Can China save Europe?

July 1, 2011, 6:50 PM UTC

FORTUNE — Greece’s recently approved austerity plan might not resolve deeper questions over how the country will repay its debts beyond this summer, but it appears one of the world’s biggest investors still has faith in the country and the greater eurozone. After all, it would be too risky not to.

Wen Jiabao, Premier of the People's Republic o...
Wen Jiabao to the rescue

Earlier this week, just days before the Greek Parliament approved austerity measures amid talks of a possible default, China said it would keep investing in Europe’s sovereign debt. Premier Wen Jiabao told reporters that the country actually increased the purchase of government bonds of some European countries and hadn’t scaled back its euro holdings.

These acts “show our confidence in the economies of Europe and the eurozone,” he said.

China’s backing isn’t all that surprising. It was only earlier this year when the Asian giant supported debt-ridden Spain by signing $7.3 billion in deals that included investments in everything from energy to banking to oil. And it was around this time last year that China pledged to make more than a dozen major commercial contracts for business in Greece.

The value of these purchases may very well be in flux amid debt problems that have put many investors on alert, but that’s beside the point of China’s voracious appetite. China has more to gain than lose by investing in Europe’s future. Even as misery and uncertainty mounts in the region, the eurozone is still China’s largest export market (accounting for roughly 20% of total shipments) and it’s in its own interest to contain the crisis.

“They’re not really concerned about short-term volatility,” says Domenico Lombardi, senior fellow specializing in international monetary relations and global currencies at Brookings Institution.

Besides, as China expert Barry Naughton of the University of California in San Diego, pointed out earlier this year: The risks are relatively low since the European Union and the European Central Bank will likely swoop into the rescue if things get really bad.

Wednesday’s $41 billion worth of budget cuts and asset purchases was part of a large-scale bailout launched last year to help debt-troubled Greece pay its loans. The European Union and the International Monetary Fund had required Greek lawmakers to pass the plan before releasing its next round of rescue payments.

China’s foreign-exchange reserve, worth more than $3 trillion, is by far the biggest in the world and is viewed by politicians and corporate executives as a key source of capital. It’s unclear just how much China has boosted its holdings of European bonds, as leaders keep the breakdown of its holdings secret. But just by saying it will invest in Europe, China indirectly calms markets and helps stabilize the euro, and in a way, sends a message to the world at large that it’s a good global neighbor willing to help in times of crisis.

Longer-term, the Chinese have been looking to diversify its massive reserves away from the volatile U.S. dollar. To be sure, the euro has also seen its share of peaks and valleys throughout the crisis but the currency is still the most practical alternative to the greenback, says Lombardi, whose research has focused on the ongoing European crisis.

This surely isn’t the last time we’ll hear the Chinese back the eurozone. If and likely when financial instability rumbles in other parts of Europe in the coming months, we’ll probably hear from the Chinese again.

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