The People's Party, the largest group in a five-party coalition, walked out amid disputes over how to cope with the country's severe problems.
Unemployment has now hit 20 per cent and the economy contracted by 18 per cent last year.
The People's Party quit after its action plan failed to get the backing of Valdis Dombrovskis, the Latvian prime minister, who labelled it "populist".
Mr Dombrovskis warned the People's Party's departure could cause yet further economic instability.
"Any contradictions in the government are immediately reflected in the financial markets, and they directly affect the fiscal stability our country... a policy that is truly responsible for the country cannot be self-centred," he said.
But he said remained confident that an emergency IMF bail-out worth £6.7bn would remain unaffected by the political instability.
Very bad news for the Baltics...
It is amazing what has happened to Latvia in the past few years...