RIGA Latvia's coalition government collapsed on Friday after the prime minister resigned to stem a fall in popularity during a deep economic crisis.
President Valdis Zatlers said he had accepted Prime Minister Ivars Godmanis's resignation and would start talks with all parties on a new government.
It was the second European government to succumb to the economic crisis after Iceland.
Political instability has added to the economic problems of the small Baltic state, igniting a riot on Jan. 13. The country had to take a 7.5 billion euro ($9.43 billion) IMF-led rescue loan last year.
"It is possible they will be able to work out a new coalition but I think what it really means is new elections," said Lars Christensen, head of emerging markets research at Danske Bank.
"There will only be one issue at stake and that will be the austerity measures and the IMF deal. It is possible that means some parties may look to move away from the IMF deal, which would be very bad news for the Latvian economy."
Mareks Seglins, chairman of the largest coalition party, the People's Party, told reporters he and the second biggest coalition party, the Union of Greens and Farmers, thought the prime minister's resignation was the only way to help boost public trust in the unpopular administration.
Godmanis, who led Latvia when it quit the former Soviet Union in 1991, was rebuffed recently when he tried to bring an opposition party into the government. He survived a motion of no confidence vote in parliament earlier this month.
Latvia's crisis, which began during the global credit crunch, has accelerated and the finance ministry has forecast a drop in the economy this year of 12 percent, meaning further budget cuts are likely.
The political crisis has struck as a team from the International Monetary Fund visits Latvia.
(Additional reporting by Jorgen Johansson and Peter Apps)