Puerto Rico debt legislation to hit growth prospects

Puerto Rico's Public Corporation Debt Enforcement and Recovery Act will likely damage the commonwealth's prospects of an economic recovery, said ratings agency Moody's Investors Service in a report.

In July, Moody's downgraded Puerto Rico to 'B2' from' Ba2', following the commonwealth's enactment of the law in June, which enables public corporations to defer or reduce payments on outstanding bonds.

The legislation will limit Puerto Rico's ability to access financing in the near future, increase its borrowing costs and making it difficult for the island to fund capital projects, which will damage its growth prospects, said the agency.

A deeper recession and higher unemployment will also weaken the ability of businesses and households to meet debt obligations, which will impact the asset quality of local banks, leading to higher provisions and capital erosion.

The legislation itself also increases banks' asset quality risk, given local lenders' exposure to public and municipal entities.

While capital is currently a strength for Puerto Rican banks, reliance on wholesale funding is a structural weakness of the commonwealth's banking system, said Moody's.

"Puerto Rico doesn't have adequate deposit capacity to fund its banking system, which has therefore turned to brokered deposits, albeit to a lesser degree in recent years."

The decline of the Puerto Rican economy can be partially traced to 2006, when the island began phasing out preferential tax treatment for US companies.

While the US economy remained solid in 2006-08, Puerto Rico entered recession and lost many manufacturing jobs in high-paid sectors, such as pharmaceuticals.

And while the US economy has been recovering since 2010, Puerto Rico's has remained stagnant, with a combination of a declining population, very low wealth levels and a decline in major industry impacting growth.

By Kieran Lonergan

Puerto Rico debt legislation to hit growth prospects