Finance Minister Bill English says New Zealand has weathered the worst of the economic downturn, but still faces significant challenges.
The Treasury has issued its Half-Year Economic and Fiscal Update which shows unemployment peaking within the next three months, at 7%.
Government debt forecasts are lower than those made at the time of the Budget in May.
The deficit is now forecast to be 2.9% of GDP compared with the Budget forecast of 5% of GDP.
Mr English says the economy did not contract as predicted in the Budget and is now growing more quickly, but exporters still face a high exchange rate and uncertainty in key markets.
He says unemployment will stay high and the deficit will remain until 2014 despite the improvement in outlook.
Prime Minister John Key says people can go into the Christmas holidays confident the economy is on the mend, but there's no room for the Government to relax its restraint on spending.
He says its plan remains to get the budget back into surplus and to pay off public debt.