How does European Debt Crisis Influence China’s Economy ？

The end of the year 2009 wit- nessed the outbreak of a sovereignty debt crisis in Greece. To add insult to injury， the downgrading by three big rating agencies have prompted the wide spreading of the crisis toward the whole Europe. Although the EU and IMF have promised to invest 750 billion euro to assist those countries deep in debt， the chance of stopping the contagion seemed to be very slim. In July 2010 and March 2011， the Moody’s， an international rating agency， lowered the long-term sovereign credit rating of Portugal and Spain in succession. On September 19， 2011， Standard Poor’s lowered the sovereign credit rating of Italy from A+ to A， giving a very negative outlook. As the third largest economy in the euro zone， Italy was suddenly thrown into a state of tension， arousing public worries about the further spreading of the European debt crisis and its negative impacts on the economic development of the euro zone.

The direct influence from the European debt crisis on China is limited， but the indirect impacts would be very prominent. The major approaches for influencing the Chinese economy include foreign trade， finance and noncontact transmission.

Foreign trade approach

Foreign trade would be the primary approach by which the European debt crisis influences the Chinese economy. To be more specific， the crisis would lead to fiscal tightening， decline of consumption， depreciation of the euro， and the rise of trade protectionism. First， many European countries adopted fiscal tightening policies to handle such a debt crisis， and this move not only curbs the economic development， but also reduces the public consumption. Since Europe is the top export destination of China， its sluggish demands might directly impact the growth of China’s exports. Wei Jianguo， former Vice Minister of the Ministry of Commerce， pointed out that such a negative impact on China’s foreign trade in the fourth quarter of 2012 and the first quarter of 2012. China’s trade surplus in September is estimated to further contract， signaling a gloomy prospect for the export condition for 2012.

Statistics confirmed such an observation. According to the latest trade data by the EU Bureau of Statistics on Sep. 29， 2011， Sino-Euro trade volume continued to decline in July 2011 by 0.8% on a year on year basis. The EU export to China increased by 12.3%， higher than the average growth rate of 4.1%; but China’s export to EU slid by 6.2% year on year. In fact， according to researches by Zheng Baoyin， such a declining trend had happened since the first half year of 2009， when the EU debt crisis was brewing. During that period of time， China’s export to 15 European countries declined by 13.0% and the export to Spain dropped by 36.1%. The export to new EU members turned out to be worse， with the decreasing rate of 17.5%.

Second， investors’ avoiding highrisk assets leads to the depreciation of the euro， which also implies the appreciation of RMB. Under this circumstance， the price of export goods will rise， leading to weaker competitiveness of these products in the European market and increasing the currency transaction risks for Chinese enterprises that use euro as unit for payment settlement. Since early 2010， the exchange rate of euro against RMB has continued to drop， down by about 15%， which posed serious impacts on China’s exporters. According to the Xinhua report on Oct. 2， since the second quarter of 2010， the growth rate of Sino-Europe trade has been declining. The first 8 months this year have witnessed an 18.5% rise in China’s export to Europe on a year on year basis， lower than the average growth rate of 23.9% since the year 2000. In August 2011， the growth rate of China’s export to Europe was-2.6%， lower than the average level of 5% since the year 2000.

Also， it needs a long period of time for export companies to settle all the outstanding orders. The sharp decrease in the value of euro will incur high risks of currency exchanges. For an order with value of 1 m euro， a 15% depreciation of euro would imply a loss of 1.5 m RMB， a heavy risk for Chinese laborintensive companies seeking for slim profits. A case from China Times could well illustrate this point. In early 2010， a garment producer in Dong Guan signed an order valuing 500 thousand euro， with 3 months for fulfilling the order. According to the exchange rate then， 100 thousand euro could be transferred to 979.7 thousand RMB. While upon delivery， the 100 thousand euro could only transfer to 850 thousand RMB. Therefore， the company suffered the loss of 600 thousand RMB for this single order. Profits would further contract and pressures of heavy costs rise. Under this background， many export companies would fall into a predicament that they would suffer losses if fulfilling the order， while would shut down if there is no order. The companies have to avoid such risks through renegotiating the price， delaying or canceling orders， and swap transaction. This would undermine the corporate image and the customer base， and also reduce orders， threatening the survival and development of these companies.

Third， the worsening European debt crisis would cause economic meltdown and rise of trade protectionism. According to statistics provided by China’s Ministry of Commerce， in 2010 the European Union lodged 11 trade investigation cases against China’s exported products， 1.6 times of 7 in the year 2009. The number of cases and the money involved have been the largest over the pass 4 years. In the past India and the U.S. were the major countries conducting trade investigations against China’s products， so in the background of European debt crisis， the EU is becoming increasingly conservative in its trade policies. The most recent case happened in August this year， when representatives from most EU member countries expressed their supports for the tax resolution， which levied 69.2% fiveyear anti-dumping taxes on ceramic tile made in China， and would come into force in the middle of September. Such a trade sanction measure shows the rise of trade protectionism in Europe. The trade barrier would further undermine the competitive edge of Chinese companies and discourage the exports.

