SAN JUAN, March 3 (Reuters) - Puerto Rico's legislature on Monday approved government plans to raise up to $3.5 billion in general obligation bonds, clearing the way for a sale as soon as this week.
Government officials have said they intend to raise about $2.8 billion at the sale, which is expected to keep the cash-strapped U.S. territory afloat through 2015.
The bonds, while tax exempt in all 50 states, are expected to require interest rates of 10 percent or more to compensate for Puerto Rico's junk-bond status and worries about a possible future debt restructuring.
Despite the risks, demand for the bonds is expected to be strong, as issuance in the $3.7 trillion municipal bond market has been extremely light so far this year. But at the Puerto Rico deal, non-traditional municipal bond buyers such as hedge funds that are able to take on the added risk are expected to dominate.
Much of the money raised in the GO deal would go to repay and refinance outstanding debt. Some would likely be used to restructure GO debt service, to refund floating-rate bonds and related swap agreements.
Robert Donahue, managing director of Municipal Market Advisors, said the deal could come as soon as this week.
The island has outstanding debt of about $70 billion and pays by far the highest tax-free rates of any big municipal bond seller. Its economy is in a nearly unbroken eight-year recession, which fuels population losses and high unemployment.
The island's senate earlier amended the bill so that investors in the deal could sue Puerto Rico in New York courts, possibly reflecting worries about a future restructuring. A previous version would have allowed investors to sue in any court in the United States.
Some officials in San Juan, however, worried about the prospect of borrowing billions at high rates to refinance debt and keep the government rolling. The U.S. federal government has repeatedly said it has no plans to offer aid to Puerto Rico.
"We are making this decision because of 30 years of irresponsibility. This emission is not for new public works; it's to keep the country afloat," Senate President Eduardo Bhatia said in approving the deal last Thursday.
Three prominent Popular Democratic Party senators - Antonio Fas Alzamora, Angel Rosa and Ramón Luis Nieves - voted against the measure, saying they believed "the moment has arrived to recognize that Puerto Rico's debt can't be paid."
"The measures taken have the effect of compromising the possibility of economic recovery," the senators said in a written explanation of their vote. "Continuing on this path in the interest of creditors is not good public policy."
The senators are calling for the start of talks with creditors to renegotiate Puerto Rico's long-term debt, something that Governor Alejandro Garcia Padilla and top members of his administration say is not on the table.
Keeping current on debt payments and operating within a balanced budget will require a $1 billion spending cut for the upcoming fiscal year 2015, according to the senators.
"A reduction of this magnitude will be fatal for economic growth, which is so necessary to combat the fiscal crisis," the senators added.
In assigning a provisional rating of Ba2 to the forthcoming bonds, with a negative outlook, Moody's Investors Service late last week made clear that Puerto Rico needed to go to market in order to retain sufficient liquidity.
"The Ba2 rating also reflects our belief that the commonwealth will raise enough cash in the upcoming financing to enable it to maintain an adequate liquidity profile through the end of 2015. Failure to raise sufficient funds in this transaction for Puerto Rico's pressing liquidity needs would have severe implications for the commonwealth's credit profile, and could result in a multi-notch downgrade," Moody's said.
Moody's mentioned the administration's "notable steps" to rein in debt and spending, reform the retirement systems, and promote economic growth, but said Puerto Rico has gone through a seven-year economic recession and still faces "uncertain prospects for future economic growth.
"Puerto Rico faces years of difficult decisions, as its debt and pension costs climb," Moody's said.