WASHINGTON - The International Monetary Fund (IMF) said Tuesday that Italy's economy would remain vulnerable to downside risks, urging the country to keep reform momentum.

"The economy is expected to continue contracting through the year owing to tight financial conditions, the global slowdown, and the needed fiscal consolidation," the IMF said in its annual Article IV economic consultation report.

It expected the recovery would take hold in early 2013, led by a modest pickup in exports, but would lag behind the rest of the region.

The IMF warned the downside risks to the outlook which would stem mainly from an intensification of the euro area crisis, predicting that Italy's economy would decline by 1.9 percent in 2012 and 0.3 percent in 2013.

The report noted the pressure on Italian banks, saying despite progress made in strengthening their capital positions and raising private capital, the banks still relied heavily on support from European central bank and faced increasing sovereign risk and rising funding costs.

The IMF emphasized that locking in prudent medium-term policies to reduce the high level of public debt would further improve confidence. It welcomed the government's increased focus on targeting a structural balance to ensure flexibility in fiscal policy and encouraged the government to rebalance the adjustment towards expenditure cuts and lower taxes. "The recently announced package of spending cuts is a step in the right direction," it noted.

The IMF forecast that the country's deficit-GDP ratio would decline further to 2.6 percent from 3.9 percent last year, stressing that more should be done over the medium-term to strengthen the fiscal outlook.

The global lender also noted that reviving growth will require not only comprehensive reforms in Italy, but also progress at the European level in strengthening the currency union.