While the Schengen visa system allows holders to visit multiple European countries, Britain requires a separate visa.

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Apart from withdrawing yet more funds, the EU could also delay Bulgaria's accession to the Schengen visa-free travel zone, planned for 2011-12.

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The Eurosceptics argue that Iceland already gets most of the benefits of full membership through existing free trade arrangements with the EU and by being part the Schengen visa-free travel zone.

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Nationals of the western Balkans (bar Kosovars) can get short-stay visa waivers to enter Schengen.

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But the row could hinder its attempt to be granted visa-free travel within the Schengen area of 25 European countries.

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In the next few weeks Bosnians and Albanians are expected to be granted visa-free travel to Europe's Schengen area.

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Kosovo is seen to have made only limited progress, although there is a chance its government may soon start talking to the EU about visa-free access to the 25-strong Schengen area later this year.

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