The statement, published on the website of the Croatian National Bank, says that attaining sustainable medium term growth will require a considerable policy shift, as recognised in the government's recently adopted Economic Recovery Program.

The IMF mission calls on Croatian authorities to implement as soon as possible as many measures as possible that would reduce public spending and improve efficiency of the economy.

The mission expects economic activity to start improving in the second half of 2010. "Performance indicators in the first months of this year remain mixed: while the fall in industrial production has stopped, the construction sector and retail services continue to contract. We expect private consumption and investment to be dampened by declining disposable income and profits, further increase in unemployment, weak credit conditions, and high private sector indebtedness.

"The recovery - mainly driven by net exports and inventories' restocking - is thus likely to be fragile. Overall, we expect zero economic growth and average inflation of about 2 percent in 2010," the mission says in the statement.

Risks to the near-term outlook are tilted to the downside. External vulnerabilities remain substantial, with a large stock of external debt and sizable external financing needs in 2010, according to the statement.

The mission thus projects the 2010 general government fiscal deficit to reach 3.6 percent of GDP.

While the mission sees merit in the planned reduction in personal income taxation rates given that they are high relative to Croatia's peers, limited fiscal space and large financing needs imply that expenditure consolidation and structural reforms should be pursued first.

The authorities' measures to stimulate credit to the economy require caution, the mission says, adding that close supervision of the quality of the issued loans should be ensured.

The proposed scheme to exchange debt of some troubled companies to the government into equity should not go against the spirit of intended privatisation efforts and only be used for companies with viable restructuring plans.

Looking ahead, attaining sustainable medium term growth will require a considerable policy shift, as recognised in the authorities' recently adopted Economic Recovery Program, the mission says, adding that in the medium-term, growth is unlikely to exceed 3 percent.

"Attaining higher and sustainable growth rate in the long run will require concerted efforts focusing on (i) income and structural policies to enhance competitiveness and rebalance economic growth in favor of tradable sectors, and (ii) medium-term fiscal consolidation to remove existing inefficiencies, reduce vulnerabilities, and provide adequate room for policy maneuver in the future."

Boosting external competitiveness will require costly, but necessary internal adjustment, which should be achieved through competitiveness-enhancing income policies relying on wage restraint, with public sector taking the lead, and through productivity-enhancing structural reforms, says the mission.

Over the medium term, it would be appropriate to pursue fiscal consolidation that would bring the overall fiscal balance to zero and put the public debt-to-GDP ratio on a downward trajectory.

The mission is encouraged that the principles of the Economic Recovery Program go to the heart of many of the reform areas outlined above and urges the authorities to frontload measures that would reduce public expenditure and improve efficiency of the economy.

"These include reducing the size of the public administration, completing reforms in pension, health and social assistance expenditures, stepping up privatization, and reforming the labor law to introduce greater labor market flexibility and participation," reads the mission statement.