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East Europe EU states face growth risks

Growth in the European Union's 10 eastern states will slow this year after accelerating in 2006 because the economies are operating close to full capacity and demand may weaken in the euro region, the World Bank said.

The countries face an increased risk of inflation amid growth of regulated prices, wages and credit, the bank said in its regular report on the development of the former communist nations. Only Poland and the Czech Republic are keeping inflation „well under control,” while inflation in Baltic countries remains high as growth rates are „overheating.” The 10 nations, including Poland and Hungary, want to boost living standards to match western European nations while also meeting criteria for euro adoption. Only Slovenia managed to switch to Europe's common currency and most of the countries have fallen behind in the euro chase because of wide budget deficits or fast inflation. „Output growth gained further steam in 2006, driven by buoyant domestic demand, but it is likely to moderate somewhat in 2007 in most countries,” the bank said in the report distributed by e-mail today.

Estonia and Latvia will experience the sharpest decline this year in growth rates, which are set to fall from 11% forecast for 2006 to 8.3% and 9% respectively. The pace of expansion in Hungary will almost halve to 2.2% this year as the government's austerity measures aimed to reduce the budget deficit will hamper demand. Romania and Bulgaria need to change the structure of their economies, the bank said. Agriculture in both countries takes up a greater%age of gross domestic product than anywhere else in the EU and may make the current pace of growth unsustainable. Romania grew 8.3% in the Q3, while the Bulgarian economy expanded 6.7%. „There are a number of areas across the region in which the reform momentum has been quite slow - and this will be quite a problem further down the line,” said Thomas Laursen, the bank's chief economist for the region, in an interview. Overhauling public finances and the labor market are the most important measures that countries must undertake, while some countries need to concentrate on ways of cutting spending, according to Laursen. „The only way to make the circle square is to address other areas of spending,” he said. „Hungary is only beginning to face this, but the Czech Republic and Poland aren't really doing anything.”

Even as growth slows, tighter labor markets and the rise in credit are adding to inflation risks. Inflationary pressures may be curbed by appreciating currencies and a recent decline in oil prices, the bank said. This may help Slovakia to curb inflation enough to qualify for euro adoption in 2009 as planned, although according to Laursen this may prove difficult. „The strong expansion of output and tightening of labor markets have been accompanied by intensified price pressures,” the report said. „Core inflation trended higher in Estonia, Lithuania, Hungary and Slovakia in 2006.” Government spending in the region is also adding to inflation because the governments haven't used excess revenue stemming from faster growth to cut deficits, according to Laursen. Only Poland and Bulgaria have managed to improve their budget deficits, according to the report, which is published three times a year. „With the exception of Hungary, prospects for significant progress of politically challenging reform agendas remain elusive,” the bank said. Most countries in the region envisage further fiscal easing this year, delaying spending cuts until 2008 or 2009. „The credibility of these delayed plans is diluted by the fact that many countries will be entering new pre-election periods by then,” the bank said. Romania and Bulgaria joined the EU this month while the eight other countries joined in May 2004. (Bloomberg)