerto Rico now has an opportunity to help get its economy back on track and to restore its fiscal health, but it needs to act.

In the spirit of assisting the Commonwealth in this endeavor, the report outlines several steps that could help improve fiscal outcomes. The first step is for the Island to reinvigorate efforts to boost economic growth. Puerto Rico has considerable strengths—a bilingual and well-educated adult population, an open economy occupying a central position in the Caribbean, and close ties to the U.S. mainland economy—and it needs to marshal those strengths to support growth. Measures to reduce the high costs of energy would be particularly helpful in improving the Island’s overall competitiveness. As a second step, the report urges a reform of the Island’s current tax system to achieve a broader tax base and lower rates across a range of taxes. Such a reform should help eliminate disincentives and could produce a bonus in terms of faster economic growth. A third step calls for an improvement in the Commonwealth’s financial reporting. New York City’s recovery from its financial crisis entailed a dramatic improvement in its financial reporting and this improvement may well have contributed to a steady increase in the city’s access to financial markets.

As a fourth step, the report recommends greater efforts to improve the financial standing and overall operational efficiency of the Island’s major public-sector corporations. The report suggests that Puerto Rico would benefit by leveraging the expertise and reputation of existing independent regulatory agencies in mainland states. The fifth step proposes that the Commonwealth government adopt a capital budget and a binding balanced-budget rule. Such measures should help Puerto Rico better align financing methods with spending priorities. The report also suggests that Puerto Rico consider setting up a “rainy day” fiscal reserve to improve the budget’s resilience to future economic shocks. As a final step, the report urges the Commonwealth to establish a legislative framework requiring multiyear budgeting, the adoption of specific targets for public-sector deficits and debt, and monitoring mechanisms to help ensure that targets are met.

The report closes by saying that these steps will require changes to a number of past policies and practices as well as some degree of sacrifice by all sectors of the population. The experience of New York City further shows that the problems are best addressed when the government and the private sector work together to find solutions. The report urges all parties to act now to put the Island on the road to fiscal health.

Disclaimer

The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York, or the Federal Reserve System. Any errors or omissions are the responsibility of the author.

Source: http://libertystreeteconomics.newyorkfed.org/2014/07/just-released-updated-study-of-the-competitiveness-of-puerto-ricos-economy.html#.U9pqIfldVK4

About the Author

James Orr is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.