Desmond Lachman, Brad Setser and Antonio Weiss have written a very strong analysis of the Puerto Rico situation. If ever there was a disconnect between underlying reality and what is happening in financial markets, it is the boom in Puerto Rican debt that has nearly doubled the value of some of its debt securities during the past few months.
Markets are now pricing in that close to $20bn more will come out of Puerto Rico to investors than at the end of 2017, following the territory’s own government, which is inexplicably projecting a substantially greater ability to repay debt today than before the hurricane.
What is going on? True, there may have been some excessive panic and liquidation selling in markets right after the hurricane. And the federal government is infusing more money into the territory than might have been expected in the immediate aftermath of the hurricane.
But there is something profoundly troubling about speculators in Puerto Rican debt reaping windfalls even as estimates of hurricane damage are revised up, tax-reform legislation undermines the territory’s competitiveness, out-migration increases, political cleavages increase, lay-offs from the public sector are set to increase and outside observers become more pessimistic about the territory’s economic prospects.
The government’s upward revision of 10 per cent in its economic forecast for 2023 over the year since the hurricane is analytically indefensible. In all likelihood, last year’s forecast should have been revised down not up. If the Oversight Board is to maintain its credibility, it will reject the government’s forecasts.
Credibility is important. My experience with crises is that they are never resolved until the authorities have made a forecast that proves too pessimistic. We are not there yet in Puerto Rico.
The fundamental problem in the territory now is the sterile debate between those who believe salvation lies in more debt relief and more federal support and those who believe in more belt-tightening and market oriented structural reforms.
Aid advocates wrongly downplay the efficacy of reform as a way of making the case for more support. Reform advocates fear that support will undermine pressure for reform and so wrongly downplay the need for debt relief and federal support.
The result is inadequate support, insufficient reform and a dismal outcome for Puerto Rico.
What is needed is much more reform and much more support, especially through debt relief, than now looks likely. Towards that end the Oversight Board, which has substantial moral authority, needs to provide real leadership by stressing that reform and support are mutually reinforcing. It needs to highlight that:
• without debt overhangs structural reforms to help business and free up labour markets will be most effect;
• structural reforms while desirable in medium and long term require some increased safety net expenditures to be politically acceptable.;
• a big push of reform and debt relief maximizes Puerto Rico s prospects for self sufficiency and will over time minimize outmigration.
The Oversight Board can do the easy thing and make all the stakeholders happy by being relatively optimistic and asking less of all the Puerto Rican stakeholders. Or it can do the hard and right thing for the territory and American taxpayers by refusing to bless any approach not predicated on large scale structural reform and extraordinarily sweeping debt relief. I hope they step up.