Puerto Rico's 'death spiral' has officially begun

Puerto rico beach san juanReutersA vendor pulls his ice cream cart past beachgoers on La Pe?a del Perro beach in San Juan, Puerto Rico, July 18, 2015.

Puerto Rico’s Public Finance Corp. (PFC) has officially failed to make a payment due August 1st.

The president of the island’s development bank has said it paid only $US628,000 of the $US58 million due.

And according to CNBC, credit rating agency Moody’s considers this a default.

This means a bunch of painful events are about to be set in motion.

Investors in the PFC will now prepare to negotiate a restructuring plan — they will likely push for the government to take on austerity measures like cutting costs and raising taxes.

The discussions will be watched closely by investors holding some of the rest of Puerto Rico’s $US72 billion worth of debt, who may end up in the same process as well.

In June Puerto Rico’s Governor, Alejandro Garcia Padilla, said that the territory’s debt burden had simply gotten too large for it to bear. After years of anemic growth and brain drain, Puerto Rico has been left with a 12% unemployment rate and stagnant wages, leading Padilla to come clean and ask investors for mercy.

“My administration is doing everything not to default,” Gov. Alejandro García Padilla said. “But we have to make the economy grow,” he added. “If not, we will be in a death spiral.”

Puerto Rico's Governor Alejandro Garcia Padilla REUTERS/Alvin BaezPuerto Rico’s Governor Alejandro Garcia Padilla.

Part of the problem is that, according to Puerto Rico’s constitution, it cannot declare bankruptcy. To deal with that, it can either lobby Congress to amend the U.S. tax code (not likely to happen) or negotiate with creditors to their satisfaction, which some analysts believe will require Congress to form a special committee to supervise Puerto Rico’s budget.

Forming that committee is distasteful to Gov. Padilla, whose term ends in 2016. A new government may be more amenable to the idea, though, according to Eurasia Group analyst Corey Boles.

“While this would be politically difficult on the island, it’s possible that a new administration in Puerto Rico in 2017 could ask Washington to create such an entity, arguing for example, that it had inherited a fiscal mess and needed help to push through messy reforms,” Boles wrote in a note last week.

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