UPDATE 1-Risk of sharp correction in some E.Europe states-WB

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By Tomasz Janowski

Several of the European Union's former communist member states must adjust policy to ensure that their economies do not overheat or risk a sharp correction in growth, the World Bank said on Thursday.

Introducing a report on 10 countries that joined the EU either in 2004 or this year, the World Bank's lead economist for central and Eastern Europe, Thomas Laursen, said the risks appeared to be magnified beyond 2007.

"We see a real risk of a sharp correction in Latvia, Estonia but also in Bulgaria and Romania," Laursen told a news conference.

"This calls for efforts on structural reforms and to avoid pro-cyclical policies and (for) policies to discourage household borrowing," he said.

The report said a number of EU members from central and Eastern Europe faced a mild slowdown this year after fast growth in 2006 while inflation in the region was on the rise.

"While inflation remains well under control in Poland and the Czech Republic, other countries are struggling," it said.

"In the Baltic countries and to some degree Bulgaria and Romania, strong wage and credit growth are leading to overheating and significant inflationary pressures."

The development lender said tax and regulated price increases were adding to price pressures in several countries, with the impact this year seen particularly pronounced in Hungary, the Czech Republic, Estonia, Lithuania and Romania.

"At the same time, the recent sharp decline in oil prices could help dampen inflationary pressures in 2007," Laursen said.

Laursen, the main author of the report, also pointed out that despite the build-up of inflationary pressures, fiscal policies were loose in 2006 and were set to remain expansionary this year.

"Fiscal deficits increased in most countries in the region despite strong growth and buoyant tax revenues, adding to concerns about overheating," the report said.

"Only Poland and Bulgaria managed to improve their structural fiscal balances (in 2006)."

HUNGARIAN EXCEPTION

The report said that this year Hungary stood out with its plans to slash its budget deficit and Poland and Slovakia aimed for lower shortfalls. But prospects for bold reforms looked dim.

"Six elections have taken place in the region since October of last year. However, the elections have generally not strengthened the mostly weak coalition governments in the region," the report said. "With the exception of Hungary, prospects for significant progress of politically challenging reform agendas remain elusive."

The World Bank also noted that only Poland, the Czech Republic and Slovenia maintained low current account deficits. Elsewhere they were close to or exceeded 10 percent of gross domestic product.

In a special section of its report the World Bank looked at buoyant credit growth in the region noting that even though so far it did not threaten the health of its banking systems.

But it said credit expansion had to be watched closely because it led to macroeconomic imbalances and could lead to asset price bubbles.

"An excessive growth rate of credit in some countries is contributing to overheating and large external imbalances, especially in the Baltic countries and to some extent Romania and Bulgaria."

The report published quarterly since the EU enlargement in 2004 for the first time includes Bulgaria and Romania which joined the EU this month. The World Bank said it would publish the new version of the report three times a year.

[WARSAW/Reuters/Finance.cz]