Also， the EU also adopted strict security and technology standards to create trade barriers. In Nov. 2010， the EU member countries reported 150 dangerous products through the EU fast reporting system of non-edible consumption goods， with Chinese products amounting to 71， 44.7% of the total that month. Such information reporting would impact China’s exports to Europe. From July 20， 2011， the new“EU Toy Safety Directives” would be implemented， which would be the most strict toy safety rule in history. It would set higher limits on toys’ physical and chemical features and also prohibit the use of substances that may trigger cancer or genetic mutations.

Which Chinese products and regions would suffer most from the changing trade policies? The data provided by EU Statistics Bureau shows that EU would mainly import from China electrical and engineering products， textile products， materials， home furniture and toys， accounting for 69.5% of China’s total exports to the European market in 2010. Considering their easy substitution and high price elasticity， these products will suffer the greatest by the economic fluctuation. So it required producers and traders of these products to make good prepara- tion against the escalating risks. In fact， export regions of these products are also very concentrated in China， mainly including Guangdong， Zhejiang， Jiangsu， Fujian and other provinces; while countries hit most by the debt crisis， including Portugal， Ireland， Italy， Greece and Spain， are the major export destinations. Such connectivity will further increase the risks of the Chinese enterprises， and local governments and companies have to watch closely on the development of the EU debt crisis.

Financial approach

The finance approach is another important channel through which the European debt crisis exerted pressures on the Chinese economy. To be more specific， the European crisis mainly cause the devaluation of the euro assets， inflow of short-term risk capital and cooling down of direct investments. First， China controlled euro assets may run the risk of devaluation due to sovereignty debt default， shrink of listed companies’ market value and depreciation of the euro. However， a piece of news from Xinhua.net on Oct. 3rd， 2011 says that China is currently holding no national bonds of Greece， and the Italian bonds it holds accounts for only 4% of the total. The expected losses will be very insignificant. Also， the commercial bank holds a very low proportion of euro assets and most of the assets are loanrelated assets with very low risks. So the short-term and middle-term financial risks are very limited. Now what worries people most is that China’s huge foreign reserve features a big chunk of euro reserve， whose sharp devaluation would cause book losses to dollar-based foreign reserve. According to data provided by the State Administration of Foreign Exchange， as of the end of June 2011， China’s foreign exchange reserve had amounted to USD3.197491 trillion. Given the large total value， China would still suffer considerable loss even if the euro reserve it holds accounts for a very small proportion.

The second is the flow of huge shortterm capital stimulated by the European debt crisis. This factor， combined with the loose monetary policy adopted by the EU， will increase the risk of “hot money flowing into China” and also pressures of imported inflation and RMB appreciation. With the European economic prospect still uncertain， risk avoidance and the incentive of achieving financial profits would drive large amount of floating capital into the relatively stable Chinese market. The loose monetary policy (for example， the EU central bank is discussing the possibility of lowering the interest rate) exercised by the EU would compound this situation and exert high “hot money inflow” pressures on China.

Data from the State Administration of Foreign Exchange shows that during the first quarter of 2011， the surplus in financial items amounts to 84.7 billion USD， rising by 40.9% year on year. It also shows that the surplus in financial items was 60.1 billion USD， and rose to 117.7 billion USD at the fourth quarter of 2011. The accumulated surplus of financial items for the 2010 whole year reached 221.4 billion USD， compared with 43.3 billion and 176.9 billion USD in 2008 and 2009 respectively. This shows that pressures from international capital inflow have been mounting in recent two years， especially the shortterm floating capital， or the so-called “hot money”. Based on a report from Shanghai Securities News on May 26th， the spread of European debt crisis has caused huge losses on people with Chinese nationalities or Chinese emigrants investing in Europe. Many people have left Europe and returned to China to restart investment. The“homeland hot money” (short-term floating capital controlled by overseas Chinese emigrants) found its way into illegal private bank through social network and also the stock market for short-term profits， which greatly increased the risks.

The injection of “hot money” leads to excessive liquidity， which might impact the macro-economic policies China adopt to tame inflation， and also increase pressures for RMB appreciation. Given the harm of inflation and the impacts from RMB appreciation on China’s foreign trade， the hot money issue actually constitutes the biggest risks to the Chinese economy during such a debt crisis.

