Europe’s Debt Crisis Casts a Shadow Over China

May 17 2010 | by Keith Bradsher | www.nytimes.com

HONG KONG — The pain of the European debt crisis is spreading as the plummeting euro makes Chinese companies less competitive in Europe, their largest market, and complicates any move to break the Chinese currency’s peg to the dollar.

Chinese policy makers reached a consensus last month about breaking the dollar peg, agreeing to let it rise in value somewhat, which would make American goods more competitive against Chinese products. But Chinese officials have not yet put that intended policy into place. And in light of the euro’s nose dive, allowing China’s renminbi to rise against the dollar now would also mean a further increase in the renminbi’s value against the euro, creating even more problems for Chinese exporters to Europe.

The euro has plunged against the renminbi in recent weeks, at one point Monday reaching its lowest level since late 2002.

The steep rise of the renminbi, also known as the yuan, prompted a Commerce Ministry official in Beijing to warn Monday that China’s exports could be threatened. The official’s comments were the most explicit yet on the implications for China of Europe’s recent financial difficulties.

The comments also suggest that even China — the world’s fastest-growing major economy and increasingly the engine of global growth — is not immune to the crisis that started in Greece and threatens to spread across much of Europe.

“The yuan has risen about 14.5 percent against the euro during the last four months, which will increase cost pressure for Chinese exporters and also have a negative impact on China’s exports to European countries,” Yao Jian, the ministry’s spokesman, said at a news conference in Beijing, according to news services.

China’s heightened concerns about exports come at a potentially awkward moment. The American secretary of commerce, Gary Locke, is in China this week, leading the first cabinet-level trade mission of the administration of President Obama. Some economists warn that China may face more problems to come. The biggest reason Chinese exports plunged early last year was not weakening demand in industrialized countries but a sudden, temporary disappearance of trade finance from Chinese and foreign banks. The availability of trade finance could easily become a serious problem again soon, said Dong Tao, the chief Asia economist at Credit Suisse.

Chinese exporters rely very heavily on bank letters of credit to finance their shipments. The availability of the letters of credit is closely linked to overnight lending rates between banks. When banks have trouble borrowing money themselves — as has been happening as a result of worries about European banks’ possible losses from the region’s sovereign debt crisis — they tend to cut sharply the issuance of letters of credit for trade finance.

The banks see that as a quick, easy way to conserve cash without violating the terms of other financial obligations, like established lines of credit for big corporations.

Interbank lending rates surged late last week and on Monday and must now come back down very quickly to persuade banks to keep issuing letters of credit, Mr. Tao said. “Without trade finance, trade won’t happen,” he said.

The Shanghai stock market plunged Monday, with the composite index falling 5.1 percent on worries about global demand as well as concerns about possible further moves in China to limit a steep rise in real estate prices this spring.

Some Chinese companies are already running into difficulty because of the euro’s fall against the renminbi.

“We have been receiving calls from some European clients who signed contracts with us earlier this month, and they all want to cancel their orders, since the depreciation of the euro has eroded all their margins and then some,” said Elvin Xu, the sales manager of Guangdong Ouyi Electrical Appliance in Zhongshan, China, which makes gas stoves, heaters and water heaters.

“They say they cannot increase the prices at their end to their customers, given intense competition in their marketplace,” Mr. Xu added.

The renminbi is rising along with the dollar against the euro. The Chinese government has continued to intervene heavily in currency markets in recent weeks to prevent the renminbi from rising against the dollar, maintaining an informal peg of 6.827 renminbi to the dollar, the level since July 2008.

Because American companies in particular compete in the Chinese market with European companies in many industries, the euro’s weakness against the renminbi is putting American companies at a disadvantage. The American commerce secretary, Mr. Locke, said Monday in Hong Kong that Mr. Obama’s goal was to double American exports by 2015. Short-term currency fluctuations do not detract from that goal, he said in an interview, adding, “Who knows what the euro will be next month, six months from now or a year from now?”

Steve Jennings, one of the American executives traveling with Mr. Locke, said that the weakness of the euro would help European companies compete against American companies in export markets all over the world.

“As the euro continues to decline, they’re going to have some advantages,” said Mr. Jennings, the chief marketing officer of BPL Global, a company based in Oregon that manufactures electricity monitoring equipment.

Chinese leaders reached a consensus in early April to break the renminbi’s peg to the dollar. That ended a dispute that had spilled into public view in March when Commerce Ministry officials warned in speeches and interviews in Beijing and Washington about the dangers of any change in the renminbi’s value. The ministry halted those warnings immediately after the consensus was reached, and Chen Deming, the commerce minister, even reversed himself publicly by saying that China’s trade deficit in March was nothing to worry about.

But events since then have delayed adoption of the consensus, including public attention paid to a visit to Beijing by the United States Treasury secretary, Timothy F. Geithner, followed by the Qinghai earthquake and now the euro’s slide.

The United States is far from alone in calling for China to let the renminbi rise. Government officials in Singapore, India and Brazil have also called publicly in recent weeks for the Chinese government to break the renminbi’s peg to the dollar. Continued Chinese inaction would antagonize many commercial rivals of China, and could fuel pressures in Washington for Congress to draft trade legislation threatening restrictions on Chinese exports.

The euro’s difficulties have also inflicted tens of billions of dollars in losses on the value of China’s $2.4 trillion in foreign exchange reserves, according to Western economists. China had been trying to limit its dependence on United States Treasury securities for those reserves in recent years, fearing that the United States might someday suffer from budget problems or inflation, and did so by expanding its holdings of European government bonds.

But China’s State Administration of Foreign Exchange, which administers the reserves, does not have to mark them to market daily — record their fluctuating value — so it is not clear what effect, if any, the losses will have on policy.

Hilda Wang contributed reporting.