China: Money to Burn on Europe?

By Tom Spence, October 29, 2011

Hu Jintao - President of the People's Republic of China

Hu Jintao - President of the People's Republic of China

The Europeans are hoping to capitalise on their success after reaching a deal to save Greece and are looking to China to help shore up the European economy. The Chinese are wary, they have money to spend but not to burn.

A few weeks ago when Lou Jiwei, the chairman of China Investment Corp, met with Giulio Tremonti, the embattled Italian Minster of Finance, the idea of Chinese investment funds being used to stabilise the European economy seemed mere wishful thinking but there now appear to be concrete and more realistic moves to try and convince the Chinese to make a significant investment in the Eurozone rescue fund. Europe is China’s main trading partner and Beijing would be hit hard by a significant decline in exports to Europe. It looks like the Chinese are willing to be persuaded if they can be offered some serious guarantees.

Chinese currency reserves
Klaus Regling, the chief executive of the European Financial Stability Facility (EFSF), flew to Beijing for talks with Chinese officials immediately after Eurozone leaders struck a last-minute agreement after having convinced private banks and insurers to accept a 50 % loss on their Greek debt holdings. However, both the Chinese and Regling are playing down the talks, suggesting that they are merely exploratory.

This time it is not the China Investment Corp but the Chinese Finance Ministry and the State Administration of Foreign Exchange, the aptly named SAFE, who might be interested in investing, as they manage the majority of the country’s foreign exchange reserves which now stand at $3,200 billion. However, the Chinese have made it clear that yes, they do have money to invest but certainly not to burn.

A political price to pay
Admittedly the Chinese have a problem as they have to invest this massive pile of money “the fruits of Chinese people’s hard work” somewhere but there will be no blank cheques. The Chinese will want guarantees and will probably want to see other countries following suit so that they do not appear to be scattering “dumb money” to the winds on their own. A significant investment of this nature could also lead to some political fallout. After a windfall of Renminbi into European coffers it may also be difficult for EcoFin to stand side by side with the US in criticising the artificially devalued Chinese currency but given the current desperation of European leaders this would be a small price to pay. The Norwegians for example, albeit not members of the Eurozone, have a $564 billion oil fund which apparently has only €100 million in EFSF investments. The Chinese may wish to see greater pan-European solidarity before they enter the market.

Taking it slowly
The Chinese are already actively involved in propping up the Eurozone economy as they have been buying the bonds being issued by the EFSF but the Europeans would be delighted if the Chinese could actually contribute to the rescue fund directly. The $420 billion rescue fund is seen as insufficient in the event of contagion beyond Greek borders. Such a sum would be inadequate to save a major economy like that of Italy or Spain. Ecofin is trying to gear up this fund to reach $1 trillion and to offer an insurance scheme for European bond buyers. All this still has to be worked out and the Chinese Ministry of Finance will want to see the details of any such deals and may even insist on a special investment vehicle suitable to their own needs with watertight guarantees.

The Chinese will also want to see a clear demonstration that European profligacy is at an end and that government spending has been reined in, something that even the ECB is still waiting for in the case of Greece and Italy.

The Chinese may elect to invest via the International Monetary Fund, which would not prop up either Greece or the Euro directly but would give a signal to investors who are currently piling out of Europe. It would be a huge confidence boost.

Cherry picking the best of Europe
The Chinese are more likely to want to cherry pick some investments that suit them rather than just chucking good money after bad. Certainly in Italy’s case the Chinese would be far more interested in buying a share in some of the government controlled companies like ENI and ENEL but the Italians (so far) are resisting selling the family silver, preferring to tweak pension measures, liberalise the job market and generally prevaricate.

The Chinese assistance will more than likely be smart money – carefully selected investments – as any pointless financial handouts in Europe would have political repercussions back home in China. The CIC will be twice shy, having been bitten after its foray in the US to shore up Morgan Stanley and Blackstone Group.

The crisis is not over yet
This sort of investment is no easy matter for China. The Chinese are keen not to appear as having a political agenda, laying them open to accusations of “reverse colonialism” – a rather churlish accusation under the circumstances. Notwithstanding this, the Chinese are at pains to present themselves as pure investors with no hidden agenda or ulterior motives.

The Chinese Ministry of Finance no doubt will not be satisfied with the Eurozone’s last minute agreement, but as Ecofin readily admits, much has still to be decided and the whole thing may unravel again if the successes are not quickly consolidated. The Chinese may not be overly eager to rush into a deal, they may bide their time as even the day after the Eurozone agreement was reached Italian bonds were sold at record high yields of 6.06%, for their 10 year bonds, up from 5.86% the month previously. Not a good sign – the fundamental economics are still what they were – awful.

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