* Lack of reforms threaten to undermine catch-up with West
* Poland, Czech least exposed, Baltics, Hungary vulnerable
* High social costs, bad budget structures call for reform
By Krisztina Than
BUDAPEST, Dec 17 (Reuters) - Inflexible budgets, looming
elections and persistent economic woes could sap reforms in the
European Union's eastern wing next year, undermining growth in
some and pushing others towards a Greek-style debt trap.
Few of the 10 ex-communist states that joined the EU since
2004 have seen public deficits spike to the levels of more
developed economies like Britain, Greece or Ireland. But for the
most part they have neither the protective umbrella of the euro
nor super-low borrowing costs to break their fall if they slip.
Volatile currencies and a thirst for investment to fuel the
economic catch-up after four decades of communism have exposed
the region to sudden shifts in market sentiment, even as many
governments try to buckle down and attract funding.
The problems vary widely from place to place, and investors
who once saw the region of 100 million people as a homogeneous
"emerging Europe" bloc converging with the more affluent West
are now picking apart public books for signs of sustainability.
Expectations the region will manage generally better growth
than Western Europe and bigger returns on investment still make
it an attractive bet for investors, but even after years of
reform and their drive into the EU there are substantial risks.
One big threat is a retreat into populism ahead of 2010
elections that could delay reforms to pension systems, social
spending and state administrations and cause higher deficits in
the short term.
High welfare costs and rigid budgets across the region lock
in a big proportion of spending, handcuffing policymakers'
efforts to lower budget deficits and cut debt.
"There have been some reforms but no country has attempted a
wholesale reform of public finances," said Zsolt Papp, an
economist at KBC in London. "Failure to implement any kind of
reform would eventually lead to a Greece-type scenario, ie. some
countries falling into a debt-trap."
Greece is scrambling to reassure investors by promising
steep deficit cuts after ratings agencies Fitch and Standard and
Poor's downgraded its debt below A grade this month.
DIFFERENTIATION
In central Europe, building cranes have fallen silent as
industry suffers and unemployment rises, and workers are
snapping shut their purses despite glimmers of recovery.
No country is expected to show growth of much more than 2
percent in 2010 -- a far cry of the 4-5 percent plus seen during
this decade's boom. That has undermined government efforts to
jump-start budget revenues and keep deficits from rising.
Whether it is the Czechs' unreformed pension system or a
public sector that accounts for a third of all jobs in Romania,
the region is still carrying much of the baggage that has
plagued public finances since the fall of communism.
Many politicians recognise that cutting in the public sector
is the key to boosting long-term growth, but analysts say they
may try to ease the pain of their austerity-weary populations
instead.
"We remain hopeful that the current crisis will act as a
spur to reform," said Neil Shearing, analyst at Capital
Economics in a note. "But a retreat to populism would obviously
be a major setback to the region's growth prospects."
Hungary, the first country in the region to be forced to
seek an International Monetary Fund rescue last year, has made
progress, cutting huge pension costs and public spending.
But it still needs to reform debt-ridden state transport
firms and oversized local government and take steps to boost its
very low employment rate.
With the help of the IMF, it is on track to produce one of
the EU's smallest deficits in 2009, at 3.9 percent of GDP.
But the main opposition party, the centre-right Fidesz, has
said it will cut taxes and the shortfall could come in at
7.0-7.5 percent of GDP if, as expected, it wins an election due
in April or May. []
Countries with higher growth prospects such as the Czech
Republic or Poland are seen better placed to overcome budgetary
problems than Hungary, the Baltics or Romania.
But even best-off Poland -- the only EU state to avoid
recession this year -- is struggling to lure investors to a 37
billion zloty ($12.65 billion) privatisation programme. That is
vital to rein in its widening budget gap and avoid triggering
constitutionally fixed debt levels that would force painful
fiscal cuts if breached.
"The need to improve their business environments and guard
macro-economic stability is bigger than at a time when there was
plenty of global liquidity," said Katinka Barysch, deputy
director of the Centre for European Reform.
East European countries may be less indebted but they mostly
still face higher financing costs than Greece, Ireland and
Britain. Hungary pays yields of 7.5 percent on its 10-year bonds
and Romania 10 percent on its 5-year bonds, versus around 3-4
percent in the euro zone.
ELECTION THREAT
Political pressure across the region has downed governments
in Latvia, Hungary and the Czech Republic this year, and more
could fall as voters rebel against belt-tightening and ruling
coalitions fall apart.
Manoeuvring ahead of elections due in Hungary, the Czech
Republic, Latvia, Poland and Slovakia next year []
has heightened investor concerns that politicians will slam the
brakes on reforms.
That happened ahead of Romania's presidential vote this
month, when a political crisis downed a centre-left government,
derailed the 2010 budget and threatened its IMF aid deal.
Bucharest and Riga have renegotiated budget deficits agreed
with the IMF, as has Budapest.
And last week the Czech parliament approved a 2010 budget
prepared by a government of technocrats only after the main
leftist party pushed through more spending with an eye on an
election next year. []
"Now that the worst of the crisis seems to be over, there
may well be a heightened risk that people will flock to
politicians... who promise them secure jobs and better social
benefits without explaining how that could be combined with
much-needed restructuring and fiscal austerity," Barysch said.