Third， the European debt crisis would reduce foreign direct investments from Europe. Statistics from China’s Ministry of Commerce show that in the year 2010， the 27 EU members set up 1688 enterprises in China， with total investment reaching 6.589 billion USD. As of March 2010， accumulated investments from Greece in China had amounted to 85.56 million USD; as of the end of 2009， accumulated investments from Portugal in China had amounted to 1.5 trillion USD; as of the end of 2010， accumulated investments from Spain in China had amounted to 2.016 billion USD. But in the single year of 2010， the total foreign investments used by China amounted to 105.735 billion USD， most of which coming from Asia countries and regions (more than 80%). South European countries and even the whole European Union would exert very limited influences on the Chinese foreign direct investment. What need to be confirmed here is that under the crisis background， as the euro devalues， European market liquidity drops and the overall economy is gloomy， EU’s direct investment into China would face huge difficulties and will exert negative influences on China’s overall economy.

Non-contact transmission approach

Besides trade and finance approaches， the European debt crisis also influences the Chinese economy through non-contact transmission approach. To be more specific， the debt crisis would discourage investors’ confidence and triggers “the effect of sheep flock” (group behaviors due to information asymmetry; individual investors’decision subject to the market group decision)， bring negative impacts on the Chinese economic development.

A case in August 2011 could well illustrate this point. According to the data on Aug. 8 provided by Sentix， a German research institute， investors’confidence index of 17 EU member countries declined to -13.5% in August from 5.3 in July， the largest drop in historical record. The primary reason is that the European debt issue， weak government policy and U.S. lifting debt limits have largely discouraged investors’ confidence and heralds a gloomy prospect for the global economy. Also， Chinese investors’ confidence has also been undermined. According to report from Yicai Daily， Franklin Templeton Sealand Fund Management Co.， Ltd concluded that the Chinese investor confidence index for August reached 42.82， falling by 8.27% from last month. About 28.82% of the investors held negative attitudes toward China’s economic growth for the next half year， double that of last year. It is very clear that as the European debt crisis deepens and external market stays gloomy， China’s investors shared the pessimistic views of their European counterparts about the long-term growth of Chinese economy. Investor confidence continues to run low.

A more direct evidence of investors’ herd behavior is that almost all the major stock markets in the world declined in August. The Shanghai stock exchange index runs the new bottom in terms of lowest price and closing price. In fact， since early this year， China’s stock market has been running low and rumors about investors selling their stocks became widespread. This shows that under the impact from European debt crisis and negative market expectations it triggered， the confidence of Chinese investors has also suffered. The continuous drop of the stock market index would compound investors’ worries and stunt the consumption growth as it is more difficult for market value-losing companies to raise new funds. Also the world financial market would become more unstable.

Under the big picture of global debt crisis， the local governments’ securities launching and flow were also impacted. Since July， the corporate bonds with local governments as main creditors slid into coldness， and panic selling of many corporate bonds happened in the secondary market. On July 21， 2011， the one-year short-term financing bonds issued by the Ministry of Railway failed to be sold at auction; the interest rates for the first four shortterm financing bonds this year also kept rising. The issuance interest rate of the fourth short-term financing bond reached a historical 5.55%. Of course， reasons vary for the corporate bond problem and funding pressures of the railway department， but it is undeniable that public worries about local government debt and railway debt securities risks， under the backdrop of the European debt crisis and the lowering of the U.S. sovereignty credit rating， also reflected the psychological impacts on investors’ options of behaviors.

China’s countermeasures

Chinese government and companies could take following measures to cope with the escalating European debt crisis and minimize its negative impacts on China. For the government， it could do start from the following work: further promote the trans-border RMB transaction of export companies， to improve the exchange rate risk management and reduce costs for currency exchange and trading; multi-department cooperation to increase supervisions on foreign exchange work， and prevent excessive “hot money” by improving the stock market and housing market supervision system; increase investments into education， medical service and social security， to stimulate domestic consumption and lessen companies’dependence on the foreign market; strengthen directions and management on local government budget， control the scale of debt at a reasonable level， prevent financial risks; enhance talks and dialogues with EU in the trade field and help direct companies to file antidumping lawsuits.

The companies could make efforts in the following aspects: to use USD and RMB to settle export accounts， reduce receivables quickly and also prevent risks by using export credit insurance; exploit overseas markets by focusing on traditional markets in the U.S. and Europe and also expanding emerging markets in ASEAN countries and the Americas; improve products’ technology and safety standards through RD innovation; crease self-owned brands to raise product competitiveness; turn risks into opportunities， actively involve into foreign MA projects in conformity with loose investment policies in some European countries， and avoid tariff barriers through making direct investments.

(Author: from International Financing)