European Union accession is expected to boost Croatia's economy over the medium term and a long and rigorous preparation process for that will be beneficial, the EBRD says, adding that the country will also have access to EU Structural Funds.

"To maximise the potential, growth prospects need to be boosted by further reforms of the public administration and towards higher competitiveness," the bank's analysts say in an outlook on the occasion of Croatia's EU accession on July 1.

"The new government has proposed a number of important reforms. Effective implementation will be challenging, in particular with regard to the labour market and reducing the public sector's role in the economy," the outlook says, adding that Croatia's business environment leaves significant room for improvement and efficiency increases.

The EBRD predicts that GDP growth will contract 0.3 per cent this year because of the impact of the Eurozone crisis and structural domestic reasons. "Household consumption continues to decline, while investments and exports of goods are further falling."

The budget deficit was brought down to three per cent of GDP through adjustment of expenditures, which reflects the government's determination to reassure markets following recent downgrades of Croatia's sovereign debt by two of the three main credit rating agencies, the bank says.

It adds that the banking sector is well-developed, liquid and well-capitalised, with an average capital adequacy ratio above 20 per cent. "However, credit growth has continued to slow down, the level of non-performing loans has been rising and cross-border deleveraging continued throughout 2012."

The economy is exposed to a number of vulnerabilities such as insufficient competitiveness, a large public sector, significant external debt and the high "euroisation" of the economy, the EBRD says, adding that Croatia has a well-developed financial sector and has made significant progress in infrastructure development.

"However, the role of the state remains large... and major enterprises and financial institutions continue to rely on state subsidies. The business leaves room for improvement which ranges from cumbersome permit processes to the enforcement of judicial decisions. The implementation of a credible reform programme will be the key challenge for a return to growth. This should include a higher participation rate of the private sector in infrastructure and energy and successful privatisations in the financial sector."