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Nestled in the Cayey mountains, a little over an hour’s drive from San Juan, sits the municipality of Aibonito. To get there you leave Puerto Rico’s sandy beaches behind and take a winding road that snakes through miles of rain forest before reaching the area’s semitropical ecosystem, 2,400 feet above sea level. The damp, temperate climate is ideal for agriculture, and for decades horticulture was Aibonito’s major industry. Not anymore. In these hard times few people buy flowers.

In the town’s main square, dominated by the brilliant white Church San José of Aibonito, a smattering of pensioners pass the time on benches while dogs roam freely. A man wearing a black suit, tie and fedora stands on the corner holding a Bible, preaching in Spanish and gesticulating wildly with his arms. He seems like a character out of the pages of a Graham Greene novel. But this is not Greene’s Havana or Panama. It’s not even Latin America. As one of the 78 municipalities that make up the Commonwealth of Puerto Rico, Aibonito is part of the United States of America.

Yet this island, just over 1,000 miles southeast of Miami, has a peculiar relationship with the U.S. — one that clouds its future. Puerto Rico’s open access to the vast U.S. market is its greatest source of commercial opportunity, but its lack of voting representation in Congress has left it with little influence over the tax breaks and military contracts that historically have played a big role in its economy. The result is a stagnant, subsidy-dependent territory that has an aging population, with 42 percent of its residents receiving some form of welfare.

The realities are all too obvious to William Alicea Pérez. The 43-year-old mayor of Aibonito tells Institutional Investor that his constituents need jobs and resources to care for the elderly. Unemployment in Aibonito exceeds 15 percent, and more than 14 percent of the municipality’s population of 25,900 is aged 65 or over. Since 1980, Aibonito has transformed from having a 57.9 percent rural population to one that is 88 percent urban. But jobs in the town — two of the three major employers are a Baxter International pharmaceuticals packaging plant and a Pilgrim’s Pride Corp. chicken-­processing facility — are under threat because of the expiry of U.S. tax incentives, increased automation and global competition.

Aibonito’s problems, mirrored in towns across Puerto Rico, are at the root of an economic and debt crisis that has the commonwealth perched on the edge of an abyss. Since 2006 output has contracted by 10 percent and the economy has lost more than 250,000 jobs, an astonishing number for an island of 3.5 million people. The U.S. beckons as a land of opportunity for many of Puerto Rico’s best and brightest, who are leaving in increasing numbers to seek their fortunes in America.

In June, Governor Alejandro García Padilla shocked financial markets by announcing that Puerto Rico was in debt to the tune of $72 billion. That figure, which the administration later raised to $73 billion, was higher than many investors realized. The commonwealth would need relief from creditors to survive, Padilla said. He hired high-­powered advisers, including Anne Krueger, a Princeton University expert on sovereign debt restructuring and a former No. 2 official at the International Monetary Fund, and Jim Millstein, founder and CEO of restructuring advisory firm Millstein & Co., and entered into debt restructuring talks with bondholders.

In September the Puerto Rico Electric Power Authority, a public entity, reached an agreement with creditors to restructure $8.6 billion in bond debt of its major power utility. The commonwealth and its investors remain far apart on other debts, but they have little time to spare. The Government Development Bank for Puerto Rico (GDB) faces a $267 million debt payment on December 1, and the commonwealth itself has $1.2 billion in payments coming due in January. In August a GDB subsidiary, Puerto Rico Public Finance Corp., defaulted on a $1 billion bond issue by missing a $58 million interest payment, a first for a commonwealth entity.

The Obama administration is supporting Padilla’s bid for help, urging Congress to allow the territory to file for bankruptcy protection as part of a comprehensive rescue package combining debt relief with fiscal and economic reforms, and federal oversight of the island’s budget. “Puerto Rico’s debt load is unsustainable,” Antonio Weiss, a U.S. Treasury Department adviser and former Lazard banker, told a Senate committee in late October, adding that debt service would soon eat up 35 percent of government revenue. “Without action by Congress the commonwealth’s crisis will escalate and result in further economic contraction, further outmigration and further suffering of the American citizens in Puerto Rico.”

