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NY Fed urges Puerto Rico to pursue economic reforms now to avoid 'painful adjustment'

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SAN JUAN, Puerto Rico - New York's Federal Reserve Bank warned on Thursday that Puerto Rico needs to improve its financial health soon or face a "painful adjustment."

The report came as the island's power company once again reached an agreement with lenders to extend a deadline to make payments on $671 million it owes to banks.

The 30-page report makes several recommendations that the New York Fed believes are needed to help push the U.S. territory out of a nearly decade-long economic slump.

"The island appears to face two alternatives: either manage its own economic adjustment and put the Commonwealth on a secure fiscal basis, or wait for outmigration and the discipline of the market to force an even more painful adjustment, particularly for those unable or unwilling to leave the island," it said.

William Dudley, president of the New York Fed, questioned whether Puerto Rico's level of debt can be sustained and said the government's challenge will be to revive the economy without accumulating more debt. The island is struggling with nearly $73 billion in public debt after having sold a record $3.5 billion in general obligation bonds in March despite having its credit rating downgraded to junk status.

After a brief uptick in 2012, Puerto Rico's economy has stagnated since 2013, the report said. It said the island of 3.65 million people has a 45 per centlabour force participation rate and has seen a significant drop in population. Puerto Rico also struggles with a largely uneducated working-age population, although the number of people with a college degree increased from about 25 per cent to nearly 28 per cent between 2010 and 2012.

Analysts recommended Puerto Rico shrink its underground economy, broaden its tax base and reduce rates, and strengthen and possibly privatize some public corporations, which account for nearly 40 per cent of the island's debt. They said the government also should approve legislation requiring the creation of a long-term budget as well as provide more transparency in its financial reporting.

"Puerto Rico's unique status means that it is one of the few places in the world where finances are not regularly surveyed by a public agency," the report said.

The administration of Gov. Alejandro Garcia Padilla has taken numerous steps to help boost the economy, including implementing changes in public pension plans, streamlining its business registration and permitting process and cutting expenditures. Garcia also appointed an advisory group for tax reform that is expected to release a report by year's end with plans to implement it by fiscal year 2016.

"We've achieved substantial results," he said in a statement. "There is more work to be done, and we continue to execute on a comprehensive plan to drive economic growth and fiscal stability."

U.S. investors remain wary of a new law that allows certain public corporations to work with creditors and restructure their debt. Many speculate the island's Electric Power Authority may be the first to take advantage of the law given its $9.3 billion debt load.

The agency was supposed to make payments Thursday on credit lines held with Citibank and Scotiabank, but lenders agreed to extend the deadline to Aug. 14 as officials continue to meet with U.S. investors.

Also on Thursday, Puerto Rico's representative in the U.S. Congress, Pedro Pierluisi, filed a measure that would allow the island's public corporations to seek federal bankruptcy protection under Chapter 9. Currently, U.S. municipalities are able to file under Chapter 9, but Puerto Rico is barred from doing so.

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