By Aaron Kuriloff 

The Federal Reserve Bank of New York weighed in on the financial woes of Puerto Rico Thursday with a report that says the island should overhaul its tax policies, its management of utilities and its budget practices to reinvigorate its economy.

The commonwealth faces serious fiscal challenges related to its continuing weak economic performance, William Dudley, president of the bank, wrote in the foreword to the report, an update of a 2012 study on Puerto Rico's economy originally requested by island officials and business owners. Mr. Dudley highlighted persistent government budget deficits and failures to shore up cash for operations of the island's public agencies such as water, transportation and power utilities.

As the Puerto Rico Electric Power Authority, known as Prepa, is contemplating a possible restructuring of about $9 billion in total debt, Mr. Dudley said the island should consider making changes to its policies that may include "sacrifice." The report didn't specify exactly how Puerto Rico should adjust its policies.

On Thursday, Prepa faces a deadline to make payments on or extend lines of credit with Citigroup Inc. unit Citibank and banks led by Scotiabank de Puerto Rico, a unit of Bank of Nova Scotia. Extending the loans would help the power authority overcome its short-term cash crunch and avoid more uncertainty about its future, which is roiling the market for Puerto Rico bonds.

Officials have been contemplating restructuring the power authority's debt after island lawmakers in June approved legislation allowing such an overhaul. The law doesn't allow Puerto Rico to restructure its general-obligation or sales-tax debt.

Strengthening the performance of the island's large, heavily-indebted public corporations is one of six recommendations made in the New York Fed's report. The island should reform the public entities' governance and ownership structures, consider privatizing them, and limit lending to them from the island's Government Development Bank.

"For any financial reform agenda to be successful, it must confront this issue head-on," the report said.

Reforming the tax system could also increase growth by broadening the tax base while reducing rates, the report said. Improving financial reporting on the island should also increase access to financial markets, it said, adding the commonwealth should adopt a capital budget and a binding balance-budget amendment, as well as a legislative framework for multiyear budgeting and specific fiscal targets.

Write to Aaron Kuriloff at aaron.kuriloff@wsj.com

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