Market players worried about sovereign credit risks in the wake of Greece’s recent rating downgrade are fleeing high-risk investments into safer havens.

Sentiment in global share markets was knocked recently by worries about a global debt crisis. Moody’s Investor Services said the United States and Britain must get a grip on their public finances to avoid threats to their top AAA credit ratings and Fitch downgraded its rating

for Greece.

“Worries about sovereign credit risk and the ongoing global debt crisis are rattling the market,” said Neil Mackinnon, global strategist at VTB Capital.

Last week, Chancellor Alistair Darling delivered a neutral Pre-Budget Report even though he conceded the recession is deeper than expected. He said the UK economy would likely contract by 4.75% this year and government borrowing would rise to £178 billion in 2009/10, or 12.6% of gross domestic product (GDP).

He said net debt would reach 56% of GDP this year and increase to 65% next year and 78% by the end of the forecast period in 2014/15.

Though the figures were fairly alarming, currency traders took the forecasts in their stride, knowing that more substance will likely emerge from whoever wins the next General Election due by June. However, the pound fell against the dollar and euro after Darling’s statement.

“Unless a deficit reduction programme is deemed credible by the rating agencies, the UK’s sovereign rating will come under question, which will push up gilt yields and the cost of debt servicing, making the problem worse,” said Ian Kernohan, economist at Royal London Asset Management.

Morgan Stanley said in a report published a few week ago that Britain risks becoming the first country in the G10 bloc of major economies to risk capital flight and a full-blown debt crisis over the coming months.

The US investment bank said there is a danger Britain’s toxic mix of problems will come to a head as soon as next year, sparked by fears that Westminster may prove unable to restore fiscal credibility.

“Growing fears over a hung parliament would likely weigh on both the currency and gilt yields as it would represent something of a leap into the unknown, and would increase the probability that some of the rating agencies remove the UK’s AAA status,” said the report, written by the bank’s European investment team.

Although Britain’s huge deficit is weighing on markets, investors are more concerned about mounting debt problems in Greece, Portugal, Spain and the Republic of Ireland.

Growing concern in financial markets about Greece and other debt-laden countries has been compounded by the growing difficulties in Austrian banks, which do extensive business in formerly communist Eastern Europe where the recession has been particularly severe.

On Monday, the Austrian government took over Hypo Alpe Adria, a subsidiary of German bank BayernLB, which had suffered losses from bad loans in Eastern Europe.

“These banks are not of themselves a huge threat to Austria’s finances, but there will naturally be fears about the wider potential for Eastern European losses among European banks,” said Kit Juckes, chief economist at ECU Group. “This will just add to concerns about the final extent of the bailout burden for European countries.”

Last week’s downgrading by international agency Fitch of Greece’s debt rating sent share prices tumbling on the Athens stock market. Standard & Poor’s cut its credit outlook on Spain to negative, threatening a rating downgrade in two years if tough budgetary action is not taken.

Standard & Poor’s said this week that Greek banks, which have seen their share prices plunge during the past fortnight, face the “highest risks in western Europe”.

The problems faced by Greece, which is seen as the weakest link in the eurozone, are staggering and have been brewing for months. The country’s debt has reached the highest level in its modern history – €300bn (£272bn) – the country’s deputy finance minister, Philippos Sachinidis, has said.

The downgrade by Fitch means Greek debt will no longer be acceptable collateral in Frankfurt at the end of 2010. If the European Central Bank sticks by that rule, the cost of borrowing for Greece (and the risk of any default) could increase substantially; the financial markets will not wait 12 months to price in the risk. If the ECB bends its rule, there will be loud protests from other eurozone members.

Greece’s euro membership had made it much easier to borrow money in international markets. Now, the cost of insuring its debt in the credit default swaps market is higher than for neighbor Turkey, which is outside the zone.

Greece has vowed to do whatever it takes to check its deficit. Prime Minister George Papandreou went on national television a few days ago to warn Greeks that drastic measures will have to be taken to tackle the country’s colossal deficit. He detailed plans to reduce borrowing with new spending cuts, which some fear could ignite a volatile public, Greece was hit by riots a year ago when a left-wing student was killed by police and trouble has resurfaced.

However, without tough action it will be impossible for Greek leaders to restore market confidence.

The Greek crisis is starting to worry other members of the eurozone, particulaly Germany, which helped bail out Hungary and other countries earlier this year. Some economists say the Germans are unlikely to be so generous again.

“People are talking about how Germany or France may bail out these countries, but I don’t think it works that way,” said Lloyds TSB analyst Kenneth Broux.

German Chancellor Angela Merkel has said that Europe’s biggest concern as Greece battles its debt problems is maintaining a stable euro. “We are agreed within the Eurogroup (of eurozone finance ministers) that we need to respect the criteria of European stability on budgetary matters,” she said at a two-day EU summit in Brussels.

“We will discuss with the nations in the greatest difficulty how to maintain a stable euro, that’s everyone’s concern,” she added.

Greece recently revised upwards its deficit forecasts, which now stand at 12.7% of its GDP for 2009 and 9.4% for 2010. But its debts are forecast to rise to 113% of GDP by the end of December and 120% during 2010, figures that raise the spectre of a Latin American-style collapse if left unchecked.

douglas.hamiilton@theherald.co.uk