Give and Take: What’s Behind China’s Debt Talks with European Leaders?

Recent visits from European leaders to Chinese Premier Wen Jiabao illustrate just how important China has become in the global economic order. German Chancellor Angela Merkel came first. Next came European Council president Herman Van Rompuy and European Commission president José Manuel Barroso. All three sought China’s support while providing assurances that Europe had tamed the debt crisis that just a few months earlier had threatened the global economy.

Wen and Chinese President Hu Jintao pledged their support, despite a growing chorus of journalists, economists and politicians in the country warning against the risk in European investments.

"Europe offers its debt with high interest, but there are not enough buyers,” notes Mauro Guillen, a Wharton management professor and director of the Lauder Institute. “China is prudent and always looks for the best investment.” Even as the world’s second-largest economy, China does not have the capacity to "buy up Europe," adds Jonas Parello-Plesner, senior policy fellow at the European Council on Foreign Relations.

Questioned by Chinese media, Van Rompuy insisted that Europe had taken sufficient measures to ensure that the crisis wouldn’t spread from peripheral nations to the European Union’s core. He emphasized plans for the 500 billion-euro European Stability Mechanism (ESM) rescue fund and the strict fiscal policies and structural reforms that certain EU members had agreed to enact.

"There is the persistent idea outside Europe that European countries do not do enough,” said Jürgen Matthes, a senior economist at the Cologne Institute for Economic Research in Germany. “We need to communicate that, on the contrary, many steps have already been taken."

Spreading the Debt

As the major contributor to the European budget (20%) and supporting an even larger 27% of the ESM, Germany has a great interest in persuading investors to buy European bonds. Not surprisingly, it has sought China’s attention.

In early February, Merkel visited Beijing to restore confidence in Europe’s financial capacity. Although the crisis was most pronounced in peripheral EU nations including Greece and Portugal, investors had balked at buying bonds from France, Italy or Belgium. Also high on Merkel’s list was her wish for China’s central bank to contribute more to the International Monetary Fund (IMF), a participant in Europe’s rescue package. "Germany believes that European central banks have already put a sufficient amount of money into the IMF,” Matthes says. “[Germany's] Bundesbank has already thrown in more than 400 billion euros. Like other countries, Germany comes up against national difficulties, too. Now it is the turn of other central banks to increase IMF funding." As an international lender of last resort, the IMF looks globally for its funding.

At home, Merkel faced mounting opposition. Hans-Werner Sinn, president of the Ifo Institute for Economic Research in Munich, estimated that, amid calls for more domestic infrastructure spending, Germany had provided guarantees to others of more than 10% of its GDP. Although Germany’s parliament, the Bundestag, supported Merkel’s line, some in her own Christian Democratic Union party voted against a bailout for Greece. "It makes sense to help European countries in difficulties in order to avoid collateral issues,” Matthes notes, “but they have to help themselves first."

Motives for China

As an increasingly important trading partner and de facto spokesman for Europe, Germany has an eager audience in China. Once a supplier primarily to Europe, Germany has expanded its export sphere. Germany’s exports to emerging economies, mainly China, grew by a third from 2000 to 2010. Meanwhile, China was the source of 9.5% of imports in Germany in 2010, more than triple the percentage 10 years earlier.

"By default and by size, Germany has been among the leaders on the EU's China policy,” says Parello-Plesner of the European Council on Foreign Relations. “But Germany also has a record-high trade volume with China of 140 billion euros, far above the U.K. or France, and a certain common view on international business. During Merkel's visit, it was also a question of giving German companies equal opportunities to local business and, in return, openness for Chinese investments in Germany and in the whole of the European Union."

It would appear that China should help Europe if for nothing else than to preserve an important export market. Exports to Europe were down 1.1% in February, a significant factor in China’s posting its largest trade deficit on record. "But exports are not the main motive for the Chinese to help,” said Zhang Jun, a professor of economics at Fudan University in Shanghai and director of the university’s China Center for Economic Studies. “First, since the crisis, trade has grown intra-regionally in Asia, so there is a balance. Second, a mounting idea in China is that Europe and the U.S. will continue to suffer over the coming years, so China should pursue trade with emerging markets."

Economists estimate that 65% of China’s $3.2 trillion in reserves are denominated in dollars. The central bank governor, Zhou Xiaochuan, noted recently that 20% to 30% of reserves are denominated in euros. Western analysts say China may desire a better balance in foreign bonds. "China has already bought some bonds, and will probably continue to buy some safe national bonds,” Parello-Plesner notes. “But nobody knows for what amount. It would be better if China would announce its [aid] and the amounts of it."

