Updated on June 30, 2015

Puerto Rico is a small island with some big financial problems. Governor Alejandro Garcia Padilla recently told The New York Times that there was no way the island, which has been struggling with about $72 billion of debt, would be able to pay, and instead would try to work out new deals and deferred payments with some of its creditors. This, of course, has lead to fears that the commonwealth will default on its loans.

The admission that Puerto Rico’s finances are much worse than originally thought was spurred by a report commissioned by the Government Development Bank, an agency tasked with developing economic and financial strategies for the commonwealth, and conducted by current and former IMF staffers. The report, nicknamed The Krueger Plan for its lead author Anne Krueger, doesn’t mince words when it comes to the outlook for the debt-laden island: "Structural problems, economic shocks and weak public finances have yielded a decade of stagnation, outmigration and debt. Financial markets once looked past these realities but have since cut off the commonwealth from normal market access. A crisis looms.”

Puerto Rico’s problems are large and interdependent, which makes solving them a complex and difficult task. Tourism is down, employment is low, poverty is high, and the island has suffered through the economic pain of falling home values, rising oil prices, and overall decreased competitiveness.

Employment stands out as a terrible problem: Only 40 percent of adults are working or looking for work (compared to 63 percent across the U.S.).  Relative to local incomes, federal minimum wages and welfare benefits are pretty high (Puerto Rico follows federal law), which means companies hire less because of burdensome costs, and workers lack incentive to work, since they know that welfare benefits can provide similar income. Without more jobs available, those who do want to work struggle to find employment and often head to the mainland—contributing to nearly a decade of population loss.

Puerto Rico’s tenuous situation and potential debt default haven’t come as surprises. For years, the island has relied heavily on borrowing via bonds to cover the costs of everything from pensions to government services. Even as the economy shrank, public-sector debt grew. “The economy is in a vicious circle where unsustainable public finances are feeding into uncertainty and low growth, which in turn is raising the fiscal deficit and the debt ratio,” the report found.

The problem goes beyond temporary economic weakness, the report goes on to say, and includes the staggering failure to adequately account for revenues and expenditures. For instance, the report finds that revenues were consistently overestimated by about $1.5 billion each year, while the government drastically underestimated the amount it would have to pay out in tax refunds. And even mid-year corrections did little to stem spending, since the Office of Budget and Management has no power to enforce budget cuts, setting Puerto Rico up for a consistent shortfall.

While the recent news focuses on the immediacy of whether or not Puerto Rico will be able to pay its debt—such as the $94 million due on July 15, or the $140 million due on August 1—the problem goes beyond the need for a new payment plan. Puerto Rico’s economy is in serious trouble.

“This has been obvious for a couple of years now,” says Barry Bosworth, a senior fellow of economic studies at the Brookings Institution, who notes that the island’s debt has been steadily downgraded for years, a sign that trouble was brewing. To make matters worse, unlike Detroit or other municipalities, Puerto Rico doesn’t have the option of filing for bankruptcy, leaving few options in the face of a debt crisis.

Those invested in Puerto Rico’s bonds, which have been used to finance the struggling commonwealth for years, will certainly face losses as bonds lose value in the face of default. But the biggest impact will be for the people of Puerto Rico: The report includes recommendations like restructuring debt payments, increasing taxes, cutting back on teachers (the number of teachers has grown 10 percent in the past decade as the number of students declined 40 percent), reducing subsidies to the University of Puerto Rico, and reductions in benefits for government safety nets such as Medicaid and minimum wage.

But even the potential success of the plan outlined in the report may not be enough to salvage the economy in the long run. “The trouble with the financial restructuring and debt relief is that if you don’t have a plan in place, you’ll need a second program,” says Bosworth. “That’s not going to solve their problem.” And cuts to government aid programs may only serve to accelerate the number of Puerto Ricans leaving the island in hopes of creating a better life on the mainland, where poverty is lower and jobs more plentiful. Real change would require steps that seem unlikely, like intervention by the federal government—which has thus far taken a hands off approach, with the White House saying Monday that they would not step in for a bailout—or a plan that would entice multinational firms to do business in the Puerto Rico. Neither option seems feasible at the moment, says Bosworth.

“There’s a lot of focus on debt, but the steady deterioration of the economy is the bigger problem,” he observes. “It’s going to get pretty grim.”

On Monday evening, Garcia Padilla made a public address in which he talked about the creation of a Working Group for the Economic Recovery of Puerto Rico, which will be responsible for steering long-term plans to shore up the island’s financial future. In his speech, the governor said that success would require sacrifice from everyone, including bondholders. “If we don't take responsibility today, we risk having no solutions at our disposal,” he said. “We will not permit the heavy weight of inherited debt to bring us to our knees. ”