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Is the Puerto Rico crisis a one-off? Praxity participant firms try to make sense of the biggest US debt restructuring in history

By Ian Lavis, on behalf of Praxity​​

With various states, territories and governments around the world teetering on the verge of economic meltdown, the bankruptcy ‘plan’ of Puerto Rico is under intense scrutiny.

The decision by the Puerto Rican government to file for a form of bankruptcy in the face of debts of US$74 billion has set in motion a complex debt restructuring process to be decided in the US courts.

While the Puerto Rico case is unique in many ways, the point at which the island’s government has declared near bankruptcy – with arrears worth 70% of its GDP – highlights the plight of debt-ridden governments around the world.

Could Puerto Rico eventually become a benchmark for the management of public debt worldwide?

Eric LeCompte, executive director of Jubilee USA, an NGO that focuses on debt relief, seems to think so. In an article published in The Guardian on 5 May, he says the restructuring process “may set a precedent for how sovereign debt can be negotiated in the world”.

Experts from Praxity participant firms are not so sure. William Henson, Partner, International Tax Services, at US accounting firm Plante Moran, says it remains to be seen whether the US territory will become a benchmark case, adding: “Puerto Rico could be viewed as more of a ‘one-off’ situation given its sovereign status”.

Commenting on the US situation, William says: “States would need enabling legislation to even consider going down the same path. Legislation that is unlikely to come from this Congress or President. Even if it were possible, it is doubtful that this would prove to be a panacea for strapped state and local governments. The economic fallout for Puerto Rico could be significant”.

Puerto Rico is by far the biggest debt restructuring to occur in the US after Detroit filed for US$18 million bankruptcy in 2013. The difference with Puerto Rico is the island represents a US territory as opposed to a state or municipality.

“Currently states can’t declare bankruptcy,” William explains. “Puerto Rico was also unable to force creditors to restructure debt until Congress passed the PROMESA act which President Obama signed into law on 30June, 2016. If states were allowed to declare bankruptcy, or restructure like Puerto Rico, then Illinois, New Jersey and Connecticut would be considered most likely to do so. However, that is very unlikely given the current make up of Congress.

“Municipalities can declare bankruptcy, Detroit being the largest example. However, bankruptcy can be expensive and may raise interest rates for the relevant state. It’s more likely that the state would work hard with the local government to help avoid another large municipal bankruptcy.

“Interestingly there is a proposal to amend the Bankruptcy Code, which is Federal law, to allow state governments to reform pension plans even where those pensions are protected under the state’s constitution. This wouldn’t allow states to restructure debts. It would face unique political hurdles as lenders and creditors would be held harmless and the cost would be borne entirely by pensioners.” 

Can parallels be drawn between Puerto Rico, where the government sees bankruptcy as a last ditch attempt to sustain public services, with other debt-ridden countries? A quick glance at GDP/debt ratios and credit ratings around the world shows that many economies are in a perilous state, from Argentina and Venezuela to Greece and Pakistan, but each case is very different.

In Argentina, for example, the burden of public debt goes far beyond the recent Puerto Rico turmoil. Patricia Diaz, Partner at Praxity participant firm Shilton, Weyers and Associates in Buenos Aires, says: “Our country has a history of restructuring of public debt, having negotiated more than once”.

In 2001, Argentina faced crippling public debt and an unprecedented level of unemployment and poverty. At the peak of the crisis, interim president Adolfo Rodriquez Saa announced the suspension and deferral of public debt payments, which totalled US$144,453 million.

Patricia explains: “The deferral of payments of a portion of the public debt was authorised and endorsed by the National Congress through successive budget laws approved over subsequent years”.

A key stage in Argentina’s debt restructuring was a rescheduling of obligations with the IMF, World Bank, Inter-American Development Bank and other institutions in what was called the Argentina debt swap. In 2004, total external debt amounted to US$178 billion. However, nearly US$81.8 billion in securities held by private investors remained in default. Several complex bond schemes were introduced to reduce the debt from 153.6% of GDP in 2003 to 34.7% in 2010, but disputes with creditors continued. It was only in 2016 that the current government of Mauricio Macri reached a final settlement to end almost 15 years of debt litigation.

Whether Puerto Rico follows such a tortuous route towards solving its debt crisis remains unclear but there is no doubt that these are difficult times for inhabitants of the island and creditors. Governments, auditors and investors around the world will be watching very closely as events unfold.