Prospects for growth remain weak and the UK is "still a long way from a strong and sustainable recovery", according to its annual economic health check.
Worryingly, assessors warned there is a key risk that persistent slow growth could "permanently damage medium-term growth prospects". After five years of relatively weak activity "additional measures are needed to raise long-term expectations of potential growth", according to the report.
Earlier this month, the Chancellor insisted the Government's plan was working and there would be no change in direction. But the new article four report, which comes after economists spent two weeks in London carrying out an in-depth assessment of Britain's fortunes, is likely to be seized upon by Labour as backing up their calls for a "plan B" to revive the economy.
The IMF said there are encouraging signs of some improvement in conditions, pointing to "notably strong" growth in private sector employment, increased demand for vehicles, and improvements in business and consumer confidence. Despite recent improvements, however, Britain's GDP remains 6% below pre-crisis levels, "making this the weakest recovery in recent history".
The IMF backed monetary policy measures unveiled by the Chancellor in the March Budget and changes to the Funding for Lending Scheme aimed at boosting business growth. It also said the Government's medium term plans have earned it "credibility". "Reducing the large structural deficit over the medium term is essential," it states. But planned fiscal tightening "will be a drag on growth", the IMF warns.
It calls on the Government to consider a range of measures, including bringing forward planned capital investment to fuel growth, and reviewing areas of corporate tax as well introducing reliefs for raising equity. A reform of property taxes and imposing VAT on a wider base could cover the cost of the measures, it suggests. But the IMF issued a warning over Help to Buy, the Government's flagship Budget measure aimed at boosting growth, suggesting there is a risk it would ultimately lead to higher house prices, which would "work against" the aim of boosting access to housing. The Government should also pursue with "greater vigour" investment in infrastructure and banking sector reforms.
Mr Osborne told a press conference to launch the report at the Treasury: "Britain will not duck its economic challenges. We will not avoid the difficult choices we need to make to have a more balanced and sustainable economy that delivers prosperity for our country. The analysis and the scrutiny of the IMF will help us to do that."
Lib Dem minister Danny Alexander told BBC Radio 4 the IMF report showed the coalition's strategy was correct. He said: "I think that far from the kind of great row that was predicted, in fact what we've got here is a sensible contribution, an interesting set of analysis about the British economy which makes clear that the IMF view that the fiscal consolidation that was set out over the medium term is exactly the right strategy that urges us to do some more things to support growth. The things that the IMF recommend, such as bringing forward investment, is precisely what we've been doing."