Part II: Chinese Investments in Europe – A Year in Review

Last year we saw developments in the EU-China trade relationship that can signify a greater convergence between these two trading partners.  The global financial crisis that led to temporary drop in western demand for Chinese goods during 2009 was followed by an aggressive investment strategy by China in 2010, acquiring a number of businesses in Europe and promising to purchase euro debt in order to alleviate the euro-zones sovereign debt crisis.  China is certainly worried about Europe’s economic future.  But how far is it prepared to go to ensure the euro survives the sovereign-debt crisis?  Recent events indicate, not far enough!

When the Greek government was looking for private capital to finance its government debt in the spring of 2010, China with its huge currency reserves did nothing to intervene.  Instead Greece had to go to the IMF for a loan, which caused further panic in the bond market and exposed the financial solvency of other European countries.  China’s later pledges to purchase Spanish bonds as well as statements of financial support for Portugal show that China understand the threat that the European sovereign debt crisis poses to the euro and therefore to global financial stability.   But while this might indicate a well-appreciated support for the euro, these purchases are mainly symbolic gestures.

It would appear that by striking investment deals with European governments and buying euro-government bonds, China is trying to take advantage of an opportunity rather than make friends and help support the global financial system.  Furthermore, however welcoming Chinese investments might be by beleaguered European governments, China is not necessarily interested in the overall prosperity of the EU.

Investment Deals –

China’s bilateral trade and economic relations with Europe are as important and relevant as its relations with the United States.  Although the U.S. runs a larger trade deficit with China then the EU, the total EU-China trade is larger than the total US-China trade.  The EU is China’s largest exporting destination, making up 20% of China’s total exports in 2009 (U.S. second with 18%).  On the other hand, the EU is China’s second largest importer, making up 14% of China’s total imports in 2009 (U.S. fourth with only 8.5%).  China’s 2010 trade with the EU is on track to meet pre-financial crisis levels.

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China’s aggressive investment activity came at the same time as credit rating agencies were downgrading Greek and other European bonds to junk status.  While the sovereign debt crisis has triggered a plunge in the value of the euro, which has made Chinese exports to the zone more expensive, it has also brought some advantages to Chinese investors.  Before the crisis China has made only modest investments in European states.  In the past, individual Chinese businesses have been hesitant in making inroads into European markets.

According to the Heritage Foundation’s China Global Investment Tracker China’s non-bond investments in Europe have reached $35 billion, compared to $28 billion invested in the US.  China clearly wants an ever greater piece of the European market, and at the moment (due to the sovereign debt crisis that is plaguing Europe) a lot of European countries are willing to overlook earlier hesitations to Chinese investments.

During the 2010 Universal Expo in Shanghai, a series of European trade missions traveled to Shanghai, trying to woo Chinese investors in an attempt to boost Europe’s weakened economies.  The Belgian trade mission was hoping to persuade Chinese car manufacturer Geely to add struggling Opel Antwerp to its collection of European acquisitions, such as Volvo.  When President Hu visited Belgium later in the fall, the Belgian government once again offered Opel Antwerp for sale, but the Chinese were not interested.

Earlier in March of 2010, the Chinese carmaker Geely paid $1.8 billion for Ford’s ailing Volvo unit.  The deal was the largest acquisition of an overseas carmaker by a Chinese company and the first time China had acquired a major luxury brand.  Although in Sweden – Volvo’s homeland – the acquisition triggered some negative comments in the media about China’s acquisition of a European icons, in Belgians the reaction was quite positive.

Other countries were not shy to solicit Chinese investments, including Greece, which used the Expo to hail China’s commitment to inject billions of dollars into the country’s debt-ridden economy and to invite Chinese companies to set up businesses in Greece.  Romania’s business envoys discussed with Chinese bankers and investors a series of projects to allow Chinese money to flow in and buy up the country’s struggling industries.

Beijing’s response has certainly been positive.  Chinese Vice Premier Zhang Dejiang signed 14 deals worth several billion dollars during his visit to Athens in July, 2010.  The investment package, reportedly the biggest by China in Europe, will enable Chinese corporations to secure controlling stakes in major telecommunications, real estate and shipping organizations.

Other Chinese investments to specific countries include:

Italy – During Premier Wen’s visit in October, 2010, China pledged to increase trade with Italy by $100 billion through 2015, and announced 10 commercial investment agreements worth $2.5 billion, covering among others the solar energy sector.  Furthermore, China’s Cosco is already expanding the port of Naples to be used by Chinese companies exporting to Europe, and HNA (a logistics, transportation and tourism group from China) is in negotiations for the construction of a giant air terminal north of Rome for cargo arriving from China.

