Puerto Rico’s bonds were downgraded to junk level by Standard & Poor’s. Thursday’s announcement is expected to have a serious impact on the island, which is already experiencing severe financial distress. The downgrade will not only affect the Puerto Rico, investors will also take a hit. Nearly 70 percent of the island’s debt is held by US municipal mutual funds.
In recent years the bonds have been attractive as they have produced high yields, which were free from traditional taxes. However, S&P’s announcement has raised concerns about possible default. Moody’s and Fitch are both expected to follow suit, which could lead to further panic.
Forbes reports that investors in the US may feel the most significant impact :
“Mom and Pop investors whose brokers told them that these bonds were a great place to concentrate their retirement and life savings are in for a rude awakening when the expected downgrades materialize.”
As the impact is likely to be widespread, Forbes compares it to the infamous dot-com crash of 2000.
Although Puerto Rico has passed numerous measures and reforms to avoid default, the impact was minimal. Throughout the last year, the government has reduced pensions for government employees, including educators. They have also reported a steady increase in tax revenue . Despite reports of a balanced budget by 2015, S&P determined Puerto Rico has a “reduced capacity to access liquidity.”
Matt Fabian, with Municipal Market Advisors, said “the full implications of this downgrade are unknown,” as it is difficult to predict how bondholders will react.
Despite Puerto Rico’s downgrade, officials remain positive. David H. Chafey, president of the Government Development Bank, and Treasury Secretary Melba Acosta Febo, issued a joint statement following S&P’s announcement:
“While we are disappointed with Standard & Poor’s decision, we remain committed to the implementation of our fiscal and economic development plans. We believe the investment community will recognize the positive impact of the reforms… “
The development plans include continued cuts to government programs and a renewed focus on tourism. The government is also working on programs that are expected to increase employment throughout the island.
While S&P praised the government’s efforts to improve their financial standing, Puerto Rico remains an estimated $70 million in debt. As reported by CNN , S&P expects the debt to lead to “continued economic weakness” and high interest rates .
Although Puerto Rico’s bonds were downgraded, government and financial officials are not willing to give up. They are committed to continued improvement .
