The International Monetary Fund cut its growth forecast for Italy on Thursday in a downbeat yearly report that said prospects for the eurozone's third largest economy remained weak and unemployment was "unacceptably high".
The IMF said in a report it expected the economy to contract by 1.8 percent this year, from an earlier forecast for a 1.5-percent shrinkage.
It predicted the economy would then grow by 0.7 percent next year but warned of possible stumbling blocks such as policy slippage and tighter credit.
A prolonged recession would increase banks' non-performing loans, especially for small businesses and the construction sectors and "raise concerns about the country's fiscal position."
The tentative recovery would come largely from export earnings and a "modest" turnaround in investment due to the scheduled payment of billions of euros (dollars) arrears that the state owes to private contractors, it said.
The government should speed up reforms and implement long-delayed privatisations, the Washington-based body said in its yearly report.
"Accelerating the momentum for reform will be essential to jumpstart growth and create jobs," it said, warning market sentiment remained "fragile".
"Italy's growth prospects over the medium term will strengthen only with the implementation of comprehensive reforms," it said.
The IMF also said it was opposed to the abolition of a property tax on primary residences, as demanded by former prime minister Silvio Berlusconi's main centre-right party.
"The property tax on primary residence should be maintained because it is more efficient compared to other taxes," said Kenneth Kang, assistant director of the IMF's Europe department.
Kang added: "After nearly two years of recession we see signs the economy is stabilising... The risk of crisis has certainly diminished".
But he said structural reforms were crucial, including cutting electricity costs, slashing red tape and overhauling the justice system.
He also said the low employment rate for young people and women should be brought closer to the European level -- a move that could increase gross domestic product (GDP) by as much as 2.5 points.
Kang said one way to boost employment could be to have "a more flexible and open-ended contract" in which job protection would increase over time.
This, he said, would make it easier for young people to join the workforce since employers are not keen on increasing current permanent contracts.
The also called for greater effort to boost low productivity and declining competitiveness, as well as lower taxes on labour and capital.
It also warned the recession had "eroded Italian banks' asset quality and profitability".
The IMF report came as new data showed the public deficit had widened to 7.3 percent of gross domestic product in the first quarter compared to 6.6 percent in the same quarter last year.
The level was the highest reached since the first quarter of 2010 when it was at 7.6 percent.
The Istat data agency said the tax burden had also risen to 39.2 percent in the first quarter -- 0.6 percentage points higher than last year.