Tallinn  - Officials at the Estonian central bank, Eesti Pank, said Wednesday that the country could meet the Maastricht criteria for euro adoption by the end of the year, but needs to work harder on reducing its budget deficit.

"When the spring forecast of Eesti Pank was being prepared, changes in the tax policy were not yet under consideration, thus we concluded the consumer basket would cheapen by 0.2 per cent as an annual average."

"But now, as a result of the increased VAT rate, prices will, after all, rise by 0.5 per cent year-on-year," the central bank said in a new overview of recent developments and future outlook.

"It is very likely that meeting the Maastricht inflation criterion will become possible in the final quarter of the year," it added.

Adoption of the euro as soon as possible has been identifed as the number one policy priority of Prime Minister Andrus Ansip and his minority government, which in July increased VAT from 18 to 20 per cent in a bid to improve revenues.

Estonia's year-on-year GDP declined 15.1 per cent in the first quarter of 2009 and estimated 16.6 per cent in the second quarter.

After a decade-long boom fuelled by cheap credit and a housing market bubble, the small Baltic state of 1.3 million people is wrestling with one of the European Union's deepest recessions.

The central bank noted "a marked slowdown in the pace of the economic contraction" but warned that the first half-year's consolidated budget deficit was "considerably larger" than the anticipated annual average at around 8 to 9 per cent of GDP and might exceed targets by up to 1.5 billion kroons (130 million dollars).

"The need to ensure long-term fiscal sustainability and to restore the trust of foreign investors does not allow having a deficit of this magnitude either this or next year," the central bank said. (dpa)