Federal Reserve Bank of New York President William Dudley said the heavily indebted island of Puerto Rico must keep any new borrowing "strictly limited" in order to find a way out of its years-long crisis.

Dudley, speaking in San Juan, said the commonwealth's economy needs some big reforms to reverse a prolonged economic slump that could "easily be called a depression." Puerto Rico's economy has shrunk by an estimated 16.5 percent since 2007 and is forecast to contract by 2 percent in the year ending June 30, according to the island's Planning Board.

"A successful fiscal reform first requires a regime in which local officials recognize and accept the reality of the changing economic situation, and set spending budgets accordingly, Dudley said in his prepared remarks. He also pointed to the island's high cost of doing business, elevated energy costs and "deeply concerning" population outflow.

The Fed speaker also suggested having an independent fiscal monitor in place "on an ongoing basis" to deliver objective -- and potentially unpopular -- analysis. The magnitude of the crisis in Puerto Rico led President Barack Obama to enact a rescue law in June that empowers a federal board to chart a turnaround plan and oversee negotiations aimed at cutting the island's $70 billion debt.

Using New York's major fiscal crisis in 1970s as an example, the Fed speaker stressed that economic transitions are not easy and can take a long time to complete. "For 10 years, the city could not access the debt markets without support from the state," Dudley said. "In the case of New York City, the transformation was from manufacturing to services, and it took a generation to complete."

In response to audience questions, Dudley said Puerto Rico is likely to regain access to markets after a "viable" fiscal plan is approved. Members of the Financial Oversight and Management Board for Puerto Rico agreed to have a financial turnaround in place by the end of January.

Puerto Rico has been defaulting on a growing share of its $70 billion debt as Governor Alejandro Garcia Padilla's administration conserves cash to avoid shutting off services to the island's 3.5 million residents, nearly half of whom live in poverty. The crisis stems from a legacy of government borrowing while the island was mired in recession.

Garcia Padilla's successor, Ricardo Rossello, has pledged to work with the federal board to implement public policy. That's a break with Garcia Padilla's administration, who's refusing a U.S. oversight board's request to redraw his fiscal plan to add additional spending cuts.

Bloomberg News