Damage caused by Hurricane Maria likely to affect Puerto Rico's economy heavily, increasing contract and protest risks

US Navy assists as Puerto Rico faces extensive damage after Hurricane Maria in Ceiba, Puerto Rico, 24 September 2017.

US Navy/Handout/Getty Images

The devastation caused on the Commonwealth by the passage of Hurricane Maria on 20 September 2017, a Category 4 hurricane, severely damaged the Commonwealth's infrastructure, with potential costs currently estimated at between USD40 billion and USD85 billion by AIR Worldwide, a catastrophe risk modelling software company. The presidential measure on 26 September amended a previous declaration of disaster issued on 21 September where the federal government had ordered federal assistance, but with the financing thereof to be shared between the Federal Emergency Management Agency (FEMA) and Puerto Rico.

Governor Ricardo Rosselló has urged the federal government and Congress to authorise additional and faster aid, warning that the Commonwealth is facing a humanitarian crisis. The hurricane has disrupted the island's entire electricity network (restoring it could take months), damaged roads, affected the agriculture industry, and caused damage to homes, telecommunications, and hotels. There are shortages of food, water, and diesel fuel needed to run smaller electricity generators. As of 27 September, 91.1% of the island's wireless telecommunication services were out of service. Rosselló also has ordered a curfew. People are allowed on the streets only between 06:00 and 18:00 local time to guarantee public order following incidents of looting, including theft of gas cylinders, electricity generators, and retail goods, in several locations including Aguas Buenas, Caguas, Carolina, and Juncos. Capital San Juan has had isolated incidents of looting but there has been an attempt to loot the El Norte shopping mall in Santurce. Looting targets have so far also included fast food restaurants, retailers, offices, and vehicles.

According to FEMA, as of 27 September, there were more than 8,800 federal staff on Puerto Rico and the United States Virgin Islands (also affected by Hurricane Maria and previously by Hurricane Irma) providing support for those affected, including search and rescue operations and the provision of food. The Defense Logistics Agency, the Northern Command, the Navy, and the US Coast Guard also are working together with the private sector to provide logistical air and sea support. An IHS Markit source on the ground said on 27 September that diesel fuel shortages persist and that many people are considering flying their families to the US. The longer the shortages of food and water persist, the higher the probability of protests and looting risks rising.

Hurricane to deepen structural problems

Puerto Rico's Resident Commissioner Jenniffer González said on 24 September that Hurricane Maria had set the Commonwealth back 20 to 30 years. Indeed, Puerto Rico's structural problems – capital flight, an unsustainably high debt burden, the shrinking of its manufacturing sector, and workforce migration to the US mainland – now appear likely to intensify following Hurricane Maria.

On 17 May 2017, Puerto Rico had entered bankruptcy protection proceedings in the US District Court of the Southern District of New York in order to restructure the territory's USD74 billion in outstanding debt as well as USD49 billion in unfunded pension liabilities (see Puerto Rico: 23 May 2017: Puerto Rico starts formal bankruptcy procedures, but all bondholders face losses in potentially complex debt restructuring). Its economy has been contracting consistently at an average of 1.5% per annum since 2006. Even prior to the shock impact of Hurricane Maria, IHS Markit had forecast GDP contraction of 3.6% and 2.8% in 2017 and 2018 respectively.

Debt sustainability concerns

The market has also reacted with concern over Puerto Rico's capacity to honour its obligations, with its bonds falling to record lows following the Hurricane. On 21 September the oversight board authorised USD1 billion in the current 2018 budget to be switched to relief efforts. It also stated that it would increase the figure in line with anticipated federal aid. Such reallocation of funds would reduce the already-slim amount available to cover debt service during the current fiscal year. Judge Laura Taylor Swain has suspended until further notice all default related proceedings under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).

Power supply modernisation

One unanticipated consequence of recent events could be that the 10-year investment plan for the Puerto Rico Electric Power Authority (PREPA) could be completed in a much shorter time-scale, subject to obtaining federal aid. Development of a modernised power system would raise the island's short- and medium-term economic outlook. However, among the fiscal board's amendments to PREPA's fiscal plan was an important statement noting that PREPA would need to substantially lower the cost of generating power and improve its distribution grid "through unimpeded public/private partnerships agreements and/or fully privatizing energy generation subject to regulated utility standards." This suggests that in the absence of sizeable federal aid moves could be taken towards privatising PREPA. PREPA bondholders offered on 27 September a new USD1-billion loan and a haircut on existent debt in an attempt to help with the recovery efforts.

Outlook and implications

Prior to the hurricane, Rossello had outlined an austerity plan aimed at maximising debt repayments. This was already a very difficult process to calibrate as he was trying to tighten Puerto Rico's fiscal balance and improve its debt service capacity without exacerbating its long-standing economic recession. Given the current circumstances, the local government's focus must of necessity change focus towards the urgent priorities of repairing the island's infrastructure and restoring essential services. More specific forecasts on the economic effects of the hurricane will be reflected in IHS Markit's late-November 2017 forecast update, but we anticipate a deeper decline in economic activity in the first half of 2018 followed by a more dynamic environment driven by the investment in infrastructure and recovery efforts. The size and the duration of the economic rebound will depend on the amount of federal public- and private-sector aid that Puerto Rico receives.

The challenges of generating economic growth and resolving Puerto Rico's debt problems will worsen if the federal government does not approve a major reconstruction package. This would increase the migration from the island and generate growing risks of protests and looting. By contrast, a federal aid package could help to modernise the island's inadequate infrastructure; for example, bringing forward efforts to upgrade its power supply. For the next few quarters, there is unlikely to be any significant progress in debt restructuring, as Puerto Rico focuses on its urgent need to re-establish basic infrastructure and essential services.