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The possibility of a major default continues to hover over the EU. Greece, Portugal and Ireland have already been bailed out. Due to sustained uncertainty in the markets, the borrowing costs of Italy, which has the largest sovereign debt of all the European countries, and Spain have increased considerably. This has led to fears that without sufficient cash to meet their debt obligations, the two countries might be trapped in a downward economic spiral.
Problems in Spain and Italy will greatly increase the magnitude of the crisis as the EU would be under great strain to rescue two key economies. The two countries have the euro zone’s third and fourth largest economies respectively, and are key contributors to the European Financial Stability Fund (EFSF). However, they now hold combined debts of over 2.2 trillion euros($3.2 trillion).
Most worryingly, the spread to other euro-zone countries is evident, with the French bank Societe Generale facing a 395-million-euro ($568 million) writedown on its Greek debt holdings, and the German economy, which was formerly seen as the engine for the euro zone, exhibiting clear signs of a slowdown. Italian government bonds are widely held by the largest European banks and a possible default would have ramifications that would go far beyond the Greek debt.
As part of the effort to contain the crisis, the 440-billion-euro ($633 billion) EFSF was agreed upon in May last year. In July this year, faced with the possibility of a Greek default, euro-zone countries had agreed to widen the scope and increase the powers of the EFSF, allowing it to intervene through preemptive actions and purchase bonds in secondary markets. But these changes have yet to be ratified by individual member states, and calls for the launch of euro bonds or a bigger bailout fund have not received support.
To their credit, EU leaders have tried to show their resolve in keeping the euro zone together. A recent summit meeting between France and Germany drew up plans for member states to include balanced budget clauses in their constitutions. They have also proposed the creation of a “true European economic government” headed by a leader who will be elected every two and a half years. It is hoped a greater degree of economic integration will pave the way for the synchronization of tax and spending,
and lend weight to the imposition of tighter restrictions on the deficits of individual member states.
A source of capital
Against this backdrop, China’s continued strong support of the euro zone merits closer analysis. Vice Premier Li Keqiang’s visit to Europe in January this year resulted in the signing of several trade and investment deals with EU member states. He also pledged to continue buying Spanish government debt. During Premier Wen Jiabao’s visit to Europe in June, he said China would continue to buy euro-denominated bonds, as a gesture of goodwill to European markets, helping to boost market confidence at a critical moment. While the exact figures remain unknown, it is estimated China holds $900 billion in euro-zone sovereign debt, approximately 10 percent of the total issued. A quarter of China’s $3.2 trillion reserves is also estimated to be invested in euro-denominated assets.
What motivates China to expose itself to the risks of the EU crisis, a move that might come across as counter-intuitive, especially in light of severe losses from holding U.S. Treasury bonds? The reasons span the political and economic domains. Vice Foreign Minister Fu Ying said at a media briefing in Beijing in June, “Whether the European economy can recover and whether some European economies can overcome their hardships and escape crisis are vitally important for us.”
China is now the EU’s second largest trading partner behind the United States and the EU’s biggest source of imports by far. The EU is China’s top export destination,
and stabilizing the euro zone is clearly in the interest of the symbiotic relationship between European and Chinese economies. China is not a large investor in EU member states, and there is indeed much space for greater investment. In 2010, the Chinese mainland made up only 0.3 percent of foreign direct investment flows into the EU’s 27 countries, up from 0.1 percent in 2009, while the United States made up 28.5 percent. Buying euro-denominated bonds also allows China to diversify away from the United States.
Trade and investment deals might open more avenues to address the EU’s trade deficit with China, which has long been a point of contention between the two sides. Significantly, China’s public support of the euro zone reflects its long-term commitment to its relationship with the EU and its sincere desire to foster stronger interdependence and, by extension, greater convergence of interests and goodwill, which might have a positive spillover effect on other facets of Sino-EU relations.
With the world’s largest foreigncurrency reserves, China is increasingly
seen as a possible source of capital by debtridden countries. In addition to its pledge to buy Hungarian debt, China has extended a 1-billion-euro loan ($1.4 billion) to Hungary, promised to buy up to 5 billion euros ($7.2 billion) of Portuguese sovereign bonds and is believed to have committed to buying about 6 billion euros ($8.6 billion) of Spanish debt.
