Foreign ownership of certain peripheral European government bonds has been dropping like a Blarney stone, in a reversal of a decade-long trend.
You can see the effect in the below chart — from Citigroup’s economics team — and made using the World-Bank Joint External Debt Database:
At the height of the European sovereign crisis, government external debt in absolute terms declined by 14 per cent quarter-on-quarter in Greece, 12 per cent in Portugal, 8 per cent in Spain and 5 per cent in Ireland — at the same time that total public debt was rising at a quick pace in all these countries. For those wondering about the eurozone as a whole, external government debt has actually increased. This suggests, to Citi, that there’s been some portfolio rebalancing going on — with eurozone investors reducing their peripheral exposure and upping their ‘core’ stuff.
So who has been buying peripheral debt?
Unsurprisingly, Citi says it’s largely been the local banks:
… banks in peripheral countries substantially increased their holdings of domestic government bonds over the past year – by a very large 88% in Portugal, 20% in Greece and Ireland, 13% in Spain and by 20% in Italy.
But bank balance sheets explain only a part of the so-called ‘home bias’ story.
As Citi points out, the increase in domestic bond holdings by banks began in the fourth-quarter of 2008 — well before the sovereign crisis (and indeed, some might say the build-up helped cause it). That was when the European Central Bank introduced its unconventional Long-Term Refinancing Operations, allowing banks to use sovereign bonds as collateral for central bank liquidity.
Something else must have shifted.
Citi reckons that other local investors have also upped their domestic inclinations during the turmoil. Insurers, pension funds, retail investors and the like may also have followed the banks example. Data on non-bank balance sheets is not as easily obtainable as for financials — but Citi have constructed a proxy which looks like this:
So will a love of all-things local be a permanent feature of the eurozone market?
Citi certainly seems to think so:
A year since its start, the sovereign debt crisis is far from over, in our view. We think the sovereign turmoil has brought about a structural shift in the assessment of sovereign risk among European investors, which is unlikely to be reversed any time soon. The trend increase in foreign ownership of government debt seen in the past decade has been abruptly interrupted in the first half of this year in all the peripheral countries most affected by the crisis, except Italy. In its place, there has come a rising reliance on domestic banks, which in turn are still highly reliant on ECB funding. Doubts remain on what will happen to these trends if/when the ECB withdraws its non-conventional liquidity measures. We reckon the reversal towards a structurally stronger “home-bias” is likely to persist in coming years.
It’s not just in the asset management industry, then, where certain local preferences may exist.