Foreign and Military Affairs

China backs Europe amid debt crisis

Updated: 2011-05-10 11:00


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BRUSSELS/BEIJING - It may be an uncomfortable anniversary to celebrate. The sovereign-debt crisis continues to cloud the euro zone's prospects a year after EU finance ministers agreed on a 750 billion euro bailout package to prevent the spread of the Greek debt crisis and safeguard the euro.

Now China seems to face a dilemma: to bail out the euro and offer a real alternative to its dollar-based reserve system, or to cut its euro investment as the crisis persist.

Investment at stake?

While Greek and EU leaders have denied mounting speculation concerning a restructuring of Greece's debt, uncertainties still hang over the markets as to whether the country would be able to pull itself out of the debt quagmire.

Eurostat, EU's statistical office, released data in late April, showing the Greek fiscal deficit stood at 10.5 percent of the country's gross domestic product (GDP) last year. The deficit was much lower than the 15.4 percent in 2009 but markedly above a previous forecast of 9.6 percent.

Meanwhile, Greece's public debt reached 328.6 billion euros ($479.2 billion), accounting for 142.8 percent of the country's GDP, the highest among the 17-member eurozone, according to the data.

Other weak eurozone members are also suffering grave debt problems. Ireland, the second eurozone country after Greece to seek a bailout, saw its deficit-to-GDP ratio rising to 32.4 percent last year. Portugal's public debt accounted for 93 percent of its GDP last year, a 10 percent jump compared with that of 2009.

The deficit-to-GDP ratio in eurozone economies is predicted to keep growing in the coming years and the debt-ridden EU members are unlikely to see the ongoing crisis ease until 2014 or 2015, said Chen Xin, director of economic studies at the Institute of European Studies of the Chinese Academy of Social Sciences.

Additional investment could be at stake on a weakening euro, especially when some sovereign debt holders will have to take losses for defaults under a new bailout mechanism which is to take effect in 2013.

In recent years, China has been seeking to diversify some of its foreign exchange reserves away from the US Treasury debt and into other investments, including euro-denominated debt.

Though not very optimistic about the European economy, China Investment Corporation, China's sovereign wealth fund, will continue to invest in Europe, the fund's chairman Lou Jiwei told the Boao Forum for Asia held in Hainan in April.

Lou added that investment returns from the economic bloc so far was "not bad."

Stabilizer for win-win results

Lou's remarks were seen as renewing China's promise to purchase debt from these troubled EU members, as Chinese leaders have repeatedly voiced backing for the European countries over the past two years.

Since the outbreak of Europe's debt crisis in 2009, China has been buying bonds from Spain and other European nations, according to China's commerce ministry.

"China has served as a stabilizer for the world's finances and economy in the past two years," said Li Daokui, a member of the monetary policy committee of the People's Bank of China, the country's central bank.

Chinese leaders have said on many occasions that they want to see a stable eurozone and a dynamic euro. China has bought European government bonds as part of its efforts to help alleviate the crisis.

During visits to a number of European nations earlier this year, Chinese Vice-Premier Li Keqiang said China, as a long-term and responsible player in the bonds market, has not reduced its holdings and even increased its buying activity amid European debt concerns.

Chinese Premier Wen Jiabao reinforced the message during a meeting with visiting Spanish Prime Minister Jose Luis Rodriguez Zapatero in April, reiterating that China would continue to buy Spain's government debts.

China's efforts have won wide applause in Europe. Although China has not said how much debt it is buying, the mere promise to buy debt has already made it difficult for investors to bet against the euro.

Zapatero lauded China's swift and firm support when his country, the fourth largest economy in the eurozone, was hit hard by the global financial crisis.

"The support helped build up Spain's confidence and capability to prevail over difficulties and ensure the stability and development of Spanish and European economies," Zapatero said.

"Chinese leaders' commitment to aiding the eurozone by buying bonds of certain European countries in difficulty in 2010 came at specific times in the crisis and has been credited by specialists with having tremendous symbolic benefits in Europe at the time," said David Fouquet, director of Brussels-based Asia Europe Project Information Service.

Meanwhile, China extending a helping hand to Europe also helps itself in curbing losses on its growing financial investments in Europe and will cheer up the EU market, now its largest trading partner.

Violability in the euro would not have a significant impact on China's strategy of diversifying its foreign exchange reserves, analysts say.

"I believe that this is China's gradual and prudent policy over a longer period of time that also fits in with its announced objective to lessen the world's dependence on the US dollar as the sole global reserve currency and begin a shift toward a more multipolar reserve system, still to be specifically defined," said David Fouquet.

China's foreign exchange reserves hit a historic record of $3.04 trillion by the end of March, according to data from China's central bank.

Chen Xin said China should not base its strategy of foreign reserve management merely on short-term considerations.

"China can still diversify its bond portfolio by buying government bonds in Europe. There are plenty of European governments that are not at risk of defaults and whose bonds are safe investments," said Fredrik Erixon, Director of European Center for International Political Economy (ECIPE).

"The eurozone crisis may expand to more countries than we have seen so far, but it will still be limited to a couple of countries in the European periphery," Erixon added.

Chen also said the crisis provides China with an opportunity to learn more about the EU bond markets, which is quite different from and more diversified than the Treasury bond-dominated US market.

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