Chinese moves set to help EU nations reeling from sovereign debt crisis

Premier Wen Jiabao checks out an MG6 car during his visit to the MG plant in Birmingham, central England, on June 26. [Phil Noble/Reuters]

China's pledge to keep investing in the European sovereign bond market has come as good news for European nations roiled by the ongoing sovereign debt crisis, analysts say.

Premier Wen Jiabao during his recent visit to Europe indicated that China could buy the sovereign debt of some troubled eurozone nations if needed and would remain a long-term investor in the European bond market despite the looming sovereign debt crisis.

"China has increased the purchase of government bonds of some European countries and we haven't cut back on our euro holdings," Wen said. "We have confidence in the European economy and in the euro."

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The Chinese government has adopted a slew of positive measures such as increasing the holdings of government bonds of some European countries and expanding investment in Europe in order to help the region tame the current crisis.

"Wen's comment sent a strong and positive signal to the Europeans that Beijing is willing to extend a helping hand if necessary," says Chen Xingdong, chief economist with BNP Paribas Asia Ltd.

The purpose of the Chinese government to increase the purchase of European debt is also to diversify the investment of the country's massive foreign exchange reserves of more than $3 trillion (2.1 trillion euros) away from US dollars, Chen says.

As the world's second-largest economy, China has started to rebalance its foreign reserve portfolio from US treasury bonds and tilt more toward euro assets. About a quarter of China's foreign reserves are estimated to be invested in euro-denominated assets.

Standard Chartered Bank in a recent report said that China may start investing less in US treasury bonds and more in euro debt. China has bought about $3.6 billion worth of "AAA" rated bonds issued by the European Financial Stability Facility, which is backed by members of the European Union and the European Financial Stability Mechanism, according to the report.

The report also said that China's foreign reserves expanded by $196 billion in the first four months of this year and about 75 percent of that investment was in non-US dollar assets.

"Even if the government were not concerned about the US fiscal situation, the yields on offer in the euro market would likely be attractive enough for it to diversify into Europe at the margin," the report said.

The euro has tumbled sharply recently amid concerns that Greece is faced with the risk of becoming the first Western European country to default in six decades.

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Economists have warned that if the Greek problem is not well addressed, the crisis will spread to other parts of the region as the economies of each member countries have become highly intertwined.

"It is in Beijing's interest to support a stable euro as Europe is the biggest trading partner of China," Chen says. The European Union is China's largest trading partner with the bilateral trade volume reaching $360 billion last year.

"By providing a vote of confidence in the European economy, China will also ask favors in return such as the recognition of its market economy status and further liberalization of its investment in Europe," he says.

Fu Ying, deputy foreign minister, said in June that Europe's recovery from the crisis is vitally important for China.

She said that China is concerned about the state of the European economy, particularly the Greek problem and feared that the crisis my prompt renewed fears that the government might default on its debt.

Last year, China offered to buy Greek government bonds and pledged to buy 2.8 billion euros in Portuguese state bonds although it did not reveal how much it actually invested.

But some economists warn about the risks of holding European debt given the uncertain situation in the eurozone.

"The European debt may offer high returns but the risk is still higher than the US debt because the euro is not as liquid as the dollar and the European bonds are issued separately by different European countries," says Zhao Xijun, deputy director of the Financial and Securities Institute at Renmin University of China.