Credit agency rates Baltic state's bonds as junk

Eastern Europe's recent economic troubles intensified yesterday when the ratings agency Standard & Poor's cut the quality of its appraisal on one Baltic state and said it may cut the others, while Serbia applied for an extra $2bn (£1.4bn) loan from the International Monetary Fund in an attempt to offset its economic spiral.

S&P cut the Baltic republic of Latvia to a junk credit rating – rare for a sovereign state – and said it may reduce its creditworthiness ranking for sister republics Lithuania and Estonia. It also said it may further cut Latvia's credit rating later this year or in 2010.

Economies in eastern Europe have suffered badly from the credit crunch as their high debt, built up as they borrowed in recent years for rapid expansion and more recently to try to fight the economic downturn, has become costly. Their currencies have tumbled too, making leverage more of a burden.

Investment from Western countries, which was one of the factors fuelling the huge growth in the region until the credit crunch, has also dried up as investors redeem cash and try to reduce exposure to smaller, riskier economies.

As City traders speculated that the Baltic states could default on their debt, the cost of insuring Latvian and Estonia sovereign debt for five years through credit default swaps (CDS) rose, while five-year CDS for Lithuania hit a record high. Serbia, meanwhile, said yesterday it will seek an additional $2bn loan from the International Monetary Fund to weather the increasingly severe effects of the global financial crisis.

Its Prime Minister, Mirko Cvetkovic, said Serbia will seek to change its current "precautionary" deal with the IMF to a "classic standby arrangement" – meaning it plans immediately to withdraw the $2bn once it is granted, instead of simply having access in case of need.

Late last year, the Balkan country reached a 15-month deal with the IMF that gave it access to $520m only in case of a sudden halt in foreign investments.

At the time, Serbian officials said the funds were not immediately needed because officials did not expect the global financial crisis to affect the economy as much as it did. But economists say that in view of the expected drop in economic production, foreign investments and exports, Serbia will need additional funds.

And as the former Yugoslav country, which unlike its Baltic counterparts has not yet become a member of the European Union, struggles, it received another blow as the Czech Foreign minister, Karel Schwarzenberg, said the European Union is becoming less enthusiastic about allowing Balkan countries to join due to the downturn. He was referring to plans to expand the 27-nation EU to include Balkan states such as Serbia and neighbouring Montenegro. The Czech Republic currently holds the EU's rotating presidency.

Meanwhile, Joaquin Almunia, the European commissioner for economic affairs, said the group of states could soon have to bail out a member country, adding that countries such as Hungary and Latvia have received assistance from the EU, and others within the 27-member bloc might need a financial support programme.

The comments are some of the strongest yet by a leading European policymaker on the chances of collective support for ailing European economies. Mr Almunia added that he sees the upcoming G20 summit in London as a critical test for leadership during the financial crisis. He added that countries had to push for a co-ordinated response.

The woes in eastern Europe echo the credit downgrade of Russia by the ratings agency Fitch earlier this month.