Guest Post Written by David Vardy
Puerto Rico Financial Control Board
Puerto Rico is a US
Territory which has for decades been autonomous. It is not a state. But it has
had sufficient independence to build up a debt of $70 billion. Its population
is just under 3.7 million and has been declining. This amounts to a debt of US $18,919
per capita or $24,935, in Canadian dollars. RBC's financial projections place the per capita debt of Newfoundland and
Labrador at $27,542 by the end of the current fiscal year, or 10% higher than
that of Puerto Rico.
Without federal
intervention Puerto Rico faced default on its debt, which would have made further
borrowing impossible. The US Senate on June 30, 2016 passed the “Puerto Rico
Oversight, Management and Economic Stability Act” (“PROMESA”) and it was signed
into law by President Obama. The Act enables the government of Puerto Rico to
restructure its debt and to regain access to capital markets.
A financial control board
(the “Financial Oversight and Management Board”) will consist of seven members
appointed by the President, of whom at least one must be a resident of Puerto
Rico. It is interesting to note that, prior to appointment, the members of the
Oversight Board “may not be an officer, elected official, or employee of Puerto
Rico, a candidate for elected office of Puerto Rico, or a former elected
official of Puerto Rico.” The Governor or his/her designate will be an ex
officio member of the Oversight Board but with no voting rights.
The Board will have broad
powers to control the financial and legislative activities of the Government of
Puerto Rico, which will continue to function. See the attached article from the
Harvard Law School Forum on Corporate Governance and Financial Regulation for
more information.
This bears some
similarity to what happened in 1934 when the UK appointed a Commission of
Government to replace the elected government of the self-governing Dominion of
Newfoundland. The debt of the Dominion had grown to the point where 60% of
revenues were going to pay interest on the public debt. While the burden of
servicing the debt had been growing, revenues were declining as a result of the
deepening Great Depression and the collapse in the world price for salt fish,
our staple export.
The government of the day
voluntarily surrendered sovereignty to a non-elected government. On February
16, 1934 six non-elected commissioners were sworn into office. The Commission
consisted of seven persons (including the Governor) appointed by the British
government. Three commissioners from Britain were assigned responsibility for
the three most important departments while three commissioners from
Newfoundland were appointed to the other three departments. The Governor
chaired the Commission, which governed the country, without a legislature and
without elections, for 15 years.
How Long Can we continue to borrow at the current level?
Our province is borrowing
more than $3 billion a year. How long can this continue? For three to five
years? Or just a matter of months? The Auditor General
recently gave a public presentation, from which the following chart is copied.
It compares the current account deficit for all provinces as a percentage of
Gross Domestic Product. Our deficit, compared with the deficits of all other
provinces, is 13 times as high!
This does not include our huge capital account deficit, inflated by the borrowing needed to inject provincial “equity” into Muskrat Falls. Nor does it include the federally guaranteed borrowing by Nalcor! It shows a deficit of over seven percent of GDP. If capital borrowing were included it would exceed ten percent. The gradual reduction of the deficit, as shown in the chart, depends upon the willingness to make deep spending cuts and upon decisions that have yet to be taken. Without such decisions the deficit could continue and perhaps balloon even higher. Is there a political will to make these draconian cuts? Where is all of this leading us? Is there any hope for us?
This does not include our huge capital account deficit, inflated by the borrowing needed to inject provincial “equity” into Muskrat Falls. Nor does it include the federally guaranteed borrowing by Nalcor! It shows a deficit of over seven percent of GDP. If capital borrowing were included it would exceed ten percent. The gradual reduction of the deficit, as shown in the chart, depends upon the willingness to make deep spending cuts and upon decisions that have yet to be taken. Without such decisions the deficit could continue and perhaps balloon even higher. Is there a political will to make these draconian cuts? Where is all of this leading us? Is there any hope for us?
Looking to the hills for outside help to avoid the Apocalypse
“I will look to the hills
from whence cometh my help” (Psalm 121:1). Will there be help? Will it come
from rising oil prices or reinstatement of equalization payments? Or will it
come from the negotiation of an omnibus deal with Quebec?
Government is dealing
with the following three wild cards, a veritable Unholy Trinity:1) the price of
oil, 2) the return of equalization payments and/or 3) a New Deal with Quebec. I
will take each in turn.
1)
The price of oil will be kept in
check by shale wells that will return to production when Brent hits $60 US.
Reactivation of these wells will invoke the law of supply and demand. With
increased supply the price will fall or hit a ceiling. There is limited potential
for royalty revenues to rise and to rescue us from our overspending.
2)
Our fiscal capacity exceeds the
national average so return of equalization payments is unlikely in the next
five years. A new equalization formula will be implemented in 2019 but it is
improbable that it will pay equalization to a province which continues to enjoy
relatively high revenues, due in part to our oil revenues, albeit reduced.
3)
A New Deal with Quebec: Is Gull
attractive to Quebec? I do not know. The cost estimates for Gull are outdated
and neither Ontario nor Quebec is short of power. My hope is that we can do a
narrow commercial transaction with Hydro Quebec, one which supplies us with a
small amount of power (250-300MW tops), at Hydro Quebec’s opportunity cost. In
other words we pay them slightly more than they can obtain in other markets in
order to obtain power to meet our commitments and to supply provincial load
growth, if it materializes.
If instead we are going
to enter into another grand imperial set of negotiations embracing Churchill
Falls, Gull Island and Muskrat Falls then we will be negotiating from a
position of weakness and Ottawa is unlikely to be an ally. We should first
attempt to do a simple commercial deal with Quebec before engaging in high level
negotiations which will open up all past wounds and grievances. If we cannot
first consummate a small commercial agreement with HQ for the purchase of power
from Churchill Falls then the prospect of some kind of Grand Alliance, perhaps
encompassing both hydroelectric development and transportation, would seem
remote. Certainly we should not agree to set aside the Court Cases as a
pre-condition to a commercial purchase of power for Muskrat Falls.
Federal Control Board
What will happen if none
of these three “solutions” materializes and if we do not put our fiscal house
in order? The inevitable answer is bankruptcy and the loss of our ability to
borrow, or else some form of Commission of Government, following the model of
the Dominion of Newfoundland in 1934 or the similarly draconian model of Puerto
Rico in 2016.
Is the loss of our
sovereignty a real threat to the province of Newfoundland and Labrador? Will
the federal government appoint a control board similar to what the US
government did for Puerto Rico, and which bears a chilling resemblance to
Commission of Government, which ruled from 1934 to 1949? If the federal
government intervenes then to what extent will they insist upon the deep
spending cuts which provincial legislators were unwilling to make? Our own past
experience and that of Puerto Rico suggest that if we cannot take charge of our
financial destiny on our own that we will face a bleak outlook for a protracted
period of time. Better that we take the medicine ourselves than having it
forced down our throats by a Federal Control Board!
David Vardy
