Budget deficits of new EU members 'could spark crisis'

Mounting budget deficits in the 10 new members of the European Union could trigger a financial crisis, the European Central Bank has warned.

The ECB said the 10, which join the EU on 1 May, would need to cut spending or raise taxes to bring their budget deficits closer to the target of 3 per cent of GDP. Six of the 10 are running budget deficits in breach of the Maastricht Treaty limits that were used to admonish France and Germany.

The ECB said the latest figures showed that the average deficit ballooned from 3.8 per cent in 2001 to 5.1 per cent in 2002 despite a pick-up in growth.

"In most acceding countries the current fiscal deficits seems to be mainly of a structural nature," it said in its latest monthly bulletin. "To stabilise the fiscal situation, the acceding countries will need to further reform their public expenditure and revenue structures in a sustainable and forward looking manner."

Hungary ratcheted up a 9 per cent deficit in 2002, the worst of the 10, followed by Slovakia and the Czech Republic on 7 per cent. The Czech government, and Malta, Poland, Cyprus, Lithuania and Estonia, forecast that their fiscal positions probably worsened last year.

The ECB said the accession countries would also be running current account deficits - the sum of their trade and investment positions.

"If current account deficits are so large that they set off unfavourable external debt dynamics, then medium- and longer-term sustainability may be endangered," the ECB said.

The ECB is tracking the progress of the 10 - Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia - because they have all committed to join the euro when they meet the convergence criteria set out in the treaty.

Angus McCrone, a senior economist at the Centre for Economics and Business Research (CEBR) in London, said the accession process did "carry risks".

"The numbers look sustainable for now, but there is a danger of inappropriate policies leading to a confidence crisis at some stage, just as it did for Italy in the mid-1990s," he said.

Overall Mr McCrone said the 10 new arrivals would have a "stimulating effect" on economic performance throughout the EU, including the UK.

However, he said the change should not be exaggerated, given that the new entrants would add 20 per cent to the total EU population but just 5 per cent to total GDP.

Last week the ITEM Club forecasting unit said immigration of skilled workers from the 10 countries would boost UK economic growth by £10bn over the decade after entry.