According to Zhang, "Initially, when the first euro sovereign debts were put on the market, some reserves were changed to euros from dollars. But as the governor of the Chinese central bank mentioned recently, the euro is already an important part of foreign currencies. Economists' voices say loudly now that although the euro has gradually acquired a greater share of foreign reserves, it remains the more uncertain between the two worldwide currencies."

A New World Currency?

China has an additional goal in terms of balancing currency power. Over the long term, China would like the renminbi to attain international currency status. At the most recent G-20 summit in Mexico, for the first time in a long while, demand for renminbi revaluation was not on the table.

"I do not know when it will come, but for sure, having a financial system based on three international currencies will help stability,” says Cui Hongjian, associate research fellow and director of the department for EU studies at the China Institute of International Studies (CIIS) in Beijing. “By helping Europe, China might help the renminbi on its path to internationalization.”

Wharton’s Guillen argues that now is not the renminbi’s time. “China must be frustrated, but I do not see it coming soon. It will take at least five or 10 years for China to have a convertible currency. Their banking system is not ready. They need to loosen control. There is nothing China can do right now.”

As the relationship between China and the United States cools, China could look toward Europe to find a closer partner and balance international ties. "Between China and Europe, it is about cooperation and commercial competition,” notes Cui, “while with the U.S., it is only competition and suspicion."

Moreover, China might be willing to exchange financial help to Europe for the privileges and recognition it has long wanted. Europe has done everything possible to protect its companies from Chinese investor buyouts. It has refused to recognize China as a developed market, which would remove certain restrictions against Chinese companies and give them greater standing in trade disputes. And China wishes Europe would agree more with its stance on international affairs. Yet if Germany and China have agreed on several points, other European countries have resisted. "The European Union is not yet ready to yield up to all this, even if China would buy its bonds," Guillen notes.

IMF as a Vehicle

China’s initial response was positive when Europe’s financial difficulties surfaced. "On the highest level, the political attitude was supportive toward Europe because it is a major trade partner, and due to the good relationship with France, Germany and Italy," Cui notes. Economists estimate that in 2008, China bought 1 trillion euros of European debt. Chinese authorities were confident that the eurozone could solve its problems, and investments appeared attractive. By contrast, the United States has been more dubious toward the EU’s ability to resolve its issues.

But since September 2011, opposition to help for Europe has grown in China. "China bought 70 billion or 80 billion euros of Greek debt, and then thought it was enough. Next, it was the turn of Italy to fall. Chinese economists wondered when and how much European debt trouble would come next," says Cui.

Chinese media joined economists in asking for greater prudence. China’s populace asked that its leaders not throw money to a richer region that doesn’t take care with its budget. China’s government ruled out direct help to individual European countries. "Good relationships and trade with France and Germany were no longer sufficient to justify buying bonds directly. The most important solution became the European Central Bank," Zhang notes. Adds Cui, "The question is not if there will be financial help, but how and when?"

The primary reason China would buy European bonds is for their return. "European deals are interesting as they pay well, with a good interest rate in comparison with the others in the markets," Wharton’s Guillen points out.

The IMF is a potential source of Chinese intervention. "Buying bonds is the second option, and will only occur through the Chinese sovereign fund, CIC [China Investment Corp.],” says Zhang. “But I do not think CIC will do more than it has already done." When Van Rompuy and Barroso visited China, Lou Jiwei, chairman of China Investment Corp., resisted the notion of buying bonds, saying China preferred to invest in the real economy, such as infrastructure and industrial projects.

"Even if China contributes to the IMF, it will never be enough, although when the renminbi will be part of the IMF currency basket, it will bring some balance,” Guillen notes. “Therefore, the renminbi needs to be convertible. But we are far from that. China would like to have more influence and, for sure, that will be welcome."

An Asian front emerged when the financial ministers of China and Japan announced before the G-20 meeting in Mexico that they would help Europe. "It is mainly a message toward markets, to show some confidence. An Asian coordination is not necessary," says Cui. Zhang adds that "China would prefer it to be part of a group, such as the IMF, rather than acting on its own."

However, one condition for receiving any support is for European countries to demonstrate that they are doing all they can first. "Greek protests against measures of the second bailout package are not a good sign,” Zhang says. “More details on actions to reduce future public spending over the next five years will restore some confidence."

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