France – During President Hu’s visit in November, 2010, France and China signed commercial agreements of $22.8 billion in total value.  They included: French nuclear power industrial giant Areva will provide $3.5 billion worth of uranium to the Chinese company CNGPC; China will buy 102 Airbus airplanes; and a joint effort to cooperate in cellular telecommunication worth $1.5 billion.

Portugal – During President Hu’s visit in November, 2010, Portugal and China signed commercial agreements including, a joint construction of optical fiber networks by Huawei and Portugal Telekom, and a banking cooperation between Millennium and ICBC.  However, efforts by the Chinese CPI to purchase the Portuguese electricity company EDP were not successful.

Ireland – Ireland’s business community is said to be working on obtaining an approval for a $61 million project to create a Chinese manufacturing hub in Athlone, in central Ireland.  The attractions for Chinese investors in the Athlone project are numerous.  A manufacturing center operated inside the euro zone will bypass a range of tariffs and quotas levied by the EU on imported Chinese goods while benefiting from a developed infrastructure network and low corporate tax rates.

United Kingdom – During Vice Premier Li Keqiang’s visit in January, 2011, UK and China signed commercial deals on auto, energy, and other ventures worth $4 billion.

Sovereign Dept Deals –

Overall, it is very difficult to ascertain which countries are being supported by the Chinese through government bond purchases.  The investment managers at the State Administration of Foreign Exchange (SAFE) (which administers the $2.85 trillion of Chinese currency reserves) devise their strategies behind closed doors and they rarely make public statements.  It’s a similar story with other Chinese entities, like the state-run Chinese Investment Corporation (CIC), which manages some $200 billion of the currency stockpile.  Furthermore, SAFE and CIC make their moves through intermediaries in London, Honk Kong, and the Caribbean’s, further disguising their international acquisitions.

More specifically, in July 2010, China spend €400 million on Spanish 10-year government bonds, a rather insignificant amount considering the size of the debt problem in Europe and the size of China’s currency reserves.  Over the fall, the EU made permanent the ‘European Financial Stability Facility,’ its 440 billion euro ($570 billion) fund intended to helps heavily indebted euro-zone nations raise funds on international markets.  China, on the other hand, whose official currency reserves are at a record $2.85 trillion, is considered to maintain an estimated 25% of it in euro’s, or about $710 billion.

Last month, Spanish newspapers reported that China was ready to buy about €6 billion ($7.6 billion) of Spanish debt, citing government sources. However, neither the Chinese nor Spanish governments have confirmed the report.  According to Lex however, €6bn does not buy much in the global financial markets any more.  It is just 5.4% of the size of the 2010 Greek rescue package, a mere 1.1% of the outstanding debt of the Spanish government and a minuscule 0.3% of China’s foreign currency reserves.

China’s recent increased its Euro-support rhetoric, and even put a token amount of money in the market, by buying €1.1 billion ($1.5 billion) on direct bond purchases of Portuguese debt, and possibly even more in secondary transactions.  The temporary euphoria across Europe resulted in a modest jump in the EUR-USD exchange rate from 1.29 on January 10, 2011 (the lowest since September 15, 2010) to nearly 1.38 a month later.

However, the true motives of the Chinese government might not be as altruistic as they seem.  China’s RMB is pegged to the dollar, so the fall in the euro against the dollar has made Chinese exports more costly in the EU.  As European governments introduce austerity measures, domestic demand is likely to fall even further, with ripple effects on imports.  The EU is China’s second biggest trade partner, and China needs the EU’s currency as strong as possible to preserve its imports.

The Chinese Dilemma –

Government bond purchases are a double-edged sword, especially for China.  Many argue that China wants to preserve the euro to diversify its holdings of U.S. dollars.  But the U.S. Treasury bonds that it owns help prop up the dollar, against which the RMB is pegged at an undervalued rate in order to boost exports.  Diminishing its dollar holdings would lead to a further strengthening of the RMB and depreciation of the U.S. currency.

This is why China simply can’t dump its dollars.  Therefore, Europe’s leaders shouldn’t expect anything more than symbolic Chinese support for the euro.  As the euro louses value again, Chinese exports to its largest exporter will drop, hurting the very part of the economy Beijing is trying to protect with its RMB-USD peg.  A euro-zone recession would be bad for Chinese business and a euro crisis would reduce the appeal of what should be, for Beijing, a helpful alternative to the dollar.  However, a hands-off approach to the euro-zone crisis could lead to accusations of a lack of solidarity with a major trading partner, and will undermine China’s assertion that it is a ‘responsible international partner.’

For Beijing, there are risks in any policy – which is why China is doing a little bit of everything.