SAN JUAN, Puerto Rico, April 29, 2015 (AMG) — Last week, leading financial officials in the Puerto Rican government issued a dire warning to their island’s top lawmakers, including Governor Alejandro Padilla. In a letter that left little room for misinterpretation, the experts claimed that the Puerto Rican government’s continued inability to grapple with its longstanding financing problems would likely lead to a government shutdown within three months.
“A government shutdown is very probable in the next three months due to the absence of liquidity to operate,” the statement cautioned. “The likelihood of completing a market transaction to finance the government’s operations and keep the government open is currently remote.”
Lenders demand austerity: Puerto Rico has an overall debt of about $71 billion and is struggling to remain solvent. The government of the U.S. territory routinely turns to transnational hedge funds for financing, but these foreign lenders are now demanding that San Juan implement strict austerity measures as a precondition for further funding. Without serious tax increases and spending cuts, Wall Street cautioned, the island would be cut off from the financing that it has come to rely on to stay afloat.
In a move that reinforced these threats, Standard and Poor’s downgraded Puerto Rico’s general obligation debt rating from B to the junkish CCC+ grade last Friday.
The authors of last week’s warning letter, which included Puerto Rico’s Treasury Secretary, forewarned of the economic consequences of sustained inaction: “A government shutdown would have a devastating impact on the country’s economy, with payroll and public service cuts, with a painful recovery and of a long duration.”
New value added tax: In an effort to secure $2.95 billion in revenue, stave off a shutdown in the near term and please foreign lenders, the Puerto Rican government is currently pursuing an unpopular value-added tax (VAT) initiative. The new policy would radically restructure the island’s taxation system by cutting income taxes on businesses and individuals and introducing new levies on the sale of goods and services to Puerto Rican consumers.
Critics of the VAT policy argue that the new taxes on necessary commodities like food could seriously undermine consumer demand and worsen Puerto Rico’s longstanding recession. They point to the harmful impact of a similar taxation experiment in St. Lucia – where the introduction of VAT on goods and services in 2012 contributed to exponential increases in poverty and unemployment – as vindication of their concerns.
Puerto Rico’s stagnant economy is already suffering from a 14 percent unemployment rate – a likely understated figure which does not account for the many workers who have simply dropped out of the labor market – and a staggering 44 percent poverty rate. Austerity critics warn that government cuts under these circumstances could transform Puerto Rico into a Caribbean Greece and throw its economy into a tailspin.
San Juan is stuck between a rock and a hard place. If it caves to Wall Street and bucks domestic public opinion by opting for austerity, a bitter medicine which so often harms the patient it is purportedly designed to cure, the already struggling Puerto Rican economy could be crippled.
Still, the price of inactivity is likewise unattractive; nobody wants a government shutdown, with all the social and economic dislocations that would undoubtedly accompany one.
Image credit: SEIU