"Financial Oversight and Management Board for Puerto Rico" - Puerto Rico

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FINANCIAL OVERSIGHT AND MANAGEMENT BOARD
FOR PUERTO RICO
Members
Andrew G. Biggs
Carlos M. García
Arthur J. González
José R. González
Ana J. Matosantos
David A. Skeel, Jr.
José B. Carrión III
Chair
SENT VIA ELECTRONIC MAIL
January 18, 2017
Honorable Ricardo A. Rosselló Nevares
Governor of Puerto Rico
La Fortaleza
PO Box 9020082
San Juan, PR 00902-0082
Dear Governor Rosselló Nevares:
Thank you for your letter of January 12, 2017 outlining the actions your Administration has
taken in its first days in office and for Mr. Sánchez-Sifonte’s January 4, 2017 letter in response
to our letter of December 20, 2016. We appreciate the degree of alignment between your
Administration’s public policy platform and the policy guidelines outlined in our letter, as
evidenced in your correspondence.
Thank you also for the opportunity to meet with you last Friday, January 13, in your office. As
discussed at that meeting, the purpose of this letter is to provide you with more detailed
information on the specific goals and objectives that we believe ought to be incorporated into a
viable fiscal plan that we may certify, as well as to provide the fiscal parameters for that plan.
We also would like to inform you of our preliminary determination regarding your request for an
extension of both the time in which to submit the fiscal plan and the stay provided for under
PROMESA.
As you are aware, and as we stated in our last letter, the Government of Puerto Rico faces a
daunting fiscal challenge. The revised fiscal plan baseline released by the prior administration
estimated that, unless significant fiscal and structural measures are implemented, the
Government will have an annual average fiscal gap of $7.0 billion from fiscal year 2019 to
fiscal year 2026.
FINANCIAL OVERSIGHT AND MANAGEMENT BOARD
FOR PUERTO RICO
Members
Andrew G. Biggs
Carlos M. García
Arthur J. González
José R. González
Ana J. Matosantos
David A. Skeel, Jr.
José B. Carrión III
Chair
SENT VIA ELECTRONIC MAIL
January 18, 2017
Honorable Ricardo A. Rosselló Nevares
Governor of Puerto Rico
La Fortaleza
PO Box 9020082
San Juan, PR 00902-0082
Dear Governor Rosselló Nevares:
Thank you for your letter of January 12, 2017 outlining the actions your Administration has
taken in its first days in office and for Mr. Sánchez-Sifonte’s January 4, 2017 letter in response
to our letter of December 20, 2016. We appreciate the degree of alignment between your
Administration’s public policy platform and the policy guidelines outlined in our letter, as
evidenced in your correspondence.
Thank you also for the opportunity to meet with you last Friday, January 13, in your office. As
discussed at that meeting, the purpose of this letter is to provide you with more detailed
information on the specific goals and objectives that we believe ought to be incorporated into a
viable fiscal plan that we may certify, as well as to provide the fiscal parameters for that plan.
We also would like to inform you of our preliminary determination regarding your request for an
extension of both the time in which to submit the fiscal plan and the stay provided for under
PROMESA.
As you are aware, and as we stated in our last letter, the Government of Puerto Rico faces a
daunting fiscal challenge. The revised fiscal plan baseline released by the prior administration
estimated that, unless significant fiscal and structural measures are implemented, the
Government will have an annual average fiscal gap of $7.0 billion from fiscal year 2019 to
fiscal year 2026.
Governor Ricardo A. Rosselló Nevares
January 18, 2017
Page 2
Verifying this number is a priority for us, and we understand it is an immediate priority for your
Administration as well. In the coming days, we expect to complete the engagement of a forensic
accounting firm to: (1) validate the bridge between the Commonwealth’s last audited financial
statements as of June 30, 2014 and the fiscal plan, and (2) provide an independent report on the
total outstanding indebtedness for the Commonwealth by issuer, list of all debt issues by issuer,
use of proceeds of each debt issuance, contractual debt service schedule and debt service
currently in default.
Based on our review, however, we believe the $7.0 billion figure is a reasonable estimate for
setting the fiscal plan’s targets and guidelines and as a parameter to engage in Title VI
negotiations with the Commonwealth’s creditors.
