Monday, 25 July 2011

Is China a White Knight for the Eurozone?

China has been concerned about the value of the US dollar since the U.S. Federal Reserve adopted a loose monetary policy in the wake of the financial crisis. At end April this year, China’s FX reserves stood at US$ 3.2 trn. But while in the past China’s US dollar acquisitions and FX reserves grew in tandem,  the US dollar share of China’s bond purchases has come down considerably. According to research at Standard Chartered, the difference between China’s new FX reserves and its purchases of US assets has grown to a record gap of $ 150bn this year, or 76 per cent of China’s total 2011 FX reserve additions (up to end April). China is buying something else. Something non-American.
Euro assets are the only other sizable diversification from the US dollar available to China for its burgeoning forex reserves. The Economist recently quoted BNY Mellon estimates that around a quarter of China’s reserves are now in euro-denominated assets. Given the recent pace of accumulation—around $200 billion a quarter—that would suggest that $ 150 billion-200 billion of Chinese reserves have found their way to the euro zone since last summer. The Chinese may have been buying as much sovereign debt from struggling states as the European Central Bank (ECB) has. China is interested in AAA European debt issued through the European Financial Stability Facility (EFSF), according to statements from the EFSF CEO Klaus Regling. AAA-rated debt yields higher for Euro than for US dollar assets – part of the attraction apart from diversification motives. Last week’s decision by EU leaders to back European peripheral credit with ‘Eurobonds’ will lead to deeper, more liquid bond markets in Europe. For Asian investors who look for deep bond markets to invest in, this should provide further reason to divest from the US into Europe.

China invests excess savings not just in liquid debt instruments, but also in equity assets, for example through sovereign wealth funds. Adding up China’s five (!) sovereign wealth funds (SAFE Investment Company; China Investment Corporation; Hong Kong Monetary Investment Authority; National Social Security Fund; China-Africa Development Fund), the SWF Institute reports current assets to total US$ 1.34 trn. Private individual and corporate investors take stakes as well, as China wants to diversify away from financial into real assets. The figure above (from The Economist)  shows that although Europe lacks behind Asia, Latin America, and Africa as  host of China’s foreign direct investment stock, the Old Continent reported in 2009 the highest percentage increase of Chinese FDI purchases. China has the reputation to love infrastructure assets. Peripheral Europe will be forced to privatise exactly those state assets that China is keen on.  This is how the Chinese state-owned company Cosco, for example, could buy up the Greek port of Piraeus, with the idea of turning it into a beachhead for Chinese exports into Europe.
China’s self-interest and gradualism (摸着石头过河) stand in the way of a major assistance to solve the Eurozone problem through Chinese capital. The regulatory framework and external competitiveness of Southern Europe are prerequisites for further important inflows from Asia; the massive net asset position that China hold in US dollars militates against abrupt moves out of US dollar assets. But a deeper Eurobond market and the fit of Europe’s saleable public-sector assets with China’s national excess savings provide avenues for policy solutions and Euro support.

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