The level of outstanding debt as a percentage of the Island’s annual GNP, a ratio used by many fiscal analysts, rose from about 60 percent in 2000 to more than 100 percent in 2013. Debt ratios in this range can inhibit economic growth in that they generally lead to higher financing costs, which in turn, can lead to constraints on access to further financing. The recent downgrading of Puerto Rico’s public debt to non-investment grade was a clear signal that the current fiscal situation poses serious risks to the Island’s economic future. Steps toward fiscal sustainability Next, I will discuss the buildup of Puerto Rico’s public debt and then provide some thoughts on ways to improve the Island’s fiscal health. To open this discussion, it is worth noting some key features of Puerto Rico’s fiscal institutional environment. The Commonwealth has a close relationship with the U.S. government which, in many ways, is analogous to that of a mainland state. Puerto Rico shares a common market and a common currency with the U.S. mainland leading to strong economic interdependencies. Federal aid is a major source of revenue for the Commonwealth and Puerto Rican residents participate in large U.S. social insurance programs such as Social Security and Medicare. In addition, Puerto Rican debt trades as a municipal security in the U.S. capital markets, and much of the interest earned on this debt is exempt from local, state and federal income taxes, regardless of where in the U.S. the investor lives.
It seems likely that any country in a similar debt situation to Puerto Rico would have faced difficulty in continuing to raise money in the bond market and would have faced questions about the sustainability of its debt level. Debt sustainability is generally defined as a condition where government debt is at a reasonable level – one with acceptable risks to market confidence and long-term economic growth – and is not on a path to increase indefinitely relative to some measure of national income. Stabilizing Puerto Rico’s debt as a share of the Island’s income and then reducing its debt to more sustainable levels should be a key goal of the Island’s fiscal and economic policy. While the precise path toward lower debt burden is uncertain, the trend is 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. Regarding the buildup of new public debt, the Commonwealth government has stated its intention that the general fund budget will be balanced in fiscal year 2015. This intention, together with the stance of not using deficit financing to support public corporations, should greatly limit the issuance of new debt. The measures put in place during this year have already had some success in cutting the projected budget gap for the current fiscal year. But what other steps can be taken to move the Island toward fiscal health?