NY Fed Chief raises red flag about Puerto Rico’s debt
Stabilizing Puerto Rico’s $70 billion debt as a share of its income and reducing it to more sustainable levels should be a key goal of the island’s fiscal and economic policy, New York Fed CEO William Dudley said during a presentation to the CPA Society on Tuesday.
During his speech, Dudley said while the exact path toward lower debt burden is uncertain, the trend will be largely determined by the interaction of three factors: the government’s fiscal policy, the growth rate of the economy and the interest rate on the public debt, currently estimated at roughly 100 percent of the Gross National Product.
“Persistent deficits in the Commonwealth’s fiscal accounts as well as mounting deficits in the operation of the several major public corporations have substantially raised the island’s overall level of public debt and led to serious concerns about whether the island’s fiscal position is sustainable,” he said.
“The clear challenge going forward will be for the Commonwealth government to continue to make progress on its efforts to raise its economic growth rate while at the same time to take credible steps to constrain the buildup of debt,” he said. “The demanding choices Puerto Rico makes today will affect its long-run economic prospects and the future livelihood of its residents.”
In his comments to the CPAs, Dudley went on to list steps that can be taken to move the island toward fiscal health, starting with a suggestion to the Commonwealth government to reinvigorate its efforts to raise economic growth.
“To restore growth and raise living standards, it is critically important for policymakers to expand efforts to marshal the island’s considerable strengths — a bilingual and well-educated adult population, an open economy occupying a central position in the Caribbean, a wide experience as a host to multinational corporations, and close ties to the U.S. mainland economy,” he said.
A second step is to comprehensively reform the Commonwealth’s tax system, which “is heavily dependent on income taxes and tends to levy high rates on narrow bases.”
“When rates are high, it increases incentives for activities to be shielded from taxes, perhaps by moving activity to the informal sector, or perhaps by halting the activity altogether. Either way, collecting the necessary revenue requires rates to be even higher on activities that remain in the base, reinforcing the problem,” he said.
“Typically, comprehensive reform is necessary to break the cycle by simultaneously broadening the tax base and reducing rates across a range of taxes. Such a reform would likely produce a significant bonus in terms of faster economic growth, particularly in the formal sector,” Dudley noted.
A third step would be to improve the island’s financial reporting. Puerto Rico’s unique status means it is one of few jurisdictions whose finances are not regularly surveyed by a public agency.
A fourth step would be to look for ways to strengthen the performance of public corporations.
“A major difference between Puerto Rico’s balance sheet and those of the states is the presence of large, heavily indebted, corporate-like entities that continue to lose money and increase borrowing,” he said, referring to the Puerto Rico Electric Power Authority, the Puerto Rico Highway and Transportation Authority, and the Puerto Rico Aqueduct and Sewer Authority, which account for almost 40 percent of the island’s total debt and have been responsible for much of the debt buildup
Of theroughly 43 percentage point increase in the debt-to-GNP ratio between 2000 and 2013, the public corporations accounted for almost 85 percent of that increase, he noted.
“For any financial reform agenda to be successful, it must confront this issue head on. Key elements of a successful reform strategy might include strengthening the public corporations’ financial standing and controlling the future flow of liabilities,” he said. “Puerto Rico could also seek out the opportunity to benefit from outside management expertise, including the wide experiences of U.S. mainland states.”
As a fifth step, the Commonwealth could benefit from adopting fiscal institutions more like mainland states. Balanced budget rules are far from perfect, but by following the states’ model — splitting the budget into an operating piece that must be balanced and a capital piece that can be financed with debt — Puerto Rico could better align financing methods with its spending priorities, he said.
A sixth step is for the Commonwealth to implement a framework to help ensure that budget targets are met.
“A key aspect of such a framework would require that the authorities implement multi-year budgeting, in which revenue and expenditure plans are articulated over a three to five year horizon,” he said, adding the framework should also incorporate a review of the central government’s macroeconomic and fiscal forecasts by a non-partisan independent entity, a method used by New York City.
“The steps should be viewed as potential ways to improve Puerto Rico’s finances over time and I present them to you for consideration and discussion. The decisions are obviously up to you,” Dudley said. “Other countries, U.S. mainland states and municipalities facing similar fiscal issues have been able to overcome them. I believe the island can develop a strategy that will enable a return to fiscal health.”
To read Dudley’s speech in its entirety, click HERE.