Puerto Rico moved one step closer to default on Friday night after its governor, Alejandro Garcia Padilla, initiated emergency measures for the island’s Government Development Bank (GDB).
The dramatic move by the US territory will suspend GDB’s lending power and freeze most withdrawals.
Last night’s measure, however, stops short of declaring a debt moratorium.
The decision follows the governor’s signing two days earlier of legislation that would allow him declare a moratorium on its $72bn debt that would trigger a default.
The GDB has a $422m payment coming due on May 1. Another $2bn in payments involving a list of issuers is due July 1.
The government’s debt issuers are in negotiations to avoid default and the US House of Representatives is considering legislation on the debt. The sticking point has been the including of clauses in draft legislation that would create a debt restructure mechanism.
His decision on Wednesday to sign legislation empowering him to declare a moratorium had already sent fears rippling through the US Treasury markets. Puerto Rico may not be a sovereign state, but the possibility of a default on the May payment could cause severe disruption.
Wedmnesday’s decision ramped up negotiations in the US Congress over the island to find solutions. The US House of Representatives is considering an oversight board and restructuring mechanism. Garcia Padilla’s government is also talking with creditors in a last-ditch effort to strike a deal.
A default would impact the US bond market and could have a ripple effect in the long run if the debt crisis continued toward the July payment date.
“This move [by Garcia Padilla] signals that Puerto Rico does not have much willingness to pay. If is does happen, we will have to wait and see if there is a ripple effect across the bond market,” said a New York-based investment manager.
“Barring action from Congress and an agreement between the Puerto Rican government and creditors, there is going to be a default,” said Eric LeCompte, executive director of Jubilee USA Network, a non-profit organisation that has worked closely on Puerto Rico’s debt crisis.
TAX MOVE
LeCompte, who testified in February before the congressional House Natural Resources Committee, said that a strong debt restructuring vehicle was required if a lasting solution were to be reached.
“We need to find a balance between transparency and restructuring, while ensuring that the bond market remains competitive,” he said.
Puerto Rico’s problems have been piling up for years, with its bonds downgraded to junk in 2014. Garcia Padilla’s government has been trying to slash spending while generating revenue, but the process has been riddled with setbacks.
The island is set to become the first US territory with a VAT tax. It was supposed to be implemented on April 1, but is still set to come into effect. The 10.5% VAT is the same as the existing 10.5% sales tax, but is seen as more effective at reducing losses.
The change to the VAT is wrapped up in the debt debate because of bonds issued by the Puerto Rico Sales Tax Financing Corporation. These bonds, known as Cofina bonds, are backed by a revenue stream using 2.75% of the sales tax. There are questions about the legality of the change.
The Garcia Padilla government also received a setback in late March when a US Federal Court judge ruled as unconstitutional a new tax on corporations. Retail giant Walmart sued the territory over the tax. Judge Jose Fuste ruled that the tax was nothing more than a “pure and simple” money grab. The government has appealed, with Garcia Padilla publicly berating Fuste for taking $100m from the pockets of Puerto Ricans.