German Finance Minister Wolfgang Schaeuble (left) speaks with Spanish Finance Minister Luis de Guindos before a European Stability Mechanism followed by a Eurogroup Council meeting in Luxembourg. John Thys / Agence France-Presse

The establishment of the European Stability Mechanism comes with warnings from experts

Brussels will continue to look to Beijing to bolster the European Stability Mechanism, the long-awaited permanent financial firewall inaugurated on Monday, China observers say.

But they have warned that Beijing needs to be wary even though the European Union and China reached a consensus recently that Beijing would buy more bonds when the mechanism came into effect.

"Beijing still needs to look carefully at the limits of key European states in backing such mechanisms and then determine how much support it is willing to give," says Gregory Chin, professor at York University in Toronto and China research chair of the Center of International Governance Innovation.

On Monday, Brussels put the ESM into effect, with a maximum lending capacity of 500 billion euros ($642 billion), after prolonged debate in the EU. But the total capital contribution of from 17 eurozone countries will be only 80 billion euros, to be offered in phases. Germany will contribute 27 percent of that, and France, Italy and the Netherlands will also be big contributors.

Chin says the ESM's establishment is a breakthrough in a process of creating new regional-level international governance mechanisms for the Europeans, one he says is clearly needed.

"The response has been too slow in coming, but better late than never, I guess," Chin says.

For China the big question in helping to finance this new mechanism is how much governments, particularly Germany's, are willing to support it.

"The reality behind the eurozone is that key states, nation-states, still matter, ultimately, to keep the project Europe afloat," Chin says, adding that the limits of the initial financial commitment from European sources for the ESM suggests that this is not yet fully resolved.

"Ultimately, the Europeans must still save Europe, though China can help to further calm the markets."

Duncan Freeman, a researcher at the Brussels Institute of Contemporary China Studies, also has a warning for Beijing.

"Risk is a key factor for the Chinese government. Since the crisis began, the EU has failed to adopt coherent policies to resolve the problems, and while the ESM is a step forward, China will want greater clarity before committing itself to supporting the ESM in a significant way."

Brian Lawson, chief global economist at Exclusive Analysis in London, believes the roles of EU member states are essential, compared with Asian creditors such as China and Japan.

"For China, ESM would be a convenient way to buy pooled European risk if it issues debt, but this was already available from its predecessor, European Financial Stability Facility."

Lawson says that the 80 billion euros of initial capital for the ESM and a further 620 billion euro in collateral commitments give it a stronger capital base than the EFSF, which was based on contingent support from its members.

"Ultimately, however, its strength relies on the larger and stronger eurozone countries, Germany and France. In this regard, little, if anything, has changed."

Overall, recent developments have reduced the risk of the eurozone rapidly collapsing, he says.

Chin and Lawson are at one in saying it took too long for politicians in Brussels to establish the ESM.

European leaders' failure to act earlier has taken a serious toll on other regions of the world economy, including the higher growth areas, Chin says.

And it has taken Europe too long to acknowledge the depth of the problems, especially on the financial lending side (bad loans), and to devise a clear road map for collective burden-sharing, with a clear sense of how the plan will be funded.

"Hopefully, the ESM announcement is another step in such international governance innovation, even if it has been too slow in coming," Chin says.

Despite the warnings, China and the EU may begin new talks on help in boosting the ESM's lending capacity, although China has no imminent funding plan.

Those talks may begin when Chinese and European banking and financial leaders meet at the annual International Monetary Fund and World Bank conference in Tokyo this week.

Klaus Regling, managing director of the European Stability Mechanism, says he will "meet those (leaders) from Asia when I am in Japan soon".

The EU still needs steady support from major Asian creditors such as China and Japan, he says.

"I am confident that the relationship with traditional and good Asian customers will continue when ESM issues bonds."

At the China-EU summit last month the Chinese Premier Wen Jiabao said Beijing had offered substantial support for debt-ridden European countries through the IMF, the EFSF or European countries' sovereignty funds.

He promised that Beijing would commit more, based on previous efforts.

In recent days, Liao Liqiang, the Chinese ambassador to Belgium, has echoed the pledge, saying China would offer more financial support once the ESM came into effect.

But Regling has declined to put a figure on Asian countries' bond investments, and official data on China's total buying of European bonds is unavailable. However, some data show that Chinese and Japanese institutions have been big buyers.

Sylvain Plasschaert, advisory board member of the Brussels think tank, the European Institute for Asian Studies, says that with the ESM, Brussels has a chance to convince the market that it is moving in the right direction.

Moody's Investors Service has given the ESM a triple-A rating, which Plasschaert says is a positive response from the market.

"If the Chinese government is willing to buy ESM bonds, that would be helpful. China has tremendously big foreign exchange reserves, and the buying can help diversify."

However, European countries should not expect too much help from China which has invested a large part of its foreign reserves in the US dollar, Plasschaert says.

If China is now going to invest more in euro bonds, the ESM system will become much stronger and such an investment may be a good move because it will help China diversify the composition of its reserves in a mutually beneficial way, he says.

Chin also says it is in China's interest to support the eurozone option, given that the Chinese government would like to see diversification in the international monetary system, beyond an overwhelming dependency on the US dollar.

"In providing support to the ESM, China would also gain greater authority to encourage European countries to strengthen their fundamentals."

Liu Jia contributed to this story.

fujing@chinadaily.com.cn

(China Daily 10/12/2012 page20)