China to Europe: that’s a sure nice EFSF you have there

"The EFSF roadshow is in Asia trying to drum up interest in the newly leveraged, newly insured, revamped fund. The Chinese are counting their chips and considering whether to double down on their European bet. (Mrs Wanatabe is also checking out the goods.)

But Europeans shouldn’t rely on China to come to their rescue, argues Julian Jessop, Capital Economics’ Chief Global Economist. In a sharp note published on Friday, Jessop offers a free reality check to anyone who thinks Europe can avoid solving its own problems.
Why? Jessop makes at least three points:

1. China’s contribution would be relatively small:

[E]ven $100bn, or €70bn, would not fill much of the shortfall of €1 trillion required to cover Italy and Spain’s financing needs over the next three years. We have also been here many times before. There have been frequent warm words of support from China’s leaders throughout the euro-zone crisis. Given the pace at which China has been accumulating foreign currency reserves, Beijing has surely already been buying substantial amounts of euro-denominated assets, including those of peripheral governments both directly and via issues made under the existing EFSF. Crucially, none of this earlier support has prevented peripheral bond yields from rising and the crisis from worsening.

2. Something cliched about a duck. China is risk averse and tough negotiator:

Nonetheless, we do not expect China to play a pivotal role. After all, the Greek government is defaulting on around half its debt. The “voluntary” nature of the agreement with bond holders means that it did not meet certain technical definitions of a default, such as a “credit event” that triggers insurance payouts under CDS contracts. But the Chinese are presumably well aware of the (Peking?) duck test – if it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. Similarly, if Greek bond holders have had to take a 50% loss, then this is a default in all but name.

In these circumstances, the idea of putting large amounts of China’s money on the line for Italy or Spain does not seem very appealing. China’s officials are acutely aware of the losses they have made on some past foreign investments and will not want to be seen to risk even more of their peoples’ capital on a potentially lost cause, especially if relatively wealthy European countries and the ECB are unwilling to put up more money themselves. China may well have purchased earlier EFSF issues, but these were AAA-rated and fully guaranteed. In the new special investment vehicles being discussed as part of the leveraging of the EFSF, only 20% to 25% of exposure would be insured against losses.

3. Chinese involvement may (slightly) reduce the magnitude of the problem, but it doesn’t change its make-up:

The upshot is that additional Chinese support, whether bilateral or channelled through the IMF, is likely to require additional guarantees, which may be unacceptable to Germany, or fiscal austerity measures, which may be unacceptable to Italy. Or it might just be that China makes another vague commitment to provide more capital on standby, but that support fails to materialise when it is actually needed. Finally, even if China does stump up more funds, the euro-zone’s structural problems are far greater than the difficulty of finding buyers for a certain amount of government debt each month. Additional Chinese purchases would do little or nothing to prevent the region from sliding into recession, to resolve the huge economic divergences that have opened up, or to ease the painful adjustment processes that weaker members will still have to undergo within the constraints of the single currency..."

at http://ftalphaville.ft.com/blog/2011/10/28/715586/china-to-europe-thats-a-sure-nice-efsf-you-have-there/