China needs to take out some insurance
Updated: 2011-10-14 11:05
By Ma Jun (China Daily European Weekly)
A Greek tragedy is looming, and its consequences will be felt in Europe - and beyond
If the euro zone countries fail to reach consensus quickly, fail to supply liquidity to the financial market appropriately, fail to ensure there is orderly default in crisis-ridden countries, and fail to invest in the banking system to improve the credibility of deposit insurance, the European debt crisis is likely to deteriorate. This will spark a crisis in banking and in the broader economy.
So China should take out insurance to protect itself from a European recession? It should be cautious if asked to buy European bonds, seize the business opportunity of mergers and acquisitions in Europe, fight for Europe's recognition of China's market status and ask Europe to loosen restrictions on high-tech exports to China.
If Greece defaults on its debt, European finance and the economy at large are likely to be hit. With poor economic conditions and problems wrought by the deficit reduction plan, a Greek default in the next six weeks is looking increasingly likely. If that happens, panic selling of bonds from other European countries looms, which will push up their financing cost.
The high default risk in the banking system will further block liquidity, and bank runs are likely to take place in countries that lack credibility with deposit insurance. When bank runs occur, governments will force these banks to temporarily close their doors, and without liquidity from the banks the economy will be hit hard.
The worries that Greece may quit the euro zone could also cause bank runs, a possibility that senior German officials have suggested cannot be ruled out. In fact, Greece may be pushed to exit the euro zone, issue a new currency or restore the drachma, given that its domestic deflation policies have no public support. Although legal hurdles stand in the way of Greece quitting the euro zone - and there would be a huge cost - many people, the capital markets in particular, have been worrying that that is just what will happen. Once the expectation is further heightened, there would be big bank runs in Greece. Even if Greece has no intention of quitting the euro zone, the country's banks and other high-risk countries may be hit as long as the market worries about such a possibility.
Given all these potential risks, European countries may be forced to nationalize banks, enhance deposit insurance, and dump toxic assets. If the risk of national debt default continues to rise, and the risk of devaluing banking assets does the same, European countries may eventually be forced to provide emergency funding to banks, which is partial nationalization, and announce more credible plans on deposit insurance and dump toxic assets so as to prevent massive bank runs and frozen liquidity, or prevent the situation from lasting too long.
The specific forms of the plan include expanding the scale of the European Financial Stability Facility to inject money into the banks, provide guarantees for deposit insurance (to deal with the lack of credibility of the deposit insurance provided by some crisis-gripped countries), and to buy the toxic assets that banks hold. Meanwhile, possibilities are that big economies would directly inject capital into their banks.
Macro policies could probably lead to a double dip in the EU and the US. If a banking crisis broke out in Europe, a severe recession would ensue. If the GDP of the EU or the US fell 3 percent, the growth rate of exports in Asia, including China, would fall 15 percent. Without a stimulus policy, China's GDP growth would probably drop to 5 percent, making thousands jobless in export-related industries. Asian countries and regions other than China and India would also see GDP growth slump.
This all means that China needs to prepare appropriate policies to marshal should the US and the Europe go into recession, great or small.
A tight fiscal policy should not last too long, and any new stimulus policy must be appropriate so as not to trigger a new round of inflation, an asset bubble or non-performing assets. Monetary and fiscal policies should be well balanced to avoid excessive expansion of money supply. In the application of fiscal policy, the Chinese government should adopt international experience, promoting public consumption and increasing investment in people's livelihoods.
Meanwhile, China should seize the opportunity to acquire enterprises in Europe. The deepening of the financial and debt crises there will lead to a disaster in the real economy. In the meantime some non-financial enterprises in Europe will be oversold, bringing down their share prices and value. In the past four months the average stock price index in Europe has dropped 25 percent, and will feel great downside pressure in the next six months. Chinese enterprises with global ambitions or institutional investors with international assets should seize the chance to acquire European enterprises that are oversold but that are highly competitive in the long term.
China should be alert for mergers and acquisitions in the European financial market.
If a large-scale banking crisis occurs in Europe, many small and medium financial institutions will collapse, and a group of large and systemically important financial institutions may require an injection of capital worth 100 billion euros. China should start to look at the low-cost acquisition of financial institutions' branches in Europe, or at the possibility of buying these banks' stakes. If China's banks start from scratch and use their own resources to build a presence in Europe, they risk being left behind.
However, if China can grasp the opportunity of mergers and acquisitions, this will open the door for it internationally, a lot more quickly and cheaply than otherwise might have been the case.
In addition, crisis-hit European financial institutions may sell assets or affiliates in Asia. China might well heed the example of Nomura Securities of Japan and its zero-cost acquisition of Lehman's securities business in Asia during the past financial crisis.
Of course, before going ahead with specific mergers and acquisitions, China should take full account of enterprises' needs for expansion and control of the acquired business skills (such as management of risk and human resources), to avoid blind acquisition and making large losses.
China can aid Europe when the risks are controlled, but it should first ask Europe to address China's market economy status, and demand that the EU and major European countries reduce restrictions on high-tech exports to China.
In addition, requests for China to buy European bonds need to be handled astutely. Some European countries want China to buy debt to help stabilize the European bond market and comfort investors' worries. But right now the default risk of some European countries is rising and the euro faces the pressure of depreciation against the US dollar. China should therefore be careful about debt investment in Europe. However, China should be more supportive with European Financial Stability Facility bonds and euro bonds, working closely with various European governments on the matter.
The author is a chief economist with Deutsche Bank. The opinions expressed in the article do not necessarily reflect those of China Daily.