China's CIC quashes Europe bailout talk. Again.

13/02/2012 | Sid Verma

China's sovereign wealth fund's restatement that it won't invest in eurozone rescue funds shines a light on its investment preference: physical assets in Europe

Just how successful was Merkel’s Chinese charm offensive? Via Reuters:

 The head of China's $410 billion sovereign wealth fund CIC brushed aside a call by German Chancellor Angela Merkel to buy European government debt, saying such investments were "difficult" for long-term investors.

In comments ahead of a China-EU summit starting on Tuesday, Lou Jiwei, chairman of China Investment Corp (CIC), said any fresh injection of funds into Europe would be in industrial and other real assets, not government bonds.

And here’s a more direct reality check for eurozone officials, again via Reuters

 China has no intention of "buying up" a debt-ridden Europe and any help Beijing offers will be for purely economic reasons, a top state-run newspaper said on Monday ahead of a China-EU summit.
...Communist Party mouthpiece the People's Daily said in a front page commentary that China's interests lay in selflessly helping Europe.
"China has no appetite or ability to 'buy up Europe' or 'control Europe' as some European commentators have said," wrote Feng Zhongping, director of the Institute of European Studies at the China Institute of Contemporary International Relations.

"China has from the beginning strongly supported the EU and the euro, in clear contrast to the 'talking down' of Europe in the international community," Feng wrote in the piece, carried in the paper's overseas edition.

Here a couple of take-away thoughts about this latest chapter in the will-China-save-Europe saga:

- CIC's comments are by no means new. At the IMF annual meeting in September last year, Gao Xiqing, vice-chairman and president of the China Investment Corporation (CIC), said the fund would not invest in securities issued by the European Financial Stability Facility (EFSF), and other bodies that may be formed in the future to support the economies of troubled peripheral members.

“You heard from our premier, we like to support Europe,” he said at the time. “But, as a corporation, our mandate from the government is to maintain a certain amount of profitability given the risk adjustment rules. We can’t just go there and try to save someone. We have to save ourselves.”

And he told us at the time: “We have our own requirements, our own mandate and asset allocations, so we have to act on that principle alone.”

- CIC’s purchase of an 8.6% stake in Thames Water on January 20 underscores its desire to snap up seemingly low-risk physical assets that carry steady long-term returns, rather than European government bonds.  

- Promisingly on that front, the perceived protectionist attitudes of cash-strapped Europe to sovereign wealth fund investments have, in relative terms, diminished, making it easier for CIC, and others, to invest in a large stock of physical assets. Here, the UK’s charm offensive is interesting. Via the FT, commenting on CIC’s investment in Thames Water:

British officials say that Beijing also regards the UK as a “demonstration project” to reassure sceptics in the US that it can be a reliable and valuable source of inward investment without compromising national security.

Mr Osborne expects the CIC to announce new investments in British utility and infrastructure companies in the coming weeks.  

-  CIC’s taste for infrastructure mirrors spending plans from a clutch of SWFs with the GIC budgeting $1.4 trillion in spending on infrastructure and construction projects from 2009 to 2015, and the Qatar Investment Authority’s $400m bid in Africa.

- CIC is, in some respects, not like other SWFs. Although liquidity is obviously coveted by most investors, China already has enough national reserves, parked at the central bank, to stem systemic risks such as a run on its currency. By contrast, in commodity-exporting economies, a balance-of-payments shock could cause national governments to raid reserves held by their SWFs, cf. Gulf nations in the crisis.

- In other words, CIC has more flexibility to hold a longer-term investment horizon and invest in illiquid, physical assets, rather than more more-liquid European government bonds, without factoring in the threat of a sudden change in its mandate in favour of domestic investments, a prospect that would expose the downside of having a large exposure to illiquid products. Unless, of course, a crisis in Chinese local government debt turns out to be greater than everyone expects..

- The eurozone’s options are vanishing. In November, when the EFSF begging bowl went truly global, the eurozone was publically courting the State Administration of Foreign Exchange, which also seemingly gained little traction, at the time. Now, the CIC has once again poured cold water on suggestions it will come to the eurozone’s rescue.

- Still, today's comments don’t necessarily rule out Chinese cash infusion for the EFSF. During a visit by Merkel to China two weeks prior, Premier Wen Jiabao had said Beijing was considering increasing its participation in rescue funds – but he didn't make any explicit commitments. Instead, comments made by Zhongping and CIC officials indicate China’s deep hostility to bailing out the fiscally-profligate eurozone and, in Reuters’ words, it’s a “a suggestion of the tone China wishes to strike at its summit with senior EU officials on Tuesday”.

Remember: Lou Jiwei, CIC's chairman, spent most of his professional life at the finance ministry before joining the sovereign fund, so his comments could also reflect his thoughts more generally on the fiscal merits, or lack thereof, of China engineering a bailout of Europe.

Further reading:

CIC’s Thames Water deal puts focus on Chinese reserves bind - Emerging Markets

CIC: don’t count on us to save eurozone - Emerging Markets

China, Japan ‘to pledge conditional eurozone support’ - Emerging Markets


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