Governments in emerging Europe must act quickly to cut their budget deficits or else risk fiscal crises similar to those experienced by Greece that would inflict severe damage on already weakened banking systems, the International Monetary Fund said.

The IMF said economies in eastern Europe will grow by 3.9% in 2010 and 3.8% in 2011, having contracted by 6% last year. But in its twice-yearly Regional Economic Outlook for Europe, the IMF warned that many economies face major challenges if they are to maintain the recovery. And it said much will depend on developments in the euro zone, which is eastern Europe's main export market.

"The main downside risk for emerging Europe is the revival of sovereign stress in advanced Europe, which could depress growth in the euro area and lead to adverse spillovers for the region," the IMF said.

And even without an intensification of the euro zone's fiscal crisis, investors may become concerned about the ability of some eastern European governments to repay their debts, and become extremely reluctant to lend, as they did to Greece. To protect themselves against that possibility, the IMF said many eastern European governments need to take urgent action to cut their budget deficits.

"To prevent the emergence of market concerns, countries with high fiscal vulnerabilities may need to proceed with fiscal consolidation at a faster rate," the IMF said.

The Fund said it expects Poland's budget deficit to rise to 7.4% of gross domestic product in 2010, up from 7.1% last year, before falling to 6.7% of GDP in 2011. In emerging Europe as a whole, it expects budget deficits to fall to 5.2% of GDP this year and 4.2% of GDP next year from 6% in 2009.

The Fund said a sharp rise in government-bond yields, and a fall in the market value of government bonds, could have a negative impact on local banking systems.

"Financial sectors would be particularly affected, especially in those countries where banks hold a large portion of their assets in the form of government securities—Albania, Hungary, Poland, and Turkey," the Fund said. "In such countries, bank capitalization could be significantly impacted if the value of government securities declined. This in turn could curtail the supply of bank credit."

The Fund said that many economies in emerging Europe will need to find new sources of growth, relying more on exports than domestic demand. Prior to the onset of the financial crisis in 2007, eastern Europe experienced a surge in economic growth. But that was largely driven by a surge in capital inflows that funded strong growth in domestic demand, something that isn't likely to happen again, the IMF said.

"Capital inflows are unlikely to return to pre-crisis levels, and domestic demand is likely to remain depressed," the Fund said. "Future growth must rely more on the tradable sector and less on the nontradable sector—especially in countries that had built up large imbalances during the boom."