Win-win outcomes
While the vocal and monetary support extended by China has been generally well received by EU member states, there are fears China might be making a strategic attempt to push up the euro exchange rate against the yuan in the process or pursuing leverage to seek EU recognition of its market economy status. In January this year, President of the European Council Herman Van Rompuy said, “When they buy euros, the euro becomes stronger and their currency a little bit weaker. That is not neutral in regard to their competitive position.”
Such a line of thought, while understandable, is clearly not constructive. While
there might be many conceivable reasons for China’s extension of a helping hand, no country can be expected to be entirely altruistic when it comes to critical investment decisions regarding its reserves, and China’s pursuit of a win-win outcome with the EU is evident. China’s central bank has expressed its strong intention to go beyond symptomatic relief of the crisis through debt purchase and address the underlying causes of global economic problems. The bank hopes to explore ways in which Chinese and European financial institutions can strengthen cooperation to increase capital strength, improve the risk-sharing system, and possibly develop financial and hedging instruments that meet the needs of both Chinese and European markets.
With several European countries facing serious solvency problems, to preempt the problem of default and lessen the debt burden, the EU has taken to reducing interest rates and extending the maturity periods of loans. The EU might also pursue unconventional monetary policy measures to solve the debt crisis. While China has repeatedly expressed its confidence in European financial markets and its belief the EU will overcome the current crisis, it has also asserted the necessity of political will and responsible actions.
The EU and the United States are China’s two largest trading partners, and their longstanding economic problems would inevitably lead to a slowdown in China’s economic growth. As evident from China’s critique of the handling of the U.S. debt crisis following an unprecedented downgrade by credit rating agency Standard & Poor’s, China expects the EU to take concrete measures to resolve its mounting debt problem and make difficult but necessary decisions regarding structural problems in the euro zone.
The EU makes up approximately 20 percent of global GDP, and a European economy mired in uncertainty and debt will have worldwide economic repercussions. More importantly, the crisis has uncovered the underlying weaknesses of the euro zone and provided the much-needed impetus for strengthening coordination and control, the results of which will certainly pay off in the years to come.
Problems in Spain and Italy will greatly increase the magnitude of the crisis as the EU would be under great strain to rescue two key economies. The two countries have the euro zone’s third and fourth largest economies respectively, and are key contributors to the European Financial Stability Fund (EFSF). However, they now hold combined debts of over 2.2 trillion euros($3.2 trillion).
Most worryingly, the spread to other euro-zone countries is evident, with the French bank Societe Generale facing a 395-million-euro ($568 million) writedown on its Greek debt holdings, and the German economy, which was formerly seen as the engine for the euro zone, exhibiting clear signs of a slowdown. Italian government bonds are widely held by the largest European banks and a possible default would have ramifications that would go far beyond the Greek debt.
As part of the effort to contain the crisis, the 440-billion-euro ($633 billion) EFSF was agreed upon in May last year. In July this year, faced with the possibility of a Greek default, euro-zone countries had agreed to widen the scope and increase the powers of the EFSF, allowing it to intervene through preemptive actions and purchase bonds in secondary markets. But these changes have yet to be ratified by individual member states, and calls for the launch of euro bonds or a bigger bailout fund have not received support.
To their credit, EU leaders have tried to show their resolve in keeping the euro zone together. A recent summit meeting between France and Germany drew up plans for member states to include balanced budget clauses in their constitutions. They have also proposed the creation of a “true European economic government” headed by a leader who will be elected every two and a half years. It is hoped a greater degree of economic integration will pave the way for the synchronization of tax and spending,
and lend weight to the imposition of tighter restrictions on the deficits of individual member states.
