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If Puerto Rico is going down, it could start this weekend

Jul 31, 2015, 20:52 IST

Caretaker Osvaldo Reuters

Puerto Rico could go into default on a chunk of its $72 billion debt on Saturday, August 1st.

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That's when the island owes hundreds of millions worth of payments on bonds issued by a number of government agencies.

The question is which ones will and will not get paid out.

A likely 'not' is a $58 million payment on Puerto Rico's Public Finance Corporation (PFC) debt. Earlier this month bondholders were informed that funds had not been transferred to the trustee tasked with making the payment.

"The government likely wants to use the PFC payment as a sort of trial balloon to see how creditors react and hope that some of the bondholders will be scared into providing them with some relief," said analysts at Eurasia Group in a recent note.

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Puerto Rico's government sounded the alarm that its debt burden had become far too large for it to handle at the end of June. The island's economy has contracted every year but one since 2006. Wages are stagnant, the population has shrunk over the last decade by around 7%, and its unemployment rate has topped 12%.

Investors were shocked by the announcement. Even 'bond god' Jeff Gundlach of DoubleLine Capital had previously stated that the island could restructure its debt payments and get investors about $0.80 cents on the dollar.

That isn't looking like it's going to happen now.

What's more, Puerto Rico cannot declare bankruptcy according to its own constitution. That's why economist hired by the island's hedge fund creditors have recommended politicians implement a regime of tax hikes and budget cuts, otherwise known as a policy of austerity.

Protesters march while holding the flag of Puerto Rico during a demonstration along Park Avenue in New York July 30, 2015. Protesters carrying a vulture puppet and chanting in Spanish marched outside the Park Avenue offices of a major holder of Puerto Rico's debt to protest proposed austerity measures.Reuters

That is something Puerto Rico Gov. Alejandro Garcia Padilla will likely try to fight. He said last month that his administration was doing everything it could to avoid default.

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"But we have to make the economy grow," he added. "If not, we will be in a death spiral."

There is no appetite for a Puerto Rico bailout in Washington - especially not among Republicans - and there is no desire to restructure Chapter 9 of the US bankruptcy code in order to create a special mechanism to restructure debt for individual entities on the island.

What's most likely, according to Eurasia Group analyst Corey Boles, is that a special committee will be appointed to carry out budget and policy reforms.

"While this would be politically difficult on the island, it's possible that a new administration in Puerto Rico in 2017 could ask Washington to create such an entity, arguing for example, that it had inherited a fiscal mess and needed help to push through messy reforms," Boles wrote.

He added that that is unlikely to take place until after the elections on the island in November 2016.

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"Such a panel could then embark upon a drastic platform of slash and burn policies unpalatable to Governor Padilla."

That though feels a long way away when the island could go into default on some bond payments in the next 24 hours.

We're about to find out how much patience the island's hedge fund creditors have.

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