FISCAL PLAN TARGETS AND GUIDELINES
At the outset, we find it appropriate to remind you that at its November 18, 2016 public meeting
here in Puerto Rico, the Oversight Board adopted and communicated publicly a set of five
principles to evaluate the Government of Puerto Rico’s proposed fiscal plan and to assess the
degree to which the plan meets the 14 criteria established by PROMESA. This set of five
principles adopted by the Oversight Board and the 14 criteria established by PROMESA
regarding the elaboration of the fiscal plan are set forth in Schedule I to this letter.
We believe the fiscal plan must target a structurally balanced budget by fiscal year 2019 and
must articulate a clear path to achieving that goal, while simultaneously pursuing restoration of
Puerto Rico’s access to the capital markets. In accordance with PROMESA, the fiscal plan must
ensure funding of essential government services, provide adequate funding for pension systems
and provide capital expenditures and investments necessary to promote economic growth in
Puerto Rico.
We expect that the fiscal plan will also contain aspirational goals for Puerto Rico and its
people—such as returning the Island to a path of economic growth and bettering the lives of its
people—as well as the reforms that you will be undertaking to achieve those goals.
With these guidelines in mind, and focusing on the objective of aligning recurring revenues and
expenditures by fiscal year 2019, below we outline a path to achieve this goal with a mix of
fiscal initiatives and structural reform proposals. Both components are equally important to
foster growth: while fiscal initiatives optimize government revenue and expenditures to create a
positive fiscal balance that attracts investment, structural reforms represent longer-term changes
that ensure Puerto Rico will regain economic growth for decades to come.
That path requires action in at least five principal areas: 1) revenue enhancements; 2)
government right-sizing, efficiency and reduction; 3) reducing health care spending; 4) reducing
higher education spending; and 5) pension reform, as summarized in the following table.
Governor Ricardo A. Rosselló Nevares
January 18, 2017
Page 3
FY 2019
$ in billions
Fiscal
Gap
1
Total Baseline Revenues
$15.4
2
Total Non-Debt Service Expenses
-19.1
Primary Balance before Debt Service and
-3.7
Measures
Contractual Debt Service
-3.9
Fiscal Gap
-7.6
Measures
% change
Proposed Impact of Fiscal Measures
3
($)
to Baseline
4
1. Revenue Enhancements
+$1.5
+15%
2. Government Right-sizing, Efficiency and
+1.5
-22%
5
Reduction
6
3. Reducing Health Care Spending
+1.0
-28%
4. Reducing Higher Education Spending
+0.3
-27%
5. Pension Reform
+0.2
-10%
7
Impact of Fiscal Measures
+$4.5
Implied Primary Surplus after Measures
$0.8
8
Available for Debt Service
Notes:
1. Source is Government baseline released in December. Assumes GNP contraction of 16.2% in fiscal year 2018 and
1.2% in fiscal year 2019 in real terms. Includes $9.8 billion of non-federal revenue.
2. Includes $13.5 billion of non-federal expenditure.
3. % increase or decrease versus baseline forecasts for each area.
4. Includes Act 154 extension and review of tax regime for Act 154 companies, improve tax compliance and right-
sizing of government fees and other sources of revenue.
5. Includes reducing non-essential government services through consolidation and headcount reduction, reducing
total government compensation, right-sizing K-12 education expenditures to the current student population,
eliminating subsidies to municipalities and private sector and introducing other efficiency measures. This target is
net of impact from potential increased pension cost from government headcount reduction and social security
expenditure for police and teachers not included in baseline projections.
6. Includes miSalud expenditures and other non-federal expenditures for healthcare related agencies.
7. Implies a 15% net revenue increase from baseline non-federal revenue of $9.8 billion and a 22% net expenditure
reduction from baseline non-federal expenditure of $13.5 billion.
8. The implied primary surplus is based on aligning ongoing revenues and expenditures for fiscal year 2019. It does
not reflect likely carry-in deficits and thus may overstate available resources in fiscal year 2019.
See Attachment A for more details.
Governor Ricardo A. Rosselló Nevares
January 18, 2017
Page 4
Please note that even with the immediate successful implementation of these measures the
Implied Primary Surplus Available for Debt Service on fiscal year 2019—before taking
into account any legacy deficits—is $0.8 billion, which represents only 21% of the contractual
1
debt service of $3.9 billion for fiscal year 2019.
