The three Baltic states have been the star performers among Central and Eastern European economies in terms of growth over recent years. Expect the same in 2004, with real growth in the region a touch under 6 percent, almost double the rate for the Czech Republic, Hungary, Poland, Slovakia and Slovenia.
Inflation in the Baltics will remain broadly unchanged from 2003, with Lithuania having the highest rate of 3 percent. Domestic inflationary pressures will be dampened by the reduction in imported inflation on the back of currency links with the rising euro, which reduces the cost of non-euro imports in lats, litas or kroons. The fixed exchange-rate regimes mean that monetary policy will continue to be fully predictable, although the rise in nominal and real exchange rates will put pressure on competitiveness and the effectiveness of fiscal policy to bear the burden of economic management without the possibility of using devaluation - undertaken for instance by Hungary and Poland in 2003.
The external account of the balance of payments remains the one area of great concern. The current account balance for the region should decline from approximately 7 percent of GDP in 2003 but remains above the bellwether 5 percent range. The external deficit as a share of the size of the economy will continue to be the highest in Estonia, declining to around 7 percent - 8 percent of GDP.
The positive macroeconomic profile of the three Baltic countries offers a good platform to take advantage of the benefits of EU membership. These benefits boil down to greater potential for sustainable economic growth and ultimately a better chance to catch up to the EU average in per-capita incomes and living standards. Per-capita GDP in the Baltics remains at around one-third of the EU level at market exchange rates but is lower when adjusted for purchasing power of exchange rates. Consistent, above-EU-average growth rates are therefore needed for the next two decades to close the gap.
The carrot of EU membership and the push for "acquis convergence" of domestic legislation has had a strong and positive structural adjustment effect on the transition economies, but membership will bring concrete opportunities - raising domestic investment via transfers from structural funds and access to the common market of 450 million consumers - but also challenges, including greater EU red tape and quality controls in all areas of life.
Whoever makes best use of available opportunities will grow faster and likely repeat the experience of Ireland - to soar from around 70 percent of the EU average to above 100 percent, an example religiously regarded as a sort of mystic EU Shangri-La by Baltic policymakers.
The first 13 years of independence for the three Baltics have seen massive macroeconomic, structural and legal reforms that stand them in good stead to make the best of the opportunities. Making the best of the EU opportunities typically requires a threshold of administrative firepower, and this will stand against the Balts, although once they get the minimum threshold their smaller size should be a blessing.
In the shorter-term, EU entry will have less immediate impact. Structural funds that could total 3 percent of GDP for each of the new EU members are unlikely to kick in until 2005. The main driver of growth in the Baltics in 2004 will continue to be strong domestic growth on the back of private consumption. With the EU economy likely to grow a little more than in 2003 to around 2 percent, net exports should also pick up, helping to reduce the current account deficits. For Estonia, EU entry will raise exports to Russia, which are currently constrained by Russia's double-tariffs on Estonian imports.
There is emerging evidence that foreign direct investment flows into Central and Eastern Europe have reached their peak and are now directed to either more low-cost acceding economies such as Slovakia or to the next wave EU enlargement economies of Bulgaria and Romania. Both Estonia and Hungary now have net outflows of FDI - a new trend. Until now foreign direct investments have broadly covered current account shortfalls. Replacement by more volatile portfolio flows creates a more dangerous environment, as it is more likely to leave than longer-term investment in bricks or factories.
On the fiscal side, the recent death knell of the inappropriately named EU Growth and Stability Pact should have been the toast of New Year parties in accession countries. The fiscal rules on domestic debt and annual deficits were never designed for transition economies, where higher deficits and debt growth are often needed. NATO-related costs, expenditure for pension and health reforms and, of course, cofinance to tap EU financial grants will all push up deficits. The main - although minor - risk is possibly the continuing growth in credit and potential asset bubbles in the property sector, which could become unsustainable, particularly if speculation that new EU investment will pour in around accession-time in May proves unfounded and if interest rates move up, thereby raising debt-servicing costs.
Rupinder Singh is an associate
professor of economics
and a former EU official now advising policymakers in acceding countries
on EU structural funds assistance.
