By Igor Ilic
OPATIJA, Croatia, May 14 (Reuters) - Croatia needs to change its growth structure and avoid relying on domestic demand, which generates external and internal imbalances, central bank governor Zeljko Rohatinski said on Thursday.
The European Union candidate's economy has been growing around four percent a year during the past decade, based on tourism receipts, state investments and consumer spending, most of it drawing on borrowed foreign funds.
"Such growth generates fundamental external and internal imbalances and overall indebtedness. The way out is to narrow substantially those imbalances, whose financing has become highly limited," Rohatinski told an economic conference in the northern Adriatic resort of Opatija.
At the end of March, Croatia's foreign debt stood at 39.1 billion euros ($53 billion), or more than 90 percent of its gross domestic product. The current account deficit at the end of 2008 reached 9.4 percent of GDP.
Reduced foreign capital inflows this year exposed the kuna currency to the strongest downward pressures in years, which only eased in recent weeks as the market started preparing for a government Eurobond issue, due in the next few weeks.
Croatia's financial sector has weathered the crisis well but Rohatinski said the real economy had yet to face the toughest challenges -- falling demand and increasing liquidity problems.
"Exports of goods and services are expected to fall 10 percent this year. Foreign direct investments could contract by 50 percent, while overall foreign debt is likely to remain at the current level," he said.
SLASH SPENDING
He said the central bank has in recent months reduced immobilised liquidity by around 10 billion kuna ($1.85 billion) to 41 billion kuna to counter the crisis. Its room for manoeuvre has therefore narrowed.
"We will boost liquidity only as much as it does not destabilise the kuna exchange rate which, in the current circumstances, has become a vital anchor for the economy," Rohatinski said.
The current account deficit should shrink to around six percent of GDP this year, while the economy is expected to contract around four percent, he said in comments seen by analysts as a prod to the government to cut spending.
Zdravko Maric, state secretary at the finance ministry, told the conference the government was well aware of the need for further fiscal adjustment.
"Last year the budget gap was slightly below plan. This year we have already slashed expenditures by some eight billion kuna and we are following developments practically on a daily basis. Several key months are ahead of us," Maric said.
Croatia needs strong receipts from the summer tourist season to soften the blow of the crisis, but Rohatinski said there was only so much tourism could do -- even in a good year -- to offset the merchandise trade gap of 23 percent of GDP.
Analysts have said more spending cuts, after those in March, may be needed in the autumn as tourism figures were likely to disappoint. Some say a deal with the International Monetary Fund might then be needed. (Reporting by Igor Ilic, edited by Zoran Radosavljevic and Victoria Main)