How Could China and the BRICs Support the Eurozone?

The Eurozone is edging toward a financial abyss. China and the BRICs could contribute to a solution, but only through compromise.

Recently, the President of the European Commission (EC) Jose Manuel Barroso warned of a crash that would instantly wipe out half of the value of Europe’s economy, plunging the continent into a depression as deep as the 1930s slump.

It was a serious warning, and it was too little too late.

Today, the EU and China are each other’s largest trading partners. In the Western media, China is often portrayed as awash with cash, primarily due to its large $3.2 trillion foreign exchange reserves.

China’s reserves are for the most part invested in long-term sovereign debt instruments. However, China and the BRICs could be part of a solution. That, however, requires compromise.

The Eurozone’s Expectations

In the past, the Eurozone problems were resolvable because the peripheral countries – Greece, Ireland, and Portugal – each represented less than 3 percent of the Eurozone economy.  However, if Spain or Italy, the two major “too big to fail” economies, fail to raise money at reasonable interest rates, the G20 will be forced to lead a coordinated response, to avoid the adverse consequences on the world economy.

Just a few months ago, former Premier Silvio Berlusconi claimed there was no crisis in Italy, but even he had to accept a highly intrusive IMF monitoring of his government’s promised reforms. That, however, is far from enough.

While we should still be mindful of the brutal historical legacy of European colonialism, contemporary Europe has played a vital role for and in the BRICs, vis-à-vis trade and investment, science and technology, finance as well as aid and assistance. In the long-term, the European markets and industries will continue to play a vital role for the BRICs.

China had already bought billions of euros’ of Eurozone bonds from Greece, Ireland, Italy, Portugal and Spain. In addition, investors from China and Hong Kong bought 6 percent of the €5 billion initial issuance of the EFSF benchmark bond in January 2011.

Earlier in the year, China signed multibillion dollar agreements with debt-ridden Spain to invest in projects ranging from energy to banking and oil. China has also agreed to enter into numerous business contracts with Greece, the most severely affected European country.

Naturally, Europe would like to see China, along with the BRICs, as the white knight. However, the bond market channel presents rising risks. According to a recent IMF report, half of the €6.5 trillion stock of government debt issued by euro area governments is showing signs of heightened credit risk.

The China/BRICs Realities

In the Western media, China is often portrayed as awash with cash, primarily due to its large $3.2 trillion foreign exchange reserves. Nonetheless, China’s reserves are for the most part invested in long-term sovereign debt instruments, with around 60-65 percent in U.S. dollar instruments, 20-25 percent in euro assets, and the remainder split between other currencies. Only a small fraction is held in highly liquid short-term paper.

Prior to the Eurozone Summit a few weeks ago, China, reportedly, was considering an investment of $50-$100 billion into the Eurozone; 1.6 percent-3.2 percent of its foreign exchange reserves. Theoretically, longer-dated instruments could be liquidated, but it would not make much sense from the Chinese standpoint and could severely destabilize the markets.

Also, China could accelerate the diversification of its reserves by investing more in euro assets.  But even that would not be enough. In 2012 alone, the Eurozone needs around €1.7 trillion ($2.4 trillion), or 17.5 percent of its estimated GDP, for refinancing.

Most importantly, Chinese public opinion would not support such risk-taking. In the coming years, China must cope with its own domestic development needs and Chinese investors are mandated to seek long-term, high financial returns, within reasonable risk tolerance.

The Eurozone is China’s most important trading partner and takes up 20 percent of China’s total exports, which is slightly more than the US share in Chinese exports. It is also China’s primary technology partner and key source of FDI. European multinationals have played a vital role in China’s economic development. And yet, China has a stock of only €7 billion ($10 billion) in foreign direct investments in the Eurozone; just 3 percent of its total outward FDI stock as of 2010.

How To Facilitate the Deal

In the recent Euro and G20 Summits, Chinese investment could have been facilitated into the Eurozone in three ways:

  • Instead of paper assets, the Eurozone could make it easier for Chinese firms and investors to acquire hard assets.
  • The Eurozone could recognize China as a market-oriented economy ahead of the World Trade Organization’s scheduled date for doing so in 2016.
  • The Eurozone could be more willing to yield to concessions regarding the representation of China and other large emerging economies in international multilateral organizations (WTO, IMF, World Bank) in which Europeans have a disproportionate representation.

Some or most of these conditions should be fulfilled for greater support by China and other BRIC economies. Additionally, they will seek for assurances for the security of their proposed investments and, naturally, they expect core Eurozone nations also to purchase Eurozone debt.

Today, the Eurozone is struggling with half a dozen overwhelming challenges: misguided fiscal policies, inadequate monetary easing, insolvency crisis (Greece is only the beginning), a grossly inadequate liquidity facility, recapitalization of major banks, the central bank’s toxic assets, as well as challenges in competitiveness and innovation. In turn, the Chinese people are Beijing’s first priority. The GDP per capita of the Chinese is still relatively low relative to European living standards. As long as China remains open and grows at 8-9 percent per year, it can drive and support global growth significantly.

Neither China nor the BRICs can bailout the Eurozone economies. The zone needs to mobilize all the political will and support to make the difficult decisions that have been avoided and deferred for too long.

Based on Dan Steinbock (2011), “The Eurozone Debt Crisis and the Role of China,” EU Centre Policy Brief, Number 3, Nov 2011