• EUROPE NEWS
• JANUARY 7, 2011, 4:02 A.M. ET

EU Aims to Seal Deal With Beijing

By MARCUS WALKER in Berlin and JASON DEAN in Beijing

Chinese leaders are stepping up their courtship of cash-strapped European countries such as Spain, pledging to buy their bonds and expand business ties. Yet China watchers caution that despite the warm diplomacy, Beijing won't save the euro zone.

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Spain's Prime Minister Zapatero applauds as Zheng Zhijie, deputy governor of China Development Bank, left, concludes a deal with Francisco Gonzalez of BBVA bank in Madrid this week.

Chinese Vice Premier Li Keqiang arrived in Berlin on Thursday on the latest stage of a European tour that began in Madrid. While in Spain, Mr. Li, who is widely expected to become China's next premier, signed a string of trade and investment deals. He also vowed that China would continue to buy Spanish government debt, a message welcomed by Spain's embattled government as a vote of confidence in the country.

However, Chinese officials made no commitment to lend Spain a specific amount, saying their investments would depend on the circumstances, despite hopeful suggestions in Spanish media that Beijing might buy €6 billion ($7.89 billion) of Spanish bonds.

China's actions "frequently fall short of the expectations raised by their words," London consultancy Capital Economics said in a research note Thursday, pointing to China's slow steps on other economic issues where Europe and the U.S. want to see Beijing take action, such as its exchange-rate policy.

Many analysts say China is unlikely to bail out Spain if the European Union can't muster enough will or money to save Madrid from a debt default. "If Spain can no longer access the bond market, will the Chinese lend enough to Spain to get it out of this crisis? I very much doubt it," says Katinka Barysch, deputy director of the Centre for European Reform, a London-based think tank. "Nor would the EU want one of its members to become beholden to China," she says.

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. Spanish energy company Repsol, below, will get an investment from China for its Brazilian operations.

The need to preserve the value of its financial reserves sets a limit on the amount of money that China would be prepared to stake on lending to Spain or other struggling European countries, economists say. Many Chinese view the country's reserves as a national treasure, and the Chinese government has come under harsh public criticism on the Internet for perceived missteps in its foreign investments. Large-scale use of those reserves in a European crisis with an uncertain outcome is therefore highly unlikely to appeal to Beijing.

Any Chinese investments in Spain, Greece and Portugal are almost certainly minuscule compared with the overall size of China's overall foreign-exchange holdings, which totaled $2.65 trillion at the end of September.

However, generous verbal support and limited financial backing for Europe's struggling economies fit neatly with China's economic and geopolitical interests, enabling it to help stabilize an essential export market, and enhance its diplomatic standing at relatively little cost.

Visits to Europe by Chinese leaders aiming to promote trade and investment ties are nothing new, but in the past Beijing focused on Europe's major power centers such as Berlin, Paris and London. But in recent months, top officials have also visited crisis-hit countries on the euro zone's periphery, with Premier Wen Jiabao visiting Greece in October and President Hu Jintao going to Portugal in November. Like Mr. Li this week in Spain, they promised to deepen trade ties and pleased their struggling hosts by expressing confidence in the European countries' economies.

"One could interpret China's policy as: 'We've got to keep these economies going because they buy our goods, and we need to protect the value of our euro-denominated holdings,'" says Vanessa Rossi, senior research fellow at London think tank Chatham House.

Not every proposed venture works out: On Thursday, a Chinese firm dropped its $1.3 billion offer for a Dutch cable-wire maker, pulling out as the EU's industry commissioner, Antonio Tajani, stepped up his campaign to give the EU the power to block foreign takeover attempts.

Europe is China's largest market, purchasing about $282 billion of the country's goods in the first 11 months of 2010, or nearly a fifth of China's total exports. China therefore needs a healthy European economy. and a strong euro.Since China manages the yuan's value primarily against the dollar, when the euro weakens against the U.S. currency it also falls against the yuan, making Chinese goods more expensive for Europeans to buy.

China also hopes that its assistance for Europe will help it advance its own agenda in the region. Beijing wants the EU to formally designate China a "market economy," a status that would limit the countries' ability to pursue trade actions against China at the World Trade Organization. EU officials have said China doesn't yet meet the criteria for that.

China also wants the EU to lift an embargo on arms sales that was put in place after the government's deadly crackdown on pro-democracy demonstrators around Tiananmen Square in 1989.

The cost to China, even if it follows through and buys more euro-zone debt, is limited. China has been vague about its possible assistance so far, in keeping with the country's intense secrecy about its foreign-exchange reserves.

On Thursday, Chinese Vice Commerce Minister Gao Hucheng said China has been increasing its holdings of EU governments' debt, including Spain's, since the outbreak of the euro-zone debt crisis last year, according to a statement on the ministry's website.

But Mr. Gao, who is traveling with Vice Premier Li this week, didn't give a number. The exact amount of bonds China buys "depends on the timing and volume of issuances by the Spanish government, as well as the bonds' prices in the primary and secondary markets," he said. Although most of China's foreign-currency reserves are believed to be in dollars, the country is already thought to have a substantial exposure to the euro zone. Ms. Rossi estimates China may hold as much as €700 billion in euro-zone government bonds, or nearly 10% of all government debt issued by the 17-nation currency bloc.

Greece needed a €110 billion bailout by EU governments and the International Monetary Fund in May after the country was shut out of bond markets amid widespread investor doubts over whether Athens can repay its ballooning public debts. Many economists believe Portugal will eventually need a similar bailout, becoming the third euro-zone member to be rescued after Ireland received an EU-IMF rescue package worth €67.5 billion in November.

Spain, with a much larger economy than the other crisis-hit countries', is widely seen as the true test of the euro zone's ability to get a grip on the debt crisis. Investors worry that Spain's large budget deficit, its imploding property market and its weak growth prospects could force Madrid to seek help from the EU. But even the euro zone's strongest economies around Germany and France, which have budget strains of their own, could struggle to prop up a country of Spain's size, many economists warn.

That makes China, with its deep pockets, an attractive partner for euro-zone countries which need all the investor support they can get. "China now has an opportunity to improve economic relations in ways that Europe was previously wary of," says Ms. Rossi.

In the past, the prospect of China investing heavily in Europe provoked fears in the region's capitals of politically motivated asset purchases and a buildup of unwanted Chinese influence in the region. "Because of the crisis, China is getting a better reception than before," Ms. Rossi says.

The Chinese delegation in Madrid agreed to buy, among other things, millions of euros worth of Spanish wine, olive oil and specialty jamon or ham, choices that some observers say were designed to flatter their hosts. But the main deal formally signed this week was a multibillion-euro investment by China Petroleum & Chemical Corp, known as Sinopec, in Brazilian operations of Spanish energy group Repsol YPF SA.

That deal, which was already well known before the visit, was in keeping with China's international focus on investing in energy and infrastructure assets, which Beijing believes will secure its future energy supplies and trade routes. In Greece, China's main investment so far has been to lease and expand the container terminal at the the country's main port, Piraeus.

"They're doing it out of self-interest but dressing it up as a goodwill gesture towards a troubled continent," says Ms. Barysch.

Write to Marcus Walker at marcus.walker@wsj.com and Jason Dean at jason.dean@wsj.com