Estonia, EU – Baltic States, Financial Services, Investments

"Moody's is cautious, given the scale of the task, but believes that meeting the target remains feasible if the economy does not deteriorate more than forecast," the rating company said in a credit opinion e-mailed today, on Monday.

Slowing inflation leaves "the budget deficit as the sole obstacle to euro adoption."

The country's A1 rating, the fifth-highest investment grade, carries a negative outlook in part because of the risk of contagion from neighboring Latvia, Moody's said.

Latvia was forced to go to the International Monetary Fund and the European Commission for a bailout in December after rescuing its second- biggest bank, writes Bloomberg/LETA.

The Baltic states of Estonia, Latvia and Lithuania all peg their currencies to the euro as part of the exchange rate mechanism.

The Estonian government's "access to external capital markets is clearly impaired due to the current state of the global financial system, but extraordinary assistance would be available," Moody's said.

Estonia had its plans to adopt the euro in 2007 thwarted by rising inflation, and the country is now going through its worst recession since recovering from the collapse of the Soviet Union in 1991.

The Baltic state needs to keep its budget deficit within 3% of gross domestic product before being eligible to switch to the euro. Estonia's economy contracted 15.1% in the first quarter, the steepest drop in the European Union after neighboring Latvia and Lithuania.

Estonia will "likely require a third round of spending cuts that will be politically difficult," to keep its budget deficit below 3%, Moody's said.

The country's current-account balance is expected to be in a small surplus this year, compared with a deficit of 18% of GDP in 2007, Moody's said, adding that the contraction "in output, employment and investment will be significant".