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Categorized | Capital Markets

Puerto Rico drops tax plan, hitting bonds

Posted on April 30, 2015

A pedestrian passes a closed shop with a for sale sign outside, along Paseo de Diego in San Juan's Rio Piedras district, September 3, 2013. Flows of Puerto Ricans leaving for mainland United States have run steadily since the 1950s, but are now a torrent stripping the U.S. territory of the young and educated people and destabilizing a weak economy blamed for the exodus. Picture taken September 3, 2013. REUTERS/Alvin Baez (PUERTO RICO - Tags: BUSINESS POLITICS) - RTX13FPI©Reuters

Puerto Rican bonds slid deeper into distressed territory on Thursday after the debt-laden island’s House of Representatives voted down measures to overhaul the tax system, deepening concerns over the commonwealth’s creditworthiness.

The House of Representatives voted 28 to 22 to reject a bill that would have reformed the value added tax and helped plug a yawning budget deficit that has led debts to spiral to more than $70bn, in an island with a population of just 3.6m.

    Puerto Rico’s Government Development Bank, which handles the island’s debt sales, said in a letter to the governor and speaker of the house last week that the financial situation was “extremely precarious”. The letter warned of a government shutdown within three months if the bill did not pass and allow the commonwealth to issue another bond to stave off a deeper crisis.

    “A government shutdown would have a devastating impact on the economy, with cuts to payroll and utilities, with a painful and long-term recovery,” an English-language translation of the letter said. “These times of crisis require the co-ordinated and determined contribution in all sectors for the good of our country.”

    The chances of Puerto Rico returning to bond markets now look slimmer. Investors were unimpressed by the legislature’s reluctance to lift taxes, and sent the yield of the $3.5bn bond issued early last year — before debt markets slammed shut — to a new high of 10.6 per cent, up 34 basis points on the day.

    “The government and legislature need to come up with a plan to close the budget deficit that is transparent and credible. Then creditors would be willing to offer some bridge financing,” said Charles Blitzer, a former International Monetary Fund official who advises some Puerto Rican bondholders.

    “Time is running out, but there is still some time to solve this,” he added. “Puerto Rico faces a liquidity problem, not a solvency problem.”

    Puerto Rico’s governor Alejandro Garcia Padilla also criticised the legislature, and said in a statement that the bill’s failure put the future of the country at risk. “The lawmakers who voted against the measure will have to answer to history for their irresponsible actions,” he said, according to Reuters.

    Puerto Rico’s predicament is complicated by its legal status. It is an unincorporated US territory, as opposed to a full state or sovereign country. This means that investors have benefited from the tax exemption given to US municipal debt, but the island cannot go to the International Monetary Fund for a bailout.

    Jack Lew, US Treasury Secretary, earlier this week urged Puerto Rican officials to come up with a “credible” budget for next year and a longer-term solution to address its crisis, but the US has so far refused to offer any direct help for the territory.

    Even bankers and investors that have been cautiously optimistic on Puerto Rico eventually navigating its way through its debt crisis are becoming more guarded on the island’s future.

    “Puerto Rico faces near-term liquidity problems,” said a municipal finance banker. “They need to demonstrate the willingness to increase taxes and cut spending . . . To get out of the distressed space they have to show some real austerity.”