The Czech Republic and Slovenia are the exceptions and over the next two years they could fulfil the conditions for full convertibility and elimination of capital controls, wrote senior UBS economist Lawrence Hatheway.
Most Eastern European countries have currency convertibility for trade transactions, known as current account convertibility, but there is no convertibility for banking or investment flows, known as capital account convertibility.
In the long run full convertibility would be beneficial to most economies in Eastern Europe as it would attract foreign direct and portfolio investment.
While current capital controls tended to discourage foreign investment, for example in stock markets, East European governments still wanted to avoid big disruptive flows of money.
"Most exchange rates in the region are overvalued, so that freeing capital restrictions would most likely result in capital outflows which would quickly deplete currency reserves," Hatheway said.
It was also questionable whether current government policies in Eastern Europe were sufficient to cut budget deficits, reduce inflation and restore external balance.
"Full convertibility will have to await the implementation of appropriate macroeconomic policies if large exchange rate swings are to be avoided," Hatheway said.
Implementing such policies were unpopular and politically difficult but necessary for proper economic conditions.
"Over time, of course, capital controls cannot substitute for sound macroeconomic policies because inevitably investment and capital flow to countries where policies are in line," Hatheway said.
Deteriorating government finances represented a potential trouble spot in all Eastern European countries, except for the Czech Republic, where improving economic fundamentals and prospects for political stability supported the region's strongest currency, the crown.
But in other countries there was a risk that government deficits would reach levels that exceeded domestic financing sources and national central banks may therefore be forced to print money to finance the shortfall.
So far deficits in Eastern European countries have not reached the proportions of Russia, for example, and a significant printing of money to finance deficits has not taken place, Hatheway said.
He added that high inflation rates in Romania and to a lesser extent in Poland, the Slovak Republic, Slovenia and Hungary would lead to a steady depreciation of their currencies against major reserve currencies such as the dollar.
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