To be totally transparent and with the aim of certifying a fiscal plan as quickly as possible, we
lay out below in more detail the set of initiatives and accompanying revenue and savings targets
that we expect the Government’s fiscal plan to incorporate in order to achieve a structurally
balanced budget by fiscal year 2019, which will accomplish PROMESA’s objective of
balancing the Government’s budget. The proposed initiatives also include, however, structural
reforms that will set up the Puerto Rican economy for long-term growth.
These recommendations are based on our collective experience with fiscal crises and analyses
conducted by our advisors. To be clear, presenting a plan that can achieve at least this level of
savings is a pre-requisite to certifying a fiscal plan. The Government may, however, determine to
employ other initiatives and make trade-offs that differ from those described below, but arrive at
a similar equilibrium.
1. Revenue Enhancements
To optimize revenue, the Government should make adjustments to the tax system, improve tax
administration and compliance, and right-size government fees, among other revenue
enhancement measures. The Government should design a tax regime that:
 Increases compliance through improved audit functions and systematically addresses
leakage in the form of non-compliance and evasion.
 Widens the taxable base through a reduction in exemptions.
 Improves property tax collection through reappraisals and property registration efforts
(and lowers municipal subsidies accordingly).
 Enhances tax administration through improved training and technology and reduced
amnesties.
Together, we expect these initiatives to increase government revenues by $1.5 billion
annually by fiscal year 2019. This estimate incorporates your Administration’s Act
154 extension and assumes a prospective review of the tax regime for Act 154
companies.
1
In this letter, the Board takes no position on the outcome of the GO-COFINA dispute, and recognizes any
restructuring will have to reflect a consensual or judicial resolution of that dispute. Any certified fiscal plan will
contemplate fulfilling all of PROMESA’s requirements, including those relating to essential services, pensions,
secured claims, and priorities. This letter is not intended to imply how funds will be allocated to satisfy those
requirements.
Governor Ricardo A. Rosselló Nevares
January 18, 2017
Page 5
2. Government Right-sizing, Efficiency and Reduction
Today, the Government directly provides and subsidizes many services, including security,
transportation, and other activities that could be provided by the private sector. The Government
has the opportunity to provide some services more efficiently and eliminate some services
entirely, while maintaining an adequate level of essential services. Overall, we have estimated
that government right-sizing, efficiency and reduction should generate approximately $1.5
billion annually by fiscal year 2019.
To realize these net savings, the Government should consider taking the following actions:
 Reducing non-personnel expenditure by at least 10% by re-negotiating large
contracts, centralizing purchasing, and implementing other procurement best
practices, such as clean sheeting and demand management, among others.
 Reducing payroll costs by approximately 30% by substantially eliminating positions
and making other reductions to total public labor compensation, including
consolidating and significantly reducing non-essential Government services.
 Eliminating municipal and private sector subsidies.
 Right-sizing K-12 education expenditures to the current student population.
From your executive orders declaring a fiscal emergency, imposing salary freezes, limiting the
number of non-career personnel and other labor cost reductions and requiring agencies to build
zero-based budgets, it appears that your administration shares this priority. Indeed, we would
welcome further detail on the projected expenditure savings of your executive orders. Yet, we
must be candid and stress that, to get closer to fiscal balance, a lot more will need to be done
beyond the measures already adopted by your Administration.
3. Reducing Health Care Spending
MiSalud is a critical element of Puerto Rico’s safety net and is fundamental to the stability of the
health care delivery system. However, like other states and many businesses, the government of
Puerto Rico has been challenged by rapidly rising health care costs that far outpace realistic
revenue growth. The size of Puerto Rico’s fiscal challenge, the loss of federal Medicaid funds
and the fundamental imbalance between the growth in health spending and achievable revenue
growth, makes significant reductions in health care spending necessary.
In fact, unless additional federal funding is provided after the expiration of funding under the
Affordable Care Act, miSALUD will face a ballooning operating deficit expected to reach at
least $1.0 billion in 2020. While the Oversight Board supports initiatives to seek additional
federal healthcare funding, we do not believe that at this time it would be a prudent budgetary
practice to include in the fiscal plan any such potential additional federal healthcare funding.
Therefore, the Board believes the Government of Puerto Rico should include measures in the
fiscal plan that would generate annual savings in health care spending of $1.0 billion by
fiscal year 2019, such as implementing: