Puerto Rico Plan Was Doomed Even Before Maria, Stiglitz Says

(Bloomberg) -- Puerto Rico’s fiscal turnaround plan may have been doomed from the start, even before Hurricane Maria barreled across the island, according to a study by a group of economists including Nobel Prize winner Joseph Stiglitz.

The roadmap, which island officials are revising in light of the storm, underestimated the degree to which austerity would slow economic growth, wrote Pablo Gluzmann, Martin Guzman and Stiglitz. Some assumptions were "unjustifiably optimistic," while others were "inconsistent with sound macroeconomic theory," according to the paper, whose analyses were done before the Sept. 20 hurricane.

The authors also criticized the plan for failing to acknowledge how an ever-deepening recession "would likely intensify migratory outflows."

"The fiscal plan will almost certainly lead to an additional decade of depressed economic activity and will worsen the island’s debt sustainability, perpetuating a crisis that all parties would like to end," the authors wrote in the paper, "An Analysis of Puerto Rico’s Debt Relief Needs to Restore Debt Sustainability," which Guzman presented Tuesday in San Juan.

By all accounts, Hurricane Maria made a bad situation worse for the bankrupt commonwealth, bringing economic activity to a near standstill and prompting a massive exodus that’s likely to further Puerto Rico’s contraction.

Puerto Rico debt prices have tumbled since Maria as investors speculate they’ll recover even less on their investments. General-obligation bonds due in 2035, the most active securities, traded for an average of about 25 cents on the dollar Tuesday, less than half what they were worth before the storm.

Fiscal Multipliers

The Stiglitz paper underscores just how dire the situation is and argues that the island was already on a dangerous path.

At the paper’s heart is the concept of fiscal multipliers, which economists use to estimate the impact of each dollar of government spending on economic growth. The paper says the architects used the most optimistic assumptions for such multipliers, and said the recent history of Greece’s austerity program should highlight the need to revisit long-held assumptions.

The analysis showed that if the current plan were to stand, the island would need to halt all interest payments and write down debt by 50 percent to 80 percent to return to fiscal sustainability, according to the report. The report said those are "conservative" figures that don’t address migration flows, and the 50 to 80 percent should be considered a "lower-bound" of what’s needed in terms of debt relief.

At least 100,000 people have left the island of 3.3 million since the storm.

So where does Puerto Rico go from here?

The authors said austerity would be counterproductive. They said the island should pursue expansionary fiscal policies immediately, potentially by borrowing more -- a move that would almost certainly face pushback from bondholders. The federal oversight board, which was installed by a U.S. rescue law and approved the prior fiscal plans, would have to approve any new borrowing.

The paper also suggests that the inclusion of gross national product-linked bonds in a debt deal would "align the incentives of the debtor and the creditors such that the creditors would also benefit from a stronger recovery."

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