there were frequent instances of extremely high inflation. in this group, in the period 1998 - 2007, the average annual inflation rate ranged from 2. 1 % in macedonia to 31. 1 % in serbia ). 7 such movements caused appreciation of the real exchange rate, which was especially emphasized in the new member states. thus in the period 19942006, the cumulative appreciation of the real effective exchange rate ranged from 8 % in slovenia to 105. 9 % in lithuania. 8 economic theory offers arguments that real exchange rate appreciation is not dangerous as long as it reflects changes in the equilibrium real exchange rate. however, policy makers in these countries, especially in the recent years, are not really comforted by these theoretical discussions which consider that real appreciation is only movement to equilibrium. what they are seeing in their countries are common signs of overheating of the economy and loss of competitiveness, which deepens the external imbalances. in the beginning of transition, current account deficits were understandable and not too much cause for concern, as these countries were importing technology and previously unavailable goods. however, the size of the deficits in the last several years exceeds the level that is usually deemed sustainable. thus, the current account deficit in the new member states in the period 1996 - 2005 ranged from 5 % to 7. 7 % of gdp, but in the last two years it has been reaching 10. 1 % and 11. 3 % of gdp. the average current account deficit in the seeu countries in the same period is even higher, and it is estimated that in 2007 it will reach 16. 3 %. 9 even though deficits are projected to fall in some of the countries, in general they remain a cause for concern in most of them. besides the trade deficit which, source : imf world economic outlook database, april 2008. source : eurostat. for the seeu countries data are available only on croatia and macedonia, from the imf international financial statistics. cumulatively, in this period in croatia there was real appreciation of 9. 1 %, while in macedonia there was real depreciation of 18. 2 %. source : ebrd transition report 2007 : november update and nbrm calculations. data for 2007 are estimates. due to lower competitiveness and higher consumption, is one of the main causes for the current account deficits, some of these countries are also experiencing deficits in the income balance, which mainly reflects repatriation of profits from foreign

update. contains two distinct patterns of the structure of the balance of payments. the first is the conventional one for the transition countries, where the current account deficit is covered mostly with fdi and portfolio investments ( e. g. croatia ). on the other hand, the second pattern is consisted of huge trade deficits, which are covered much more by remittances from abroad than by foreign investments ( e. g. macedonia, albania ). however, the dilemma appears whether these high current account deficits are sustainable. regarding the economic history, despite the fact that in certain areas macedonia was a pioneer in the implementation of reforms in south eastern europe, under the influence of negative external and domestic shocks it had relatively low rate of economic growth of averagely 2. 7 % in the 1997 - 2007 period. this resulted in a relatively low level of real convergence of 25. 7 % of gdp per capita in the euro - zone ( 23. 6 % in 1996 ). the use of the exchange rate as an anchor for inflation expectations has been effective until now, producing low and stable inflation rates. in circumstances of high import dependence and relatively slow implementation of structural reforms aimed at increasing the export potential, contributed to the maintenance of high trade deficit, which was mainly financed by high private transfers. however, the transition process in macedonia is specific because of the relatively slower process of real convergence and the continuous real depreciation of the macedonian denar. namely, according to some research, 14 there has been an absence of the balassasamuelson effect in macedonia, that is the productivity in the tradable sector compared to foreign partners rises with relatively lower rates. this was a result of the absence of big foreign companies and the loss of important foreign markets, particularly after the independence. in such circumstances, the only way to maintain the competitiveness of the macedonian producers was the specialization and exports of lower quality products. these developments did not generate inflationary pressures, which caused absence of real appreciation that was evident in the other transition countries. in the past several years, macedonia is quickly moving closer to the more advanced transition economies. several years in a row we have achieved positive and stable growth rates, equaling 5. 1 % in 2007, which is the highest growth rate since independence. even though economic growth rates are lower than the ones in baltic countries as well as some of the countries in the region, this is a sure sign for the acceleration of the process of real convergence. this process is also