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US households appear to have lost their appetite for Made in China goods and would now rather save than spend.
US households appear to have lost their appetite for Made in China goods and would now rather save than spend.

China rides to rescue euro but there is a price to pay

China may have preferred to put its huge surpluses elsewhere but it will make a virtue of necessity and position itself to benefit from bailing out eurozone strugglers.

Sinking billions into troubled European economies might not have been the first investment option for China, but it will make a virtue of necessity and position itself to benefit

China has signalled its willingness to bail out the beleaguered economies of the euro zone, but this help may come at a price. Not surprisingly, countries such as Ireland, Greece, Portugal and Spain are only too happy to sell their bonds to anyone who wants them. If the recent US experience is anything to go by, the gratitude of debtors is short-lived.

The past decade has seen phenomenal flows of funds from China to the US. However, what was once fertile lending ground is now saturated. US households appear to have lost their appetite for Made in China goods and would now rather save than spend. Corporations are also struggling with high debt.

In a less nationalistic world, China would be ideally placed to help rebuild the US's creaking infrastructure. But in the real world, US politicians still struggling with a debt burden of 95 per cent of GDP would baulk at the Chinese building toll roads and then charging Americans to drive their Chevys along them.

So China is having to look elsewhere. South Americans are adamant that they do not want any Asian money and are busy warning of currency wars.

As the list of potential debtors dwindles, countries on the periphery of the euro zone start to look like the best option. It may be just what some of them need, already with the threat of default, collapse or even the break-up of the euro hanging over them. Spanish government debt to GDP is less than 65 per cent, but the refinancing of the cajas and non-financial corporation weighs heavily on top of that. Ireland has already introduced swingeing budget cuts but lacks the power to deal with the burden of the banking liabilities it has taken on. All the signs indicate that Portugal is next on the list to teeter on the brink. Greece looks set to miss its budget targets and default is looming large.

To make matters worse, Germany is losing its faith in the single currency. Worse still, in the event of mass default, break-up may start to look sweeter than bailout in German eyes. This leaves the periphery rather exposed.

Despite the risks, China has a lot to gain from helping the troubled European countries. First, having been evicted from the US, China's main goal is to find a new home for its surplus cash. It cannot take the money home: repatriation at this stage would spur domestic inflation and put further downward pressure on rates of return that are already hitting zero. Second, China is ostensibly well placed to stomach the risks. The 11 billion (Dh54bn) gambled on Spain and Portugal's ability to repay makes up less than 0.5 per cent of China's foreign reserves. These risks will ensure that if the move pays off, the Chinese will be handsomely rewarded.

Equally important is the political kudos they will gain in Brussels and Berlin.

It is possible that both borrowers and lenders could benefit from this new arrangement. Debtors need Chinese cash as a short-term measure to set their houses in order. The Chinese need to make a positive impact on the international stage and show they are playing a key role in the battle to revive the ailing global economy.

However, China still needs to put its own house in order. Serious micro-reforms will be needed if China is to transform its economy from export-led to consumer-driven.

As painful as these adjustments would be, the alternatives are much worse. But the governments that are borrowing the money will be hoping that they are able to revive their economies and grow their way out of trouble.

In this as well, China seems willing to lend a hand. Li Keqiang, the country's vice-premier, signed US$7.5bn (Dh27.54bn) of trade deals on his trip to Spain this month. China earlier helped Greece pay for a purchase of more than $5bn of ships. But this calm and friendly relationship, seemingly beneficial to all parties, could still end up in choppy waters.

business@thenational.ae

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