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Latvia, Lithuania, Estonia at risk of overheating, Fitch says

The economies of Latvia, Lithuania, and Estonia are showing signs of overheating as rapid growth, accelerating inflation and high foreign debt increase the risk of a market correction, the Fitch rating agency said yesterday.

Widening current-account deficits, high inflation rates and rising debt denominated in foreign currency all pose dangers to the economies of the three Baltic states, and if not addressed could lead to „negative rating actions,” Fitch said in its report, „Risks Rising in the Baltic States?” Growth boomed as interest rates fell, foreign direct investment poured in and the three countries joined the EuropeanUnion in 2004. Rising prices - Latvia's 7.1% inflation rate in January was the highest in the EU - forced the three nations to abandon euro adoption dates. The A credit ratings of Lithuania and Estonia are five levels above investment grade and Latvia's A- rating is four levels above, according to Fitch. „Sustained inflationary pressures and rising external imbalances coupled with the lack of a credible and not-too-distant target for joining the euro zone increases the chance of an economic and financial correction,” the report said. Much of the growth is being driven by mortgage lending, Fitch said. Property prices in the Lithuanian capital of Vilnius are more expensive per square meter than in Copenhagen, Stockholm, or Berlin, while in the Latvian capital of Riga, prices outpace Vienna or Frankfurt, the report said.

The countries must use fiscal policy to fight inflation, since monetary policy has little effect due to a currency peg in Latvia, and currency boards in Lithuania and Estonia. The peg and currency boards may be responsible for some of the inflation, Fitch said. „The Baltic countries' currency pegs and the inflation differential with the rest of the EU contributes to `perverse' pro-cyclical low real interest rates, spurring the economic and asset-price boom in these countries,” the report said. Latvia is the most vulnerable of the three states to an economic slowdown brought about by an „abrupt adjustment in capital and financial flows,” the report said. Latvia's current-account deficit almost doubled last year to 22% of GDP from 13% in 2005. Latvia's Cabinet accepted a committee proposal to fight inflation by balancing the budget through 2008 and create surpluses in 2009, and 2010, and to pass a real estate tax to slow speculation, the Finance Ministry said yesterday. (Bloomberg)