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It raised particular alarm about Latvia, which is in the grip of the deepest recession in the 27-nation European Union after a sharp end to several years of double-digit growth stoked by rising wages and easy credit, informs AFP/LETA.

"The downgrade of Latvia's ratings reflects the deterioration in the prospects for the Latvian economy and elevated risk of policy slippage" since Riga clinched a 7.5-billion-euro (9.99-billion-dollar) bailout from the International Monetary Fund, the EU and other lenders in December, Fitch said.

Under the rescue package, the Latvian government has to slash spending to try to bridge a yawning deficit, and has already made deep cuts. Last week, however, Latvia missed out on a 200-million-euro tranche from the IMF because it had failed to go far enough in amending its budget in time.

Prime Minister of Latvia Valdis Dombrovskis, who has been seeking leeway from lenders, has warned that Riga could face bankruptcy by the end of June if it fails to receive the promised cash.

As part of the loan deal, Latvia pledged not to run a deficit in excess of 5.0% of gross domestic product for 2009. Dombrovskis later failed to persuade lenders to allow a 7.0-% deficit.

Reacting to the downgrade, the Latvian finance ministry said it would not "affect the work of the plan on stabilisation and rejuvenation of the economy", but protested that it could harm investment.

Latvia, which along with Estonia and Lithuania won independence from the crumbling Soviet bloc in 1991, had a reputation as a "tiger" in the European Union, which it joined in 2004.

The economy of Latvia, a country of 2.3 million people, grew 11.9% in 2006 and 10.2% in 2007. But output fell 4.6% in 2008 and the government forecasts it will shrink 13.0% this year.

Fitch said it expected a 12.0-% fall, but noted that the Latvian government's deficit target had been based on a 5.0-% contraction."On unchanged policies, Fitch estimates that the budget deficit could rise to 10.0% of GDP in 2009," it said.

The economic crisis has stoked political uncertainty in Latvia, which has suffered regular bouts of instability since independence two decades ago, prompting the fall of the previous government in February and sparking street protests.

Fitch said its decision to downgrade Estonia and Lithuania was partly based on fears they would be hit by the Latvian crisis due to strong trade and banking ties among the trio.

However, it also pointed to their deteriorating domestic economic prospects.

Estonia, a country of 1.3 million people, posted 10.4-% growth in 2006 and 6.3% in 2007. But output fell 3.6% in 2008 and the government forecasts an 8.5-% slump this year.

Fitch however said it expected a 10-% contraction and noted that Estonia would have to make a new round of spending cuts.

Lithuania, a nation of 3.4 million people, enjoyed 8.9-% growth in 2007 after 7.8% in 2006. Its economy slowed to 3.1% in 2008 and is officially expected to contract 10.5% this year – although Fitch said it was forecasting 10.0%.

Fitch noted that Lithuania had already slashed spending and was planning more cuts but that the moves had sparked street protests.

"The risk of a public backlash against further budget cuts may constrain the government's room for manoeuvre," it warned.