The failure of a government bond auction yesterday heightened fears that the tiny Baltic state will have to devalue its currency, the lat, which could have a huge impact on the rest of the region and other EU states.

If the lat, which is pegged to the euro, is devalued, Estonia and Lithuania’s currencies are likely to follow suit.

Sweden would also be affected because large Swedish banks, such as Swedbank and SEB, control 50 per cent of Latvia’s lending market.

Some economists believe that the panic caused by a devaluation in the Baltic States could spread to other weaker members of the EU, such as Romania and Hungary, and even older members such, as the Irish Republic, Greece and Portugal.

This could mean that the stronger economies in the eurozone, such as Germany, would have to bail out their fellow EU countries or risk the break up of the single currency.

Latvia, a recent addition to the EU, was bailed out by the Union and the International Monetary Fund (IMF) in December after its economy was pummelled by the financial crisis.

It has followed a monetary policy of “fixing” its exchange rate and encouraging its citizens to borrow in euros and Swiss francs, which is one of the reasons it is now in so much debt.

However, there are fears that this could lead to more civil unrest in Latvia, where the previous Government was forced to resign in February as rioting erupted in Riga over unemployment and poverty.

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