The progressive easing of underwriting standards that was needed to support housing demand could only persist as long as housing prices were rising rapidly. But for home prices to rise rapidly, underwriting standards had to be progressively relaxed in order to generate more buyers. When home prices began to slip beginning in 2006, the dynamic swung into reverse. The collateral values supporting borrowing and spending began to fall. As banks’ and other financial intermediaries’ credit losses began to mount, credit availability became impaired and this exacerbated the downward pressure on home prices and on borrowing and spending. Not only did households that had overextended themselves have to cut back; others also retrenched because they were also affected by declines in wealth and heightened uncertainty about the economic outlook and their job prospects. It is not surprising that the workout from the excesses of this type of boom would take a long time. Just as it took several years for the boom to begin and run its course, so it would take years, not months, for households and financial intermediaries to adjust their balance sheets and behavior to the new environment. Households had to raise their saving rates in order to rebuild their balance sheets. Financial intermediaries had to replenish their capital to replace losses via loan charge-offs and other credit impairments. Both adjustments would need to occur before the economy could grow rapidly.
A rational domestic demand and import policies will be required (with a 5.3% rise in imports, given the oil price growth), in order to keep the current account deficit at about 6.5% of GDP (EUR 3 billion), the same as in the current year. Of course, this implies a continuation of heavy dependence on foreign sources of financing in 2010. (2)  Given stagnation in direct and portfolio investments (EUR 2.1 billion in 2009 vs. EUR 2.3 billion in 2010), this would mean that: −  the current account deficit will have to be financed by foreign borrowing;  −  the external debt-to-GDP ratio will increase from 83% last year and about 93% in 2009, to about 100%, which is feasible, but will certainly not improve the country’s credit rating, and the question is to what extent the global downward trend in interest rates can carry over to this country. This is all too important, as we know that in 2010:  (3)  −  total debt repayments (EUR 8.3 billion in principal and EUR 1.4 billion in interest) will amount to EUR 9.6 billion (EUR 10.8 billion in 2009); and  −  total utilisation of foreign sources of financing will stand at EUR 12.6 billion (13.5 billion in 2009). The anticipated fiscal deficit reduction, in terms of consolidated general government (including HAC), from HRK 15 billion to HRK 12.1 billion, i.e.