NEW YORK, USA -- Fitch Rating's current 'BBB+' rating on Puerto Rico's general obligation bonds reflects the significant progress made by the outgoing administration in implementing widespread reforms despite economic underperformance. Maintenance of the rating will require policy decisions that continue this progress and achieve budget balance and a slowing in the growth of long-term liabilities, including passing significant pension reform.
The weak pace of economic growth makes reaching these goals more challenging. The change in administration following the November 2012 election has not in and of itself caused Fitch to reconsider Puerto Rico's general obligation and related bond ratings; however, initiatives by the new administration will be monitored to assess the direction of policy as it evolves and any implications for the financial stability of the commonwealth.
Despite Progress, Fiscal Balance Challenging: Structural budget balance has not yet been reached despite four years of aggressive cost cutting and other fiscal restructuring measures. The outgoing administration made significant progress in reducing the operating deficit from 47% of general fund revenues in fiscal 2009 to 3.8% in fiscal 2013, excluding the additional impact of debt restructuring for fiscal relief. Maintenance of the current rating will be contingent upon meeting current year budget estimates, which included some borrowing to balance, and enacting a budget for fiscal 2014 that does not rely on borrowing to achieve balance beyond some limited ongoing refunding.
Very High Liabilities and Poor Pension Funding: Puerto Rico's bonded debt levels are exceptionally high and pension system assets are expected to be depleted by the end of this decade absent significant reform. These high liabilities both limit Puerto Rico's ability to use additional leveraging for capital improvements or as a budget solution and create spending pressures that will be difficult to absorb within slowly growing revenues. The commonwealth's ability to take action that supports the solvency of the pension system while not significantly increasing the demands that pensions place on the budget will be critical to long-term rating stability.
Risk of Reliance on Market Access: The commonwealth has relied heavily on borrowing under its various bonding programs in order to fund operations. Although such borrowing has been reduced, continued reliance on capital markets to refinance debt for current-year budget savings introduces risk to operations and increases the already high debt burden. Fitch will be looking to the use of sustainable solutions to balancing the fiscal 2014 budget rather than reliance on capital market solutions.
Looking for Traction in Economic Growth: As it begins to emerge from the prolonged recession, Puerto Rico faces a longer term question of how to grow and diversify its economy, increase employment and workforce participation levels, enhance wealth and income, and address contraction in its existing pharmaceutical and electronic producing industries. The ultimate test of the success of future policy will be whether or not Puerto Rico is able to find a sustainable path to economic growth, growth that is necessary to support the commonwealth's high debt levels and other long-term liabilities, as well as to maintain a structurally balanced budget going forward.