In its autumn outlook, published last November, the Commission expected that the Croatian economy would stagnate this year and grow 1.4% in 2014. However, in its report published on Friday, the Commission confirmed a projected decline of the Croatian economy in 2012 of 1.9%, citing a 1.9% year-on-year drop in GDP in the third quarter of 2012 and noting that the available data for the fourth quarter suggested a renewed contraction of economic activity.

The Commission highlighted persistent obstacles to growth.

"The Croatian economy continues to face both cyclical and structural headwinds. Contracting economic activity in many EU Member States, not least among some of Croatia's most important trading partners, will continue to weigh on the domestic economy in 2013," the report says.

It adds that Croatia's international competitiveness has been insufficient to prevent a declining trend in the country's export market share, while weak market conditions continue to exert downward pressure on incomes and spending.

"The high level of indebtedness of households and companies and their need to deleverage are curbing domestic demand. Credit conditions remain unfavourable. Consumer and business confidence are still subdued. There has also been little progress in lowering deep-seated structural obstacles to growth," according to the report.

In the current year, the upturn in investment and exports will still be insufficient to offset the drag from continued declines in consumer and government spending and rising imports, so the net result is projected to be a GDP contraction of 0.4% in 2013, the Commission predicts.

"In the following year, the balance of the various contributions to GDP growth turns positive, resulting in annual GDP growth of 1.0%," the report says. Rising exports, in combination with growing investments, will result in increasing employment and incomes and, ultimately, consumer spending, while private investments should be stimulated by Croatia's accession to the EU on July 1, 2013.

The Commission revised up its projections for Croatian exports in 2012, predicting a 0.2% increase instead of a 1% decline as initially forecast. However, it slightly revised down its projections for this year and the next, expecting growth in exports of 1.4% and 3% respectively. In its earlier projections, it had expected a rise in exports of 1.5% in 2013 and 3.3% in 2014.

"Fiscal policy has, to some extent, contained the negative budgetary consequences of the recession in 2012. General government expenditure stabilised while revenues increased due to a VAT rate-hike, other tax measures, and improving tax compliance. Consequently, the fiscal deficit is projected to have shrunk to 4.6% of GDP," the Commission said.

The fiscal deficit, however, is likely to remain high. It is expected to rise to 5.0% of GDP in 2013 due to the planned increase in expenditure of 3.5%, but should drop to 4.5% in 2014, which shows that the Commission has revised its autumn projections of 4.2% for this year and 3.9% for the next.

"Given the persistent fiscal deficits, the debt ratio is projected to continue its steady increase and to reach 60% of GDP in 2014," the report says.

This year the debt ratio is expected to rise to 57.4% of GDP, from the projected 53.6% in 2012. In its autumn report, the Commission projected the debt ratio at 53.8% of GDP in 2012 and its rise to 56.6% in 2013 and to 60.6% in 2014.

In line with the decline in economic activity, the labour market deteriorated further in 2012. Unemployment is projected to have increased to 15.8% in 2012 from 13.5% in 2011. In 2013, it is expected to increase to 15.9% and then fall to 14.9% in 2014. By comparison, the autumn report predicted an unemployment rate of 14.2% in 2012, its decline to 13.9% in 2013 and further to 12.9% in 2014.

Consumer price inflation is projected to remain relatively elevated at 3% in 2013, following the projected 3.4% in 2012. In 2014 the inflation rate is forecast to decline to around 2%.