Puerto Rico’s Financial Crisis Causes Government Shutdown

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<h3>Jay Abrams</h3>

Jay Abrams

For now, debt service payments by Puerto Rico’s governmental agencies are not at risk, even though the Commonwealth faces a shutdown of governmental services. An estimated 100,000 employees are out of work, while the Governor and legislature wrestle over the best solution for a chronic budget shortfall. The Island’s government has not been able to agree on a budget since 2004. This has necessitated continuous borrowing from the Government Development Bank. Because of the political deadlock, Puerto Rico faces a $740 million deficit for the current fiscal year. The Development Bank has demanded the imposition of an Island wide sales tax of 5.9% before it extends a $532 million line of credit to allow continued government operations.

Monies designated for debt service are segregated from governmental revenues before they can be used for spending purposes, providing insulation from the on-going budget conflict. Standard & Poor’s has put the Commonwealth’s “BBB” general obligation bond rating on CreditWatch-Negative, and has warned it may downgrade the rating if a budgetary compromise is not reached. Moody’s has done the same. Because of the strong protection given to debt service funds, neither rating agency sees a short term impact on the Commonwealth’s ability to meet its debt obligations. However, should the current crisis continue, preventing the Island from accessing a loan from the Development Bank, debt service pressures could increase.

Standard & Poor’s expects the crisis to be short-lived. Already, the Governor and Senate leaders have acquiesced to the Development Bank’s 5.9% sales tax demand. It remains to be seen whether other branches of the government, particularly the Commonwealth’s House of Representatives are willing to compromise as well. Although Puerto Rico’s finances are chronically out of balance, this latest crisis has been exacerbated by overarching political differences between the Governor and legislature, who represent different political parties.

Jay Abrams

Chief Municipal Credit Analyst

Jay Abrams is the Chief Municipal Credit Analyst of FMSbonds, Inc.
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May 4, 2006

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