Polish and Swedish officials urged swift action to help beleaguered Latvia on Friday to prevent its economic crisis from spilling over into other countries in Europe.
The tiny Baltic state, facing a brutal economic contraction of up to 20 percent this year, is struggling to avoid a currency devaluation that would hammer heavily exposed Swedish banks and reignite worries over East Europe's prospects.
Latvia's prime minister reaffirmed on Friday that his government was not planning to devalue the lat.
The European Commission said it believed regional contagion could be averted if Latvia's parliament takes adequate measures.
"There is a threat that the situation in Latvia may spill over into the region," Dariusz Filar, a member of the Polish central bank's Monetary Policy Council, told reporters on the sidelines of an economic conference in Warsaw. "This situation is a challenge that requires a reaction on a broader scale than just Latvian, there is a need for more international assistance," he said, without giving details.
Filar's comments knocked regional currencies. Poland's zloty and Hungary's forint traded down about 1 percent against the euro in afternoon trade.
The International Monetary Fund and European Commission say Latvia must implement further deep spending cuts before receiving fresh loans. Negotiations with the lenders are now underway.
Economists say failure to clinch a deal could make devaluation unavoidable, greatly increasing the pain for the many Latvian companies and households holding large debts denominated in foreign currencies.
"We need to reach a result in the negotiations and it must happen soon," Swedish Finance Minister Anders Borg said on Friday in Stockholm. "The government's view is that they need to take more measures (in Latvia)."
DIFFICULTIES
Speaking at the Warsaw conference called to mark the 20th anniversary of the fall of communism in Poland, EU Monetary Affairs Commissioner Joaquin Almunia said he expected Latvia's parliament to approve further spending cuts.
"I recognize the difficult situation of Latvia but at the same time I am confident that adequate measures will be adopted," he said.
A J.P. Morgan analyst played down fears of regional contagion beyond the three Baltic states.
"In our opinion the likelihood of Lithuania lita and Estonia kroon devaluation would increase significantly in the event of a lat devaluation, but contagion risk is limited elsewhere," J.P. Morgan analyst Nana Francois wrote in a note to clients.
"We note that the GDP of the 3 Baltic countries equates to less than 1 percent of eurozone GDP and around 5 percent of emerging Europe GDP, so the regional impact would be low."
Ex-communist eastern Europe has suffered a big outflow of funds since the global crisis struck last year as investors shun markets perceived as too risky. Almunia held out little prospect of early relief for the region.
"Beyond the current short-term liquidity risks, the region is also likely to face more difficult and volatile funding conditions in the coming period," Almunia said.
The chief economist of the European Bank for Reconstruction and Development (EBRD), Erik Berglof, echoed this.
"Capital will be more expensive in the region for the forseeable future… Even if the… crisis goes away very fast, it leaves a legacy for many years. At least four or five years in terms of the cost of capital for these countries," he said.
NO SOFTENING OF RULES
Almunia and European Central Bank head Jean-Claude Trichet, who was also in Warsaw, both made clear there would be no easing of the rules for euro zone membership because of the crisis.
"For the governing council of the ECB, what counts are the criteria," said Trichet, referring to tough rules on inflation and budget deficits which most east European states keen to adopt the euro will now have great difficulty meeting.
Almunia urged Poland to maintain its goal of joining the euro, adding that the calendar was up to Warsaw, but he also expressed concern about Warsaw's general government deficit, which the Commission expects to hit 6.6 percent of GDP in 2009.
Trichet said Poland had built up fewer macroeconomic imbalances, allowing it to weather the global crisis better than many of its peers in ex-communist Europe.
And addressing all euro aspirants, Trichet said: "Only after the elimination of major macroeconomic imbalances and when sufficient convergence has been achieved can countries expect to reap the full benefits of euro area membership."
Poland, the largest ex-communist EU member, wants to join the euro in 2012 but economists say this date is unrealistic.
Underlining eastern Europe's economic travails, Hungary reported on Friday an annual fall of 27.1 percent in industrial output in April, based on preliminary unadjusted data.
Like Latvia, Hungary has reached out for IMF-led aid packages to plug its large financing gaps.
