17 February 2012
Helmut Reisen
(Former Chatham House Expert)


Global stock markets were enthused last week when the People's Bank of China Governor Zhou Xiaochuan pledged that China was willing to play a bigger role in solving Europe's economic problems via the IMF and the European Financial Stability Facility (EFSF). 

It is hard to tell whether China is now prepared to play the 'white knight' for Europe or whether these are the usual pronouncements expected from an EU-China Summit. Only time will tell if these words will turn into action. Zhou's comments were similar to those made by Chinese Premier Wen when Germany's Chancellor Angela Merkel visited China earlier in February. The Chinese leader said then that, 'China is investigating and evaluating concrete ways in which it can, via the IMF, get more deeply involved in solving the European debt problem'. However, more recently China Investment Corporation (CIC), the country's giant sovereign wealth fund, said that any fresh injections of funds into Europe would be in industrial and other real assets, not government bonds.

Chinese leaders have to be cautious. According to IMF data, per capita income (GDP PPP adjusted, in current international dollars) in 2011 was 31,548 in the EU, but only 8,394 in China. These numbers reflect the widespread apprehension that a poor country would support a rich(er) region. Furthermore, China's relatively low per capita income is unequally distributed, and while absolute poverty has fallen strongly in China over the past decades, relative poverty has slightly increased. So any foreign investment of the massive assets that China has accumulated in its central bank reserves and sovereign wealth funds must be compared to the social return of local investment. In other words: the social shadow costs of helping Europe have risen. From a social perspective, the right time for China to invest in Europe is when it has caught up with European per capita income and when the income is more evenly distributed across people and regions.

Clearly, there are other parameters for the timing of Chinese investment in Europe. Perhaps, the Chinese authorities think of the sustainability of the eurozone when they talk about 'the right time to help Europe'. The European Central Bank’s long-term refinancing operations (LTROs) have been good news for the eurozone and brought down risk spreads of eurozone government bonds - for now - by allowing banks to borrow at roughly 1% and buy government bonds that yield much higher returns. But as Professor Charles Wyplosz says, the ECB's 'clever move falls short of bringing the crisis to an end. Much more remains to be done. Greece and Portugal will be unable to grow with their existing debt burden – and this may also be the case for Italy and other countries as contagion takes hold'. 

LTROs effectively eliminate the risk of illiquidity, but they do not address the risk of insolvency. The balance sheets of Europe's (especially French, German and Spanish) banks are too precarious to allow write-offs to sustainable debt levels in Europe's periphery, say toward 60% of GDP.

The right time for China to be Europe's 'white knight' is once Europe's banks really have written their claims on peripheral Europe's sovereign debt down to sustainable levels, rather than the 120% of Greek GDPs currently envisaged.