* IMF says Bulgaria economy is already contracting
* Sees GDP declining 3.5 percent in 2009, 1.0 percent in 2010
* Forecasts budget deficit unless spending cuts are made
* Fiscal surplus needed to bolster currency board
(Updates with details, background)
By Tsvetelia Ilieva
SOFIA, April 22 (Reuters) - The Bulgarian economy will shrink this and next year and the government must curb spending to cope with the global crisis and avoid slipping into deficit, the International Monetary Fund said on Wednesday.
The IMF, ending a week-long mission in Sofia, said falling industrial output and sales indicated the east European country was already shrinking and forecast a contraction of 3.5 percent this year and 1.0 percent in 2010.
This would be the first economic contraction in Bulgaria since 1997 when a severe financial and economic meltdown wiped out a third of the Balkan country's banks.
The IMF had previously forecast growth of 1.0 percent for 2009 after an increase of 6.0 percent in 2008.
The Fund repeated its warning the European Union newcomer's 2009 budget was far from tight, despite aiming for a surplus of 3 percent of GDP, and the government had to curb spending.
"Without spending cuts it (the budget) could result in a deficit of 1.0 percent of GDP," IMF mission chief Bas Bakker told a news conference. "Keeping a surplus is important to ... maintain confidence in the currency board."
He said Sofia was committed to maintaining fiscal prudence and the IMF was confident it would curb spending further. The Socialist-led government has limited spending to 90 percent of the budgeted amount in response to the crisis and frozen plans to raise public sector salaries by 10 percent.
Bakker said the Fund believed there was room for further cuts mainly in operating and maintenance costs, government subsidies, public wages and investment.
Analysts have warned the government's plummeting support and rising public unrest before July parliamentary elections could raise temptations to untie the public purse.
Prime Minister Sergei Stanishev has said he will not allow any loosening. Bulgaria operates under a currency board regime which pegs the lev to the euro and limits monetary policy, leaving fiscal policy as the main tool to steer the economy.
NO FUNDIMG DEAL FOR NOW
Bakker said the Fund expected Sofia to produce a surplus of about 1.0 percent of GDP this year to counter risks arising from its huge external imbalances and confirmed the government had not asked it for a loan to help it cope with the crisis.
A growing number of economists say Bulgaria might be the next in line after Hungary, Latvia, Serbia, Romania and Poland to seek IMF aid to protect its economy.
Stanishev told Reuters in an interview last month his country did not need IMF aid for now and it would only send a negative signal.
After years of booming growth driven by strong credit lending and hefty foreign investment, east European countries are now suffering as the main EU export markets drift into recession and investors flee emerging economies.
Bulgaria's growth of about 6 percent annually in the past few years has come at the expense of a huge current account deficit and private foreign debt, making the country exposed to the global cash squeeze.
The IMF said Bulgaria had considerable foreign currency and fiscal reserves and its banking system had remained stable due to its prudent policy in the past few years.
"To maintain confidence, it is important that these buffers not be eroded quickly, and policies adjust to the worsened reality in a timely manner," Bakker said. (Editing by Andy Bruce)