Baltic economic slowdown?

Can the euro project go wrong? In the Baltics seems it can. The Baltic states of Latvia, Lithuania and Estonia must quickly stem inflation or risk an economic slowdown and an investor pullout, emerging market economists said.

The three tiny former Soviet states have been forced to delay adoption of the euro because inflation soared and current account deficits were jumping.

Two credit rating agencies, Standard & Poor's and Fitch, as well as private sector economists, have drawn attention to economic overheating in Latvia and urged the government to take drastic action. Fitch warned last week that a severe correction in Latvia could trigger "psychological contagion" across the three fast growing Baltic states of Latvia, Lithuania and Estonia, possibly spreading further across eastern Europe, Financial Times reported.

Latvia has the fastest-growing economy in the European Union, at 11.7% in the Q4, compared with 3.3% in the 13 nations that share the euro. Estonia's GDP grew 10.9% in the period, while Lithuania's growth was 6.9%.

Much of the region's growth is being driven by mortgage lending. 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.

Lithuanian central bank Governor Reinoldijus Sarkinas agreed with Finance Minister Zigmantas Balcytis that warnings of a meltdown may be too severe. "There are signs of warming up, but, all in all, no overheating," Sarkinas said in an interview quoted by several agencies.

Demand for real estate and borrowing in Lithuania slowed in the second half of 2006 after the country's attempt to adopt the euro was rebuffed. Latvia's real estate market "doesn't show any signs of stabilizing," analyst of Nordea said in its report in January. There have been rumours in the market that the country's currency, the Lat, may have to be devalued. It has been trading at a record low within the band at which it is pegged to the euro.

Finally, Latvia's central bank increased interest rates by 50 basis points to 5.5 per cent on Thursday in an attempt to take some of the steam out of the country's overheating economy. International analysts on Wednesday welcomed this package of inflation-cutting measures (balancing the budget, taxing real estate transactions and regulating bank lending, and so on), but warned that the efforts may be "too little too late" and that the fastest-growing economy in the European Union still risked a hard landing, AP reports.