China should invest in european instruments that carry low risk

The Greek government has recently reached a new agreement with 85.8 percent of the total private investors over Greek sovereign bonds. This paved the way for a second bailout from the European Union. Last month, in line with a commitment made at the China-EU summit, the Chinese government bought 2 billion euros of Spanish government bonds to help European countries hit by the sovereign debt crisis. If China continues to give such help, what exactly should it do?

First, according to the Financial Times, the Chinese government is now holding a "significant amount" of Greek sovereign bonds. At the beginning of this year some people suggested that China should bargain-hunt more Greek government bonds. From an investment point of view, because of the high risk of default, holding more Greek government bonds is particularly unwise.

Second, the investment risk in other European sovereign bonds in crisis, such as those of Portugal, Spain and Ireland, is also too high. More seriously, in the event of Greece defaulting, the systemic credit contagion risk is huge.

If the Chinese government hopes to buy sovereign bonds to aid problem countries, it can buy them from the European Financial Stability Facility (EFSF) or Italy's national debt.

Third, buying European bonds is not the only way to help the beleaguered European countries. China can also take part in the process of privatizing State-owned enterprises, such as those of Greece and Portugal, looking for favorable, complementary businesses for China.

All that a new agreement for a second tranche of aid does is to put off default for another day. The first batch of aid Greece received, up to 110 billion euros, not only failed to help it but exacerbated its problems, and policy tightening has driven it into recession.

If the country cannot obtain loans from the capital markets on its own strengths it is likely to need a third bailout loan.

The problem is that if a country carries huge liabilities but lacks the scope to grow, then a tightening policy will simply suck the economy into recession. What the government needs to do is to promote economic expansion, rather than to tighten fiscal policy. As things stand, it will take the economy at least a generation to recover.

Since joining the euro, Greece's prices and wages may well have risen overall, but they are out of sync with its economic development. To obtain economic growth, prices and wages need to be halved, but doing the latter is extremely difficult because of the country's powerful trade unions.

Since wages cannot be brought down, production costs remain high, and that means the economy cannot grow.

The country's mountain of debt and its high unemployment have left the economy and the state apparatus in chaos, and after the latest bailout Fitch lowered the country's bonds to a "partly default" grade.

Because of the high degree of financial and monetary integration, the risk of contagion between the eurozone countries is high. Once Greece defaults, others will follow. Italy's Greek exposure is 6.3 billion euros, France's is 71 billion euros, and Germany's is 56 billion euros.

If the Chinese government hopes to help avert a crisis by buying bonds, it should consider investing in the EFSF and Italian bonds. Compared with the bonds of other countries, the EFSF bonds issued by 17 eurozone member states provide better credit support. And, according to the different levels of credit guarantee, the credit ratings of the EFSF bonds are different.

The best bet seems to be to invest in bonds with a stronger guarantee, bonds that enjoy the right of priority payment. This, to some extent, reduces risk.

Among the countries in crisis, the situation in Italy is relatively good, and its austerity and reform measures have achieved preliminary results. In addition, the Italian money market situation has gradually eased, and refinancing costs have reached their lowest level in the past 18 months.

Research indicates that the fundamentals in Italy are in order, its deficit is relatively low, household savings are rising, banks are relatively healthy and there is a high degree of industrial diversification. The government has implemented the appropriate reforms, and within three or four years its debt burden will be considerably lighter and it will have achieved economic growth.

Research also indicates that in the past decade the country's economic growth indicators have been good. In contrast, economic and political indicators, such as management efficiency, bribery, national legal system have fallen sharply.

In addition, the asset structures of Italy's banks remain healthy. During the financial crisis they have performed relatively well and were relatively unscathed by the subprime mortgage crisis in the US and the collapse of the investment bank Lehman Brothers. The main reasons for that are the conservative strategies of Italian investment and its focus on private banking, rather than investment banking.

Summing up, Italy's economic competitiveness far outstrips that of Greece.

Since the European debt crisis erupted, the EU has provided assistance to the crisis-hit countries, while still advancing the privatization process of State-owned enterprises in countries such as Greece, Portugal and Spain, enabling them to increase government income, and use their own strength to recover from the crisis. To invest in these countries and to be involved in the privatization process is still attractive to foreign investors.

Greece, in many areas, still has great prospects. Its port cities are the gateway to the Mediterranean, it connects southern Europe and North Africa, and its transport is highly advanced. In addition, Greece has plenty of sunshine, and can use its position in the union for the Mediterranean to strengthen relations with southern Europe and North Africa, and participate in the privatization of the solar energy industry.

Last year the China Three Gorges Group, aiming to expand its clean energy influence, bought a 21.35 percent stake in Portugal's largest energy company, EDP, for 2.7 billion euros.

Portugal also plans to partially privatize many other State-owned enterprises. The Chinese government can use this opportunity to support the country's enterprises to join in the privatization process. This will help these countries to increase government revenue, and it will help Chinese enterprises open up new operations on the world stage.

The author is a professor at the Chinese-German College, Tongji University in Shanghai. The views do not necessarily reflect those of China Daily.