Jan. 8 (Bloomberg) -- Lithuania’s economy may “decline sharply” in the wake of the global financial crisis, Christoph Rosenberg, head of the International Monetary Fund’s mission to central Europe, said.

Lithuania may see its economy contract “at least” 2 percent this year, the Washington-based fund said in December compared with the Lithuanian central bank’s October outlook for an expansion of 1.2 percent. The IMF forecast signals that the Baltic nation will follow Latvia and Estonia into a recession next year as domestic demand wanes after banks tightened lending.

The three countries, which spent almost half a century as communist-run Soviet states, have been hit hard by the crisis as banks saw external funding dry up and exports slowed. Last month Latvia took a 7.5 billion-euro ($10.2 billion) IMF-led loan to strengthen the currency and shore up the banking system.

“Lithuania is in a more difficult position as GDP growth is predicted to decline sharply this year and this may create fiscal problems,” Rosenberg said in an interview conducted on Tuesday in Warsaw. “Estonia is the least vulnerable of the Baltics because it has big buffers, it’s been running a budget surplus for a number of years now and so there are fiscal assets.”

‘No Need’

The Lithuanian government said it “has no need at the moment” to seek a loan from the IMF. “By implementing an anti- crisis plan, Lithuania guarantees the necessary fiscal stability,” the Vilnius-based government said in an e-mailed statement today.

Lithuania’s economic sentiment index, which measures expectations in sectors including manufacturing, construction, retail and services, fell to the lowest in six years in December as concerns grow over a recession this year.

Estonia and Latvia lead the EU’s slowdown after contracting an annual 3.5 percent and 4.6 percent in the third quarter, respectively. Lithuania’s economy expanded 2.9 percent for the period. Latvia joined Iceland, Belarus and Hungary and other emerging-market nations in asking the IMF for aid.

“The problems are across the board in the Baltic states,” said Vanessa Rossi, a senior research fellow in the international economics program at London’s Chatham House, by phone. “Coping with large external debt and deficits isn’t unique to the Baltics, but they’ve been particularly savaged as credit has dried up,” she said, adding that the spotlight was now on Lithuania and Estonia because of the Latvian situation.

Soaring Wages

Latvia’s problems were created by a soaring wages and a credit boom which saw funds channeled into non-tradable industries like real estate, retail and banking, Rosenberg said.

The economy wasn’t diversified enough and officials failed to curtail rapid credit growth or use counter-cyclical fiscal policies to cool the economy off before it was too late, he added.

“Latvia had the highest growth rate in the EU for several years, but it was a bubble,” he added.

Moody’s Investors Service said yesterday it had cut Latvia’s foreign-credit rating for the second time in three months amid fears of a deeper-than-expected economic decline. Inflation in Latvia, at 11.8 percent in November, is the highest in the 27- member European Union, compared with 2.1 percent in the euro area.

According to Rosenberg, the largest of the EU’s eastern members, Poland, is better equipped to survive the credit crunch.

“Poland avoided bubbles like the ones we’ve seen in the Baltics, where the economies are small and a few sectors have all resources poured into them,” he said. “Poland is fundamentally in a good position. Its economic fundamentals are much sounder than in the countries that are in trouble at the moment like Hungary or Latvia.”

To contact the reporter on this story: Katya Andrusz in Warsaw at kandrusz@bloomberg.net

Last Updated: January 8, 2009 12:50 EST