'The spark of the external economy hasn't yet spilled over to domestic demand. But signs are increasing that point to an imminent recovery of the domestic economy,' the report said.

The economy contracted 0.1 per cent last year. Domestic consumers' reluctance to spend against the backdrop of high unemployment haunts the economic outlook.

There are about 4.41 million unemployed in recent estimates. The jobless rate in the east of the country is 18.5 per cent, more than twice the 8.6 per cent in the western side.

Consul-General Heinrich Wilhelm Beuth said the economy's growth rate was flat, though the International Monetary Fund forecast a 1.6 per cent increase for the year.

However, companies were doing well, he said.

'When you look at the first six months results year on year, all the blue-chip stocks are doing extremely well. Many of them rely on exports, with the core sectors being chemicals and heavy machinery. What is lagging is domestic consumption. Consumers do not have enough confidence, given the unemployment [level] and looming cuts in the social welfare sector.

'The retail sector is doing badly. When shops are empty, it has a bad psychological impact.'

The government, led by Chancellor Gerhard Schroeder, is pushing an ambitious structural reform plan to upgrade the country's competitiveness.

The controversial Agenda 2010 package includes moves to cut government outlays for pensions, health care, unemployment allowance and other social welfare benefits. Many of the changes came into effect in January, and more are on the way.

Finance Minister Hans Eichel recently set out a financial plan for this year to 2008 in which there were provisions for continuing the reform programme.

Dr Beuth said it was essential to implement the structural reforms because there was a need to cut outlays in the health sector, pensions, unemployment allowances and social security benefits. He said debt levels had reached unacceptable proportions and the situation could not afford to worsen.

'We hope, once the programme is well under way, we'll see the economic benefit in terms of renewed confidence and renewed competitiveness,' Dr Beuth said.

'We can then have a higher growth rate on a national level.' Dr Beuth said this would take some time.

The new welfare policies have attracted criticism from opposition parties, and many eastern Germans were publicly protesting cuts in social benefits.

Mr Schroeder vowed to hold his reform course and insisted the proposed changes would make the economy more competitive.

Government officials said the economy would be in dire trouble if the reforms were not implemented.

Germany has a population of about 82.5 million. The lingering economic burden following the reunification of the former communist east and capitalist west in 1990 has been a subject of debate for years. The government hopes labour market reforms and signs of an economic revival will help improve employment conditions.

There are calls from economists and industry experts to further ease job protection rules and relax the rigid controls on employment contract agreements.

In keeping with efforts to boost competitiveness, pressure to lengthen Germany's working week appears to be picking up momentum. Some enterprises have reached an agreement with employees so they work longer weeks to save jobs and cut costs. Shops used to close at 2pm on Saturday. Some now open until 8pm over the weekend.