July 31 (Bloomberg) -- Puerto Rico, the junk-rated U.S. commonwealth, needs to reduce its debt levels, end deficits and broaden its tax base, according to recommendations released today by the Federal Reserve Bank of New York.
The island should lower the ratio of public debt to its gross national product to 60 percent -- the level of 2000 -- from 100 percent last year, the New York Fed said in its first report in two years on Puerto Rico, which is part of its district. The ratio and the commonwealth’s speculative-grade ratings raise borrowing costs, which the report said can impede economic growth.
The self-governing territory of 3.6 million, which has $73 billion of debt when including its agencies, lost its investment grades this year. The commonwealth is contemplating restructuring some of its public-corporation borrowings.
“While these adjustments can be difficult, the experience of New York City suggests that it is possible to tackle fiscal pressures head on and come out stronger,” William Dudley, president of the New York Fed, wrote in a foreword. “Puerto Rico clearly has the assets and attributes to do so.”
The island’s economy has struggled to expand since 2006. Its population has declined for eight straight years as residents leave for the U.S. mainland, according to Census data. The report cites New York, which was on the brink of bankruptcy in the 1970s, as an example of economic turnaround and fiscal change.
In response to the report, Governor Alejandro Garcia Padilla, who took office in January 2013, said that his administration has reduced the commonwealth’s deficit, attracted businesses and created 50,000 jobs.
“There is more work to be done, and we continue to execute on a comprehensive plan to drive economic growth and fiscal stability,” he said in a statement.
Puerto Rico and its agencies, including the Electric Power Authority and the Highways & Transportation Authority, have borrowed over the years to help balance budgets. The commonwealth is the third-largest municipal debtor behind California and New York. The bulk of its obligations are tax-free nationwide, leading 66 percent of U.S municipal mutual funds to hold the securities.
Borrowing by public corporations accounts for almost 85 percent of the increase in the island’s debt ratio, according to the report.
While those agencies have benefited from Puerto Rico’s ability to borrow through capital markets, “they have now harmed that access, threatening the delivery of the commonwealth’s core public services,” according to the report.
Those entities need to improve their finances and become more efficient, and may benefit from changes in “governance and ownership structures, including implementing selective privatization,” according to the report.
Lawmakers last month approved a measure allowing certain public corporations to negotiate with bondholders to reduce their debt.
To gain investors’ confidence, Puerto Rico needs to eliminate budget deficits and implement multiyear spending plans, build reserves against economic shocks and improve its financial reporting, according to the New York Fed, whose markets desk implements monetary policy and monitors financial conditions.
The report also suggests expanding Puerto Rico’s tax base and reducing rates across a range of levies to stimulate growth.
The report follows a speech by Dudley last month in San Juan, the Puerto Rican capital, where he outlined steps the island should take to address financial challenges.
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