Riga - Latvia's economy shrank by 4.2 per cent in the third quarter, the government said Friday, while a downgraded credit rating added to the Baltic country's woes.

Fears about the future of the three Baltic economies grew as the flash estimate showed Latvia's gross domestic product (GDP) falling more than analysts had expected. Second-quarter growth in 2008 was 0.1 per cent.

This year's slump in the Baltics follows nearly a decade of roaring growth fuelled by foreign capital and consumer spending - until the global credit crunch hit.

"Internal demand is falling like a stone and an adjustment in the labour market is coming. Some businesses are already laying off workers as a precautionary measure," said Peteris Strautins, an economist with Latvia's biggest bank, Swedbank.

But Andris Laurins of Nordea Markets said that given the current state of the world economy, Latvians had no need to panic.

"Yes, economic growth has fallen sharply, but we will still be living better than we did three or four years ago," he told Deutsche Press-Agentur dpa.

Both analysts said Latvian GDP declined more than they had forecast.

Also Friday, ratings agency Moody's cut its credit rating for Latvia from A2 to A3.

"Latvia's status as a large net importer of capital leaves the country particularly exposed to liquidity problems in the international financial markets," said Kenneth Orchard of Moody's.

Orchard added that the economic downturn, which is already well underway, is now likely to be much worse than previously anticipated.

"The global liquidity crisis will probably cause a shock to the Latvian banking system, which will reverberate throughout the rest of the economy," he said.

Moody's also reduced its outlooks for Latvia's Baltic neighbours Lithuania and Estonia from "stable" to "negative," due to rising fears of a serious economic slump on the back of the global liquidity crisis. (dpa)