Hereâs a singularly-arresting chart from Deutsche Bankâs excellent fixed income team: http://av.r.ftdata.co.uk/files/2010/01/greekdebt1.jpg That is foreign banksâ holdings of European government debt, and there is an unexpected standout: Greece. The chart highlights two concerns; firstly, the potential for banks to be burned by the situation in the Hellenic Republic, and secondly, the extent to which the country has relied on outsiders to finance its deficit in recent years. Here are the DB analysts, headed by Gilles Moec, with a bit more detail: Such inflows leave an economy vulnerable to a sharp withdrawal of funds at some point in the future should foreigners lose confidence or face liquidity constraints that prevent them from maintaining this exposure. A breakdown of net international investment positions for some of the more vulnerable EMU economies highlights this predicament. Financing of C/A deficits generally takes two forms â debt creating and non-debt creating inflows. Non-debt related inflows refer to FDI and equity, debt-related inflows can be in the form of either portfolio flows into domestic public or private fixed income markets or loans (e.g. trade credit, syndicated loans). In Greeceâs case the majority of its negative net international investment position relates to portfolio flows into the public sector which foreigners can choose to sell whenever they wish. At end-Q3 foreigners held EUR216bn of Greek government debt (72.3% of the total market, 90.2% of GDP), having doubled their position since end-04. Given recent downgrades and another round of revisions to budget data from previous years, a sharp slowdown or even reversal of inflows from foreigners into the local debt market has become an increasing risk. Matters are made worse by the fact that the ECB has taken a hardline stance on the collateral criteria for its liquidity ops. That means if Greece is downgraded by Moodyâs (the only agency still rating it at the A-level) its debt will no longer be eligible for the ECB facilities once the central bank raises its collateral-threshold back to its original level of A-. Greece is probably hoping that foreigners will continue to finance the government for the rest of 2010, some investors have been piling in to Greek bonds in anticipation of a bailout, but there are signs that may get more difficult. The countryâs Public Debt Management Agency has already said it will not sell any bonds to the market this month, instead opting to focus on T-bills. Bid-to-cover ratios for last weekâs auction of 52-week bills was fine at 3.05, but yields rose 119bps to 2.2 per cent. Which means, in short, that investors are demanding more and more of a premium for holding Greek debt. If foreigners do retreat from Greek debt, the government will no doubt be hoping that its domestic banks could step in to replace them. That however, may also prove problematic, according to DB: Full financing from the domestic banking sector is probably also not viable. December saw the government sell EUR2bn in bonds in the form of a private placement to 5 banks, 4 of which were Greek. Should the government rely entirely on its domestic banking sector for financing this year, it would result in a 163% increase in their holdings of Greek government debt relative to end- October (EUR32.5bn)1. In the absence of an increase in banking sector liabilities, Greek banks would move from holding 8% of their assets in Greek government debt at end October to 20.2% of their total assets by end-2010. This would only materialise if Greek government debt could not be posted at the ECB as collateral but would undoubtedly translate into a sharp fall in the stock of private sector credit and a more negative growth outcome than is projected by the government, endangering the governmentâs fiscal targets. http://ftalphaville.ft.com/blog/2010/01/18/128096/grεεk-dεbt-disastεr/?updatedcontent=1 Ay, ay, ay.