Critics of the Padilla administration insist the island can meet its obligations; they say its government just doesn’t want to bite the austerity bullet. “Puerto Rico is not Greece,” says Charles Blitzer, former assistant director of the IMF’s monetary and capital markets department. “I’ve never seen a fiscal crisis that on paper looks easier to overcome with the least damage to everyone.” The island’s debt-to-GDP ratio is 65 percent, according to government figures, well below the U.S. level of 105 percent and much lower than Greece’s 177 percent or Japan’s 246 percent, according to IMF data.

Puerto Rico is not a country, however. It doesn’t have its own currency or central bank, which allow independent nations to sustain higher debt levels, and it can’t borrow from the IMF. Investors regard Puerto Rico as they do U.S. states, which also finance themselves in the municipal bond market. By that measure, the commonwealth’s debt is off the charts. New York State, the most indebted of the 50 states, has total state and local debt of 24.24 percent of output. Even troubled Illinois has a ratio of just 18.61 percent.

Puerto Rico’s debt isn’t just large; it’s extraordinarily complex, which complicates efforts to find a solution. After rating agencies downgraded the commonwealth’s debt to junk levels in 2014, closing off access to the U.S. muni market, Puerto Rico borrowed $3.5 billion from hedge funds at a rate of 8.73 percent. Altogether hedge funds hold an estimated 14 percent of Puerto Rico’s debt. For the most part, hedge funds own the island’s most senior debt, including general obligation bonds, GDB debt and bonds issued by the Puerto Rico Sales Tax Financing Corp., known by its Spanish acronym, COFINA. Hedge funds have scooped up debt at steep discounts — the island’s GO bonds due in 2035 trade at about 76 cents on the dollar, according to UBS — and they are insisting on payment in full. A hard-line stance could keep Puerto Rico frozen out of the capital markets just like Argentina, which has been unable to complete a debt restructuring because of holdouts led by New York hedge fund firm Elliott Capital Management.

“My view is I’m constitutionally senior, I know they’ve got the money to pay me, so I’ll just wait for my check, thank you very much,” says one New York hedge fund manager who owns Puerto Rican bonds. This manager believes the commonwealth could close much of its funding gap if it was more efficient in collecting taxes owed and cutting nonessential expenditures.

THE SHOWDOWN IS TAKING PLACE against the backdrop of the 2016 elections, both in the U.S. and on the island; this seems likely to complicate efforts to find a compromise. In Washington, Republicans Orrin Hatch, chairman of the Senate Finance Committee, and Lisa Murkowski, who heads the Energy and Natural Resources Committee, have indicated a willingness to help Puerto Rico, but key Republican members of the House of Representatives have been more skeptical. In June, House Judiciary Committee chairman Bob Goodlatte and committee member Thomas Marino said that granting Chapter 9 bankruptcy protection “would not, by itself, solve Puerto Rico’s difficulties, which are associated with underlying, structural economic problems.” The Republicans generally have stressed the need for transparency and an understanding of how Puerto Rico got into its present condition.

Critics of the Padilla administration accuse the governor of exploiting the debt crisis to further his reelection ambitions and those of his left-leaning Popular Democratic Party. Padilla long insisted that Puerto Rico would never default on its constitutionally protected debt, says Marcos Rodríguez Ema, a lawyer, banker and member of GOP-­affiliated opposition group the New Progressive Party, who served as chief of staff to Padilla’s predecessor Luis Fortuño. Then, he says, “within a span of two months and after hiring the same people who have been advising Argentina, all of a sudden Puerto Rico does not have money to pay the bills,” he says.

Whatever the outcome, the commonwealth will have to tighten its belt, which will likely mean public sector job cuts and tax increases. But a crisis of this magnitude is also an opportunity: It could force Puerto Rico to change its ways and fix its ailing economy. A number of entrepreneurs are already hard at work, hoping to benefit from the turnaround opportunity.

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