China is not a cash cow for resolving eurozone crisis

While media reports are emphasising the role China could play in helping to resolve the eurozone debt crisis, Steffen Dyck warns that expectations pinned on China might be far from realistic.

THE eurozone is China's most important trading partner. The region takes up around 20% of China's total exports, which is slightly higher than the US share in Chinese exports. From this angle, China has a vital interest in a stable eurozone, as exports and export-related investment account for a substantial share of GDP (Gross Domestic Product) growth and - what is probably even more important - employment.

Estimates show that Chinese export growth could drop by 6-7 percentage points (pp) and real GDP growth by 1 pp in case GDP growth in the US and EU slowed by 1 pp.

Furthermore, China has already invested in euro assets. According to various estimates, around 20-25 per cent of China's total foreign currency reserves or 480-600 billion euros are held in euro assets, presumably predominantly in highly rated sovereign instruments like German government bonds.

In addition, investors from China including Hong Kong bought 6% of the 5 billion euro initial issuance of the EFSF (European Financial Stability Facility) benchmark bond in January 2011. China has a stock of 7 billion euros in foreign direct investments in the eurozone, which comprises 3% of its total outward FDI stock as of 2010. Last but not least, the euro is part of China's envisaged tripolar world order - that is, co-existence of the US dollar, euro, and Chinese yuan as three leading global currencies.

The eurozone as a whole needs around 17.5% of estimated GDP for refinancing in 2012, equivalent to 1.7 trillion euros. (Refinancing requirements are calculated as the estimated government budget deficit in 2012 plus outstanding T-bills plus government bonds and loans.)

The largest share is of France with around 25% of the total, followed by Italy with a share of almost 23%. Spain, Greece, Portugal and Ireland together make up another 20% or 340 billion euros. Together, the five GIIPS countries (Greece, Ireland, Italy, Portugal and Spain) will probably need 730 billion euros in refinancing in 2012. In comparison, Germany needs 325 billion euros or 19% of estimated GDP in 2012.

China not awash with cash

Many news reports paint a picture of China as being awash with cash due to its large foreign exchange reserves. However, these reserves are for the most part invested in long-term sovereign debt instruments, with around 60-65% in dollar instruments, 20-25% in euro assets and the remainder split between other currencies. Presumably only a very small fraction is held in highly liquid short-term paper.

Theoretically, even longer-dated instruments could be liquidated, but given the large amounts necessary in the case of the GIIPS countries, this would send ripple effects through the UST (US Treasury) market - except that Beijing decided to sell German government bonds and other core-EMU (Economic and Monetary Union) government bonds instead. Therefore, a more realistic scenario would be a slight acceleration of foreign exchange reserve diversification by investing an increasing share of additional or new reserves in euro assets.

Let us assume that total reserve accumulation in 2012 amounts to $650 billion (500 billion euros), which is the Deutsche Bank forecast. Even if the euro share were to rise to 30-35%, this would only mean $195-228 billion (150-175 billion euros) in financing available from China - or 20-24% of the GIIPS countries' total refinancing requirements.

The analysis above shows that even if China were willing to buy more troubled eurozone countries' sovereign debt, this would not be sufficient to resolve the GIIPS debt crisis. Moreover, we doubt that China is willing to take on substantial additional risks. Even China Investment Corporation (CIC), China's sovereign wealth fund with a global portfolio of $135 billion, would be hesitant to load on GIIPS bonds as its 'underlying investment objective is to seek long-term, sustainable, and high financial returns [.] within acceptable risk tolerance.'

On top of that, Chinese public opinion towards increased investment is unlikely to be supportive as the general perception is that the troubled eurozone member countries have lived beyond their means and are now turning to the savings of a country that is still confronted with domestic development needs of its own. - IDN-InDepthNews                                

Steffen Dyck is a Deutsche Bank research analyst. A version of this article appeared on 16 September 2011 on www.dbresearch.com under the headline 'China - Not really a white knight for the eurozone'.

*Third World Resurgence No. 253, September 2011, p 16