The IMF delegation issued its concluding statement on findings of its mission on Wednesday in which it welcomes recently announced public sector wage cuts and intended pension and health sector reforms as "steps in the right direction."

"However, further enhancements as well as swift and front-loaded implementation are needed to rein in the unaffordable pension and health care spending."

"In the financial sector, it is important to keep striking the right balance between safeguarding financial stability and supporting credit growth recovery," reads the statement in which the IMF also welcomes the Zoran Milanovic cabinet's intention to revise the 2013 budget.

"The mission supports the government plans to raise the penalty for early retirement and the retirement age to 67 for both men and women at a pace of six month per year, stop indexation of privileged pensions, and tighten control over the apparently abused system of disability retirement."

The mission believes that in order "to speed up their beneficial effect, it is important that these reforms become effective already in the second half of 2013."

It also warns that "economic conditions have deteriorated since mid-2012 and risks to the outlook are substantial."

"GDP likely contracted by 1.8-2 percent in 2012 amid weak external demand, continuing debt reduction by households and businesses, and rising unemployment that is sapping consumer confidence," reads the statement.

"Strengthening of economic activity in 2013 would depend mainly on the timely realization of the large public investment plans."

"However, possible delays in their implementation, negative growth surprises in Croatia’s main external partners, and further bank credit contraction pose important downside risks to the country’s economic prospects."

"The challenges Croatia is facing demand comprehensive, ambitious, and steady policy response," the mission said adding that it sees three immediate priorities.

In this context, Zagreb is urged to "rapidly move on the structural reform agenda to improve Croatia’s competitiveness and boost medium-term growth," and "to continue with the gradual but steady fiscal consolidation to restore debt sustainability and retain market access at reasonable cost, " as well as "keep an appropriate balance between enhancing financial stability and supporting recovery in credit growth."

The Croatian government is urged "to enact long-overdue reforms in the pension system and the Labor Law, and ease barriers to investment."

In this context the statement notes that "the planned Labor Law amendments appropriately aim to enhance the functioning of the labor market, but could be more ambitious in the areas of reducing hiring and dismissal costs, including for poor performance, and allowing firms to opt out from onerous sector-level collective agreements."

"Moreover, the mission recommends that the authorities facilitate agreements between the social partners to bring labor remuneration in line with business conditions."

The mission believes that "the recently adopted Law on Strategic Investments will ease the implementation of large investment projects. However, more needs to be done to reduce investment barriers at the local level for all projects and speed up the privatization process."

The mission warns that "the current trajectory of public debt remains unsustainable and interest costs are rising rapidly, crowding out productive expenditure."

"The longer this process continues, the larger and more disruptive the eventual adjustment will be. Moreover, the recent loss of the sovereign’s investment-grade credit rating raises Croatia’s vulnerability to a rise in interest costs for public and private borrowers and further hits on growth and fiscal soundness should the current benign international financial environment worsen again. To minimize these risks, the government must dispel doubts about its commitment to fiscal consolidation by rapidly implementing further adjustment policies that will put the budget back on the consolidation track."

The mission greets the adjustment achieved in 2012 as "a welcome first step". "However, the 2013 budget partly reverses the gains from 2012 and needs additional policy measures to establish its credibility," the IMF warns.

"While the recently announced 3 percent wage cut in the public sector should broadly ensure the budgeted wage bill reduction, the planned savings in pension/health spending are not sufficiently supported by explicit policies yet, although medium-term policy intentions in these areas are encouraging."

"To move toward debt sustainability and reduce the risk of a loss of market access, the mission recommends targeting a structural deficit of 21 percent of GDP in 2013, which is estimated to translate into a headline deficit of 31 percent (ESA 95)."

In this context the mission recommends that such targets can be achieved by swift implementation of the planned pension reforms, with the new parameters effective already in 2013; by determined cost-cutting in loss-making hospitals, rationalization of the hospital network, and limiting exemptions to co-payments to support the budgeted reduction in health care spending by reducing inefficiencies and waste and improving targeting of benefits; and, by further cuts in other current expenditure, including subsidies, while protecting essential capital expenditure.

The mission also support the Croatian government's objectives "to enhance the financial system’s resilience to shocks while fostering credit growth recovery and corporate debt restructuring."