The report on US government assistance to and cooperation with East European countries said that over the past year Croatia had made significant, although uneven progress in meeting Western democratic standards.
The report said that in its first year in power, the Croatian Democratic Union (HDZ) had surprised many critics by staunchly implementing a policy oriented towards reform and Euro-Atlantic integration.
Croatia was given European Union candidate status and led the way in regional cooperation and reconciliation, read the report.
The State Department said, however, that Croatia's democratic transition continued to lag behind northern transition countries, notably in the rule of law, public administration and combating corruption.
The report praised economic and social reforms, highlighting macroeconomic stability and a solid economic growth. It said that Croatia had agreed with the International Monetary Fund to cut the national deficit to 4.5 per cent in 2004, 3.7 per cent in 2005, and to below three per cent in 2007.
The report said that despite promises, the Croatian government had not carried out the privatisation process swiftly.
The section covering security underlined that Croatia had continued to progress towards Euro-Atlantic and regional security institutions and developed good relations with countries in Southeast Europe, which the report said was crucial for the realisation of the US goal of strengthening security in the Balkans.
In 2004 Croatia made significant headway in meeting criteria for NATO membership, and NATO assessed Croatia's annual national plan to reform the armed forces the best so far, said the report.
Croatia has the potential to become a strong regional leader in security issues and US assistance is directed towards the realisation of that goal, the report added.
It noted that Croatia's ability to train its troops according to NATO standards was limited because of financial restrictions and the loss of US military aid following Croatia's refusal to sign an agreement against the extradition of Americans to the International Court of Justice.
The report added, however, that the US Department of Defence had continued to help the reform of the Croatian armed forces through other bilateral and multilateral activities.
In the fiscal year 2004, the United States set aside 28.89 million dollars for Croatia, of which 24.85 million came through the Support for East European Democracy (SEED) programme.
The US plans to cancel SEED assistance to Croatia by the end of 2006, assessing that by that time Croatia will have progressed sufficiently in terms of reform and will not need the assistance anymore.