A source of capital
Against this backdrop, China’s continued strong support of the euro zone merits closer analysis. Vice Premier Li Keqiang’s visit to Europe in January this year resulted in the signing of several trade and investment deals with EU member states. He also pledged to continue buying Spanish government debt. During Premier Wen Jiabao’s visit to Europe in June, he said China would continue to buy euro-denominated bonds, as a gesture of goodwill to European markets, helping to boost market confidence at a critical moment. While the exact figures remain unknown, it is estimated China holds $900 billion in euro-zone sovereign debt, approximately 10 percent of the total issued. A quarter of China’s $3.2 trillion reserves is also estimated to be invested in euro-denominated assets.
What motivates China to expose itself to the risks of the EU crisis, a move that might come across as counter-intuitive, especially in light of severe losses from holding U.S. Treasury bonds? The reasons span the political and economic domains. Vice Foreign Minister Fu Ying said at a media briefing in Beijing in June, “Whether the European economy can recover and whether some European economies can overcome their hardships and escape crisis are vitally important for us.”
China is now the EU’s second largest trading partner behind the United States and the EU’s biggest source of imports by far. The EU is China’s top export destination,
and stabilizing the euro zone is clearly in the interest of the symbiotic relationship between European and Chinese economies. China is not a large investor in EU member states, and there is indeed much space for greater investment. In 2010, the Chinese mainland made up only 0.3 percent of foreign direct investment flows into the EU’s 27 countries, up from 0.1 percent in 2009, while the United States made up 28.5 percent. Buying euro-denominated bonds also allows China to diversify away from the United States.
Trade and investment deals might open more avenues to address the EU’s trade deficit with China, which has long been a point of contention between the two sides. Significantly, China’s public support of the euro zone reflects its long-term commitment to its relationship with the EU and its sincere desire to foster stronger interdependence and, by extension, greater convergence of interests and goodwill, which might have a positive spillover effect on other facets of Sino-EU relations.
With the world’s largest foreigncurrency reserves, China is increasingly
seen as a possible source of capital by debtridden countries. In addition to its pledge to buy Hungarian debt, China has extended a 1-billion-euro loan ($1.4 billion) to Hungary, promised to buy up to 5 billion euros ($7.2 billion) of Portuguese sovereign bonds and is believed to have committed to buying about 6 billion euros ($8.6 billion) of Spanish debt.
Win-win outcomes
While the vocal and monetary support extended by China has been generally well received by EU member states, there are fears China might be making a strategic attempt to push up the euro exchange rate against the yuan in the process or pursuing leverage to seek EU recognition of its market economy status. In January this year, President of the European Council Herman Van Rompuy said, “When they buy euros, the euro becomes stronger and their currency a little bit weaker. That is not neutral in regard to their competitive position.”
Such a line of thought, while understandable, is clearly not constructive. While
there might be many conceivable reasons for China’s extension of a helping hand, no country can be expected to be entirely altruistic when it comes to critical investment decisions regarding its reserves, and China’s pursuit of a win-win outcome with the EU is evident. China’s central bank has expressed its strong intention to go beyond symptomatic relief of the crisis through debt purchase and address the underlying causes of global economic problems. The bank hopes to explore ways in which Chinese and European financial institutions can strengthen cooperation to increase capital strength, improve the risk-sharing system, and possibly develop financial and hedging instruments that meet the needs of both Chinese and European markets.
With several European countries facing serious solvency problems, to preempt the problem of default and lessen the debt burden, the EU has taken to reducing interest rates and extending the maturity periods of loans. The EU might also pursue unconventional monetary policy measures to solve the debt crisis. While China has repeatedly expressed its confidence in European financial markets and its belief the EU will overcome the current crisis, it has also asserted the necessity of political will and responsible actions.
The EU and the United States are China’s two largest trading partners, and their longstanding economic problems would inevitably lead to a slowdown in China’s economic growth. As evident from China’s critique of the handling of the U.S. debt crisis following an unprecedented downgrade by credit rating agency Standard & Poor’s, China expects the EU to take concrete measures to resolve its mounting debt problem and make difficult but necessary decisions regarding structural problems in the euro zone.
The EU makes up approximately 20 percent of global GDP, and a European economy mired in uncertainty and debt will have worldwide economic repercussions. More importantly, the crisis has uncovered the underlying weaknesses of the euro zone and provided the much-needed impetus for strengthening coordination and control, the results of which will certainly pay off in the years to come.