If it doesn't look like junk or smell like junk, why is it junk?

Ratings agencies have made their feelings on Puerto Rican bonds pretty clear – they're junk. First, Puerto Rico's passing the Recovery Act caused them to downgrade the debt. Then, the courts striking down the Recovery Act caused them to downgrade again. So that's two downgrades for a law that was passed and then blocked, or two downgrades for nothing.

It's time to take a step back and look at where Puerto Rico stands.

First, while historically it's been a heavy borrower, the Commonwealth should be credited for reducing its deficits from $2.5 billion to just $800 million over two years and consistently making payments on its debt obligations. In fact, in 2015, the Commonwealth is projecting a balanced budget, the first in 20 years.

Second, Puerto Rico has also attempted to ring-fence its debt. Even prior to the Recovery Act, Puerto Rico launched a series of tough budget initiatives at state-run enterprises. Already, wage freezes, firings, and reforms are now on the agenda of every state-owned board of directors. The Recovery Act has been struck down in court, but this ruling doesn't take away from the government's intent to ring-fence the Government Obligation debt from public corporations. This debt is 40 percent of GDP – far lower than comparable sovereigns – and is serviceable going forward.

Now, they need to capitalize on these two initially positive steps with long-term economic rejuvenation.

With oil prices down, Puerto Rico needs to enact further reforms to boost their economy. The island's power authority, PREPA, will need to use the low oil price environment and other energy market changes to modernize Puerto Rico’s electricity system and its finances. For the economy more broadly, lower oil prices should boost spending, helping to create more jobs and new businesses. Juan Lara, chief economist at Advantage Business Consulting, has argued that the drop in oil prices could inject $2 billion into the Puerto Rican economy in 2015.  

Simultaneously, continuing targeted efforts to bring in international business should be more aggressively pursued. Puerto Rico provides a unique landscape for companies around the world due to its Latin American cultural roots. Further, the World Economic Forum's competitiveness report ranks Puerto Rico the 32^nd most competitive economy in the world.  And businesses have taken notice. Last year, private investment backed the recent Lufthansa deal. In the pharmaceutical industry, a once significant employer on the island, shakeouts and consolidations are now being followed by increased investment. In fact, $650 million flowed into the Commonwealth last year, according to former Merck executive Ivan Lugo. More needs to be done to build off this foundation.

However, while they lay the groundwork for this growth, the Government Development Bank (GDB), Puerto Rico's government bond issuer and fiscal agent, will likely look to do another large bond issuance in the first half of this year.

Investors across the board want continued revenue enhancement and deeper reforms for the public corporations to believe in Puerto Rico once again.

On the former, tax reform has the ability to increase revenues and boost the economy by broadening the base, lowering rates, and functioning more efficiently. The initial report from KPMG suggests the value added tax plan for Puerto Rico may generate $2.5 billion more relative to current law. Puerto Rico projected a fiscal deficit of $800 million in 2014, just one-third the size of the potential gains from tax reform.

On the latter, the Commonwealth should explore two options. First, the Elected Executive can institute a control board to oversee public corporations and ensure effectiveness and efficiency in their operations. It should use this power to convene the stakeholders of all state-owned enterprises to discuss wage freezes, debt reorganization, and, further operational reforms.

Chapter 9 is one tool Congress should grant Puerto Rico, but Puerto Rico should only use it as a last resort. It does not replace business, civic and political leaders working to keep Puerto Rico a livable, thriving place to grow businesses and build communities.

Second, it should consider pulling some debt from troubled public corporations into a special investment vehicle and tying revenue – secured from those public corporations not the tax base – to service that debt. This act will provide some assurances to the market in restructuring scenarios.

Puerto Rican debt isn't junk. It's fairly serviceable and the government has made difficult but necessary steps to cut its costs and boost revenue. It's not the time to discourage the Commonwealth. It's time to encourage it to continue, and even deepen, these reforms and initiatives.

Sanzillo was the first deputy comptroller and acting state comptroller of the State of New York from 2003 to 2007. The first deputy comptroller has oversight responsibility for $300 billion in debt: $70 billion in state/related debt; $170 billion in authority debt and over $70 billion in local government debt.

By Tom Sanzillo

If it doesn't look like junk or smell like junk, why is it junk?