By Michael Winfrey
PRAGUE (Reuters) - Growth in eastern Europe should accelerate only slightly this year as domestic demand recovers, but trouble in the euro zone periphery, wide budget deficits and inflation pressures still pose risks, the IMF said on Thursday.
In its regional economic outlook for Europe, the International Monetary Fund said it saw the region expanding 4.3 percent in 2011 and 2012, from 4.2 percent in 2010.
But it added that a high level of non-performing loans continued to weigh on banking sectors and high commodity prices could spur inflation.
It saw full-year inflation of 7.3 percent in 2011, slowing to 6.2 percent next year, and urged the region's central banks to remain vigilant.
"Monetary policymakers will need to stay on high alert," the Fund said. "Even countries with well-anchored inflation expectations may find it hard to avoid second-round effects if first-round effects are large or persistent, as global commodity prices rise disproportionately over the medium term."
The IMF said strong economic ties to the euro zone exposed it to risks of the potentially escalating debt crisis in the single currency area's weaker members, as western banks could cut their lending exposure to emerging Europe if they were to take a significant hit.
It said that although the region had so far been shielded from contagion, authorities should tackle wide fiscal gaps.
"Consolidation needs to rebuild fiscal buffers. This will improve key fiscal indicators and thus diminish the risk of financial tensions in the euro area spilling eastward," it said.
"It will also help contain inflationary pressures and support the monetary tightening that is already underway in several countries."
GROWTH PICKING UP, MOSTLY
Fiscal deficits in the region -- where nine countries have active or precautionary deals with the IMF -- should decline from 4.5 percent of gross domestic product in 2010 to 2.5 percent in 2011 and 2012, mainly due to Russia, the Fund said.
But it said public debt as a percentage of GDP would grow in two thirds of the countries and high fiscal deficits showed vulnerabilities in Latvia, Lithuania, Poland and Romania. It also said the region's fiscal position no longer compared favorably with emerging markets in Asia and Latin America.
It remained optimistic on the recovery, predicting the former Soviet CIS countries would lead the region's recovery with growth of 4.5 percent or higher this year.
It expects Belarus to lead the region with 6.8 percent growth in 2011. Russia was seen growing 4.8 percent this year, slightly faster than its southern peer Turkey at 4.6 percent.
Among the European Union's newest members, Poland was seen flat at 3.8 percent this year before slowing slightly in 2012. Hungary was seen growing 2.8 percent each year, but Romania was expected to accelerate its pace to 4.4 percent next year.
"Domestic demand will become the main pillar of growth as it catches up to recover in those countries where it had languished," the Fund said. It added bank lending still lagged.
"The worst of the credit crunch is over, but real credit still contracts in just under half of the region's economies." (Editing by Susan Fenton)