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UPDATED: August 29, 2011 NO. 35 SEPTEMBER 1, 2011
China's Stake in Europe
China's support of the debt-ridden euro zone shows its long-term commitment to Sino-EU ties

A GLOBAL WORKSHOP: An Airbus staff member works at an assembly line in north China's Tianjin Municipality on July 13. The Tianjin facility is the European aircraft maker's first final assembly line outside Europe (XINHUA)

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."

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