Tensions To Heighten As More Austerity Measures Are Implemented

BMI View: We see rising scope for social and political tensions to increase in Puerto Rico in the near term. Indeed, the rising prospect of a technical default by the commonwealth will pressure Governor Alejandro García Padilla to continue implementing unpopular austerity measures. The economy remains in a recession and a decline in fiscal support will generate significant discontent among the population and could lead to higher crime rates.

We are downgrading our Short-Term Political Risk Rating for Puerto Rico to 61.5 from 64.0, which puts the commonwealth below the 66.1 average score for the Caribbean. The main dynamic underpinning our rating downgrade is our expectation for Governor Alejandro García Padilla to continue implementing highly unpopular austerity measures to alleviate a deteriorating debt profile. Indeed, weak fiscal revenue growth as the economy remains in a recession, combined with recent credit rating downgrades of the commonwealth's municipal bonds to 'junk' status by major ratings agencies, leads us to believe that there is a high likelihood that Puerto Rico will have to restructure its debt within the next 12 months ( see 'Negative Economic Outlook As Risk Of Debt Restructuring Remains High', January 30). In an attempt to avoid a technical default, we believe García Padilla will pursue additional austerity policies in the coming months, which will continue to generate social and political discontent. Furthermore, given the already delicate condition of the economy, which has contracted in six out of the last seven years and has double-digit unemployment, we also believe crime will become an increasing concern among residents.

Credit Downgrade Increases Pressure For Additional Austerity Policies

Ratings Remaining Below Regional Average
Short-Term Political Risk Ratings And Sub-Components, out of 100

BMI View: We see rising scope for social and political tensions to increase in Puerto Rico in the near term. Indeed, the rising prospect of a technical default by the commonwealth will pressure Governor Alejandro García Padilla to continue implementing unpopular austerity measures. The economy remains in a recession and a decline in fiscal support will generate significant discontent among the population and could lead to higher crime rates.

We are downgrading our Short-Term Political Risk Rating for Puerto Rico to 61.5 from 64.0, which puts the commonwealth below the 66.1 average score for the Caribbean. The main dynamic underpinning our rating downgrade is our expectation for Governor Alejandro García Padilla to continue implementing highly unpopular austerity measures to alleviate a deteriorating debt profile. Indeed, weak fiscal revenue growth as the economy remains in a recession, combined with recent credit rating downgrades of the commonwealth's municipal bonds to 'junk' status by major ratings agencies, leads us to believe that there is a high likelihood that Puerto Rico will have to restructure its debt within the next 12 months ( see 'Negative Economic Outlook As Risk Of Debt Restructuring Remains High', January 30). In an attempt to avoid a technical default, we believe García Padilla will pursue additional austerity policies in the coming months, which will continue to generate social and political discontent. Furthermore, given the already delicate condition of the economy, which has contracted in six out of the last seven years and has double-digit unemployment, we also believe crime will become an increasing concern among residents.

Ratings Remaining Below Regional Average
Short-Term Political Risk Ratings And Sub-Components, out of 100

Credit Downgrade Increases Pressure For Additional Austerity Policies

While García Padilla has already implemented extensive austerity measures, such as raising the retirement age, hiking value added taxes and increasing mandatory pension contributions, we believe he will pursue additional policies that seek to shore up government accounts the coming months. Indeed, Puerto Rico is highly reliant on issuing debt to finance the government's operations, and following credit rating downgrades to 'junk' status by both Moody's and Standard & Poor's in early February, the commonwealth needs to prove to investors that it is taking aggressive steps to address its fiscal issues before returning to capital markets. Puerto Rico has about US$940mn dollars in debt-related payments this year, which is about half the reported cash held by the Government Development Bank - the commonwealth's financing arm. As a result, García Padilla is on a tight schedule to demonstrate fiscal improvements in order to issue more debt at affordable rates, without seriously denting the government's liquidity, and further increasing the risk of a technical default.

High Unemployment To Make Crime An Increasing Concern

Given Puerto Rico's already high unemployment rate, which has remained between 13.0% and 15.0% in recent years, we believe that additional austerity measures could see higher crime rates. While unfavourable economic conditions have driven many to leave the island in search of better opportunities, with the population shrinking by about 1.6% since 2007, the homicide rate has reached record highs in recent years, and is reported to be at 26.2 murders per 100,000 residents. As a result, we expect crime to be an increasing concern among residents and firms operating on the island. Therefore, we downgraded the 'Social Stability' component of our Short-Term Political Ratings from 52.5 to 47.5, which remains significantly below the Caribbean average of 60.7.

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Sector: Country Risk
Geography: Puerto Rico
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