The rating agency Standard and Poor's has downgraded Latvia's debt to BB+ with a negative outlook and has warned that the two other Baltic states, Estonia and Lithuania are on creditwatch for a downgrade.

The Financial Times reports that the downgrade to so-called 'junk' status reflects fears that the IMF-led rescue package for the country of £6.6 billion may not work.

Latvia is the second EU country to receive junk level status after Romania.

"The downgrade of Latvia reflects what we consider is a worsening external outlook and the associated implementation risks on the government's ambitious economic program," said Eileen Zhang, S&P's credit analyst.

The state of the Baltic states and some other CEE countries is causing concern for for western European banks that have big expoure in the region.

In a worst case scenario, Austrian banks face losses of up to 11% of GDP, Swedish banks of 6% and Belgian banks of 3.5%, Danske Bank estimates, the FT reports.

Latvian GDP is forecast to shrink by 12% this year. To maintain the terms of the IMF bailout, Latvia will have to deep spending cuts, so worsening the country's recession.

An alternative is to abandon the IMF plan, the FT reports, and instead to drop the Lat's peg to the euro and let the currency devalue.