Puerto Rico Faces Greek-Style Austerity Nightmare After Default

Guy Bentley | Research Associate, Reason Foundation

Puerto Rico could be facing a similar fate as Greece, with massive spending cuts and tax rises, after the debt-laden commonwealth went into default Monday.

Puerto Rico was due to make a $58 million bond payment Monday but managed to scrape together just $628,000. Melba Acosta, president of the territory’s Government Development Bank, said the default “reflects the serious concerns about the Commonwealth’s liquidity,” according to Standard & Poor’s.

Puerto Rico’s debt equals its GDP at a staggering $72 billion. The default was, however, not unexpected with Gov. Alejandro García Padilla warning about unsustainable debt levels in June. Thanks to the relatively small size of its economy, the crisis is unlikely to have any major effect on U.S. markets but analysts suggest the island’s financial situation will most likely deteriorate further.

“This is a first in what we believe will be broad defaults on commonwealth debt,” said Emily Raimes, vice president of Moody’s Investors Service. Puerto Rico’s credit rating has dropped dramatically over the past year and the government itself could run out of cash within months, Standard & Poor’s reports.

While not enjoying the full status of a state, Puerto Rico is in a monetary union with the U.S. This puts it in a similar situation as Greece in that it cannot adjust monetary policy to ease a harsher fiscal policy. Neither can Puerto Rico follow the course of Detroit and enter Chapter 9 bankruptcy.

Puerto Rico’s creditors believe there is still room to cut spending and raise taxes so the commonwealth can meet its debt obligations. However, the territory is already in recession and further austerity could depress the economy further.

As well as taking advantage of a strong dollar in the good times, Maurice McTigue, vice president of the Mercatus Center at George Mason University, listed government spending as one of the central factors behind the crisis.

“The one thing that is clear is the problem is the fault of Puerto Rico and its government, over the past 20 years, in spending huge amounts of money they did not have and being able to produce some very dodgy accounts that hid how serious the problem was,” McTigue said.

“The outlook is quite grim as those bonds await substantial losses. The outlook for the people of Puerto Rico is equally bad as they face scenarios of hardship and austerity equal to that of the Greeks,” he added.

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