ZAGREB (Reuters) - Croatia acknowledged on Thursday it would not be able to cut its budget deficit this year, as required by law, due to its long recession and the government's efforts to repay earlier debt.

Croatia joined the European Union two months ago and is soon expected to be placed in the Excessive Deficit Procedure (EDP), a mechanism designed to enforce a target ceiling of three percent of GDP for budget deficits.

The country's own fiscal rule, adopted independently in 2010, requires the government to reduce spending by at least one percent of gross domestic product (GDP) each year, until a balanced budget is reached.

"After five years of recession we cannot satisfy the fiscal rule," Finance Minister Slavko Linic told a cabinet session on Thursday.

Croatia, which gained independence from Socialist Yugoslavia in 1991, has been running up deficits for years on welfare spending and subsidies to agriculture and loss-making firms. On top of that, its economy has been shrinking since 2008, denting budget revenues.

Linic said debt servicing costs are driving up spending.

"We will soon propose a new fiscal rule which we've prepared in consultations with the European Union and the International Monetary Fund," he said.

"In the first eight months our central government budget gap amounted to more than 13 billion kuna (1.4 billion pounds) or 3.8 percent of GDP."

The government still officially targets a central government budget gap of 3.0 percent of GDP and a general budget gap of 3.4 percent of GDP for 2013 as a whole, but the figures are likely to be revised later this month.

Linic did not provide new full-year expectations or say how the higher deficit could be covered, adding only that he expected some improvement in revenues in the next four months.

Since late 2008 until this year Croatia has lost some 10 percent of its GDP and most analysts expect another contraction of up to one percent this year, while the government forecast growth of 0.7 percent.

"We want to remove all the (budgetary) problems that have been burdening our economy for years, like debts in the health sector and state railway company or state guarantees issued for loss-making shipyards," Linic said.

($1 = 5.7045 Croatian kunas)

(Reporting by Igor Ilic; editing by Zoran Radosavljevic and Ruth Pitchford)


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