by Steve Schifferes BBC News Online economics reporter

The economies of Eastern Europe and the former Soviet Union are slowing down, after outperforming most of the rest of the world in 2001.

The region grew by 4.3% in 2001, but growth is expected to slow to 3.3% in 2002 - still higher than the rest of Europe and other major industrial countries.

Imports of cars are increasing Poland's trade deficit

According to the European Bank for Reconstruction and Development (EBRD), which lends to the region to aid the transition to market economies, the strong growth was led by higher energy prices in Russia and strong domestic demand in Eastern Europe.

However, growth in Eastern European countries - which is closely linked to the eurozone - is likely to be unchanged at 2.6%, with Poland showing particular weakness.

Foreign investment

The EBRD expressed particular concern about the level and type of foreign investment in the region, which it said "point to some persistent weaknesses in the region's investment climate."

While foreign direct investment (FDI) has been stimulated by privatisation, the development of foreign investment in stock markets, and international bank lending, remained "limited and selective".

It said this reflected "weak protection of investor and creditor rights and under-developed financial sectors," and it wanted more reforms, especially in regard to corporate governance.

Nevertheless, FDI rose from $22.5bn in 2000 to $26.7bn in 2001, while it was declining in many other emerging market economies.

The bulk of FDI is concentrated in the more advanced countries in the region who are expected to join the European Union.

Poland, for example, has received over $1,050 per person in foreign investment since the end of Communism, compared to just $67 per head for Russia.

Transition issues

Eight Eastern European countries are expected to be admitted as members of the EU by 2004, following years of negotiations and legal changes.

Poland, Hungary, the Czech Republic, Slovenia, Slovakia, and the three Baltic states of Estonia, Latvia and Lithuania have been candidate members since 1998.

However, the EBRD has expressed some worries about the situation in each of the three largest candidate countries.

It is worried that in Hungary "there have been setbacks in some areas, such as re-nationalisation and privatisation" - particularly in relation to the unilateral cancellation of a public-private partnership to redevelop Budapest airport's main terminals.

It said that the Czech authorities needed to focus more on small and medium enterprises "which face numerous administrative obstacles to their development, including an inefficient judiciary".

But the EBRD is most concerned by the slowdown of growth in Poland, which fell from 4% in 2000 to just 1.1% in 2001, and is only projected to recover to 1.5% in 2002.

Poland is the largest economy among the EU candidate countries, and its combination of 17% unemployment, and a huge Budget and trade deficit is causing concern.

The Central Bank is resisting pressure from the government to cut interest rates, which stood at 10% in real terms at the end of 2001, until inflation and the twin deficits are under control.

The EBRD said that "necessary structural reforms (such as crucial agriculture and labour market reforms) have been delayed because of the difficult political climate caused by high and rising unemployment."

It urged faster progress on reform to boost growth rates, as well as some "flexibility" in fiscal and monetary policy.

But as the political debate about EU membership heats up, tough decisions are looming on both sides.