Will China bail out Italy by buying its bonds?

15th September 2011

The story was reported on BBC News, the Financial Times and the Wall Street Journal.

If the reports are to be believed China Investment Corporation (CIC), wholly owned by the Chinese government, has been holding meetings with Italian officials in the last month.

CIC, has deep pockets for sure; it has assets of around $400bn (£250bn).

The FT reported how Lou Jiwei, the chairman of China Investment Corporation, had met Italian finance minister Giulio Tremonti and other officials in Rome.

Since the meetings the Italian government has approved an austerity plan which will raise €54 billion ($74 billion) via tax increases and spending cuts over the next three years.

But the eventual efficacy of the plans, which sparked rioting on Wednesday evening (14 September), has been questioned

The Wall Street Journal noted that the "tortured" austerity package could help Italy comply with demands to eliminate the budget deficit by 2013, but may not actually help slash Italy's public debt by much.

The WSJ quotes Société Générale economist Vladimir Pillonca, who believes the austerity package will push Italy into recession, "even though the fiscal cuts are twice as large".

Italy therefore remains vulnerable.  So long as the debt ratio remains high, doubts about Italy's solvency will remain.

The BBC notes that many analysts questioned whether a purchase of Italian assets by China would do anything to resolve Europe's debt problems.

They said there was still a danger the crisis would spread, not least because Greece was still at risk of defaulting on its debt holdings.

"Europe is not just lurching from one crisis to another. It is lurching into a new one before the previous one is solved," said Makoto Noji of SMBC Nikko Securities.

According to the International Monetary Fund, Italy will need funds equalling as much as 20% of its GDP in 2012 to refinance its debt while China has foreign exchange reserves in excess of $3 trillion.

Analysts said given its deep pockets, it was no surprise that countries were seeking China's help.

But on Bloomberg China’s Premier Wen Jiabao is quoted as being less than happy at the prospect of having to bail out a European economy. He maintains that developed nations should cut deficits and create jobs rather than relying on his country to bail out the world economy.

Zero Hedge blog asks why Asian investors should buy Italian bonds when they are not even being bought by the European Central Banks

The Italian Economy Minister Giulio Tremonti admits as such. "I note that the Bank of Japan today launched quantitative easing and the Swiss National Bank cut rates to zero, we are waiting for decisions if possible, but desirable (from the ECB)."

When you talk to Asia they say: "We don't understand what Europe is," he continued. "The second point is that they say 'if your central bank doesn't buy your bonds, why should we buy them?"

China.org points out that the Chinese are right to be wary. "They participated in the Portugal bonds this year, and they lost money."

So far In Beijing, the State Administration of Foreign Exchange, the nation's manager and regulator of the foreign exchange reserves, declined to comment on the reports.

But China's economic growth is largely reliant on the European economic bloc, via exports as well as the US; of course China is the world's biggest foreign holder of US government debt, with about $1.17 trillion.

So how long they choose to stand back is anyone's guess.

It's for that reason Rajeev De Mello, head of Asian Fixed Income at Schroders believes that Asia bonds themsevles are a investor's safe haven:

"There are a number of reasons why we strongly believe Asian currencies and fixed income will prove to be a superior store of value for the foreseeable future.

"The Asian economies are supported by strong economic fundamentals. There is strong growth potential in Asia. It is a diversified investment universe The sector has one of the best risk/return profiles over the last 10 years and there is the rise of China."


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