Bank of China deputy governor Yi Gang: 'We do have confidence in European financial markets and the euro'

China is worried about Europe's economic future, but how far is it prepared to go to ensure the euro survives the sovereign-debt crisis? Not far enough.

China's pledges to purchase Greek and Spanish bonds as well as statements of financial support for Portugal show trade and investment are at stake. After all, Europe is China's premier export destination.

"We do have confidence in European financial markets and the euro," People's Bank of China deputy governor Yi Gang said earlier this month. "We will be here for a very long period of time. China has been a long-term, stable investor in Europe."

But while signaling a well-appreciated support for the euro, these purchases are mainly symbolic gestures. They won't be massive, nor will they increase in any meaningful way. By buying bonds and striking investment deals in cash-strapped European companies, China is trying to make friends and build bridges. It is keen to be recognised by the European Union as a market economy. This recognition would force Europe to limit the number of anti-dumping cases launched by the EU against imports from China.

China's display of "soft" business-centered diplomacy may also help it in sensitive discussions with Europe's leaders over the EU arms embargo imposed against China after the Tiananmen Square crackdown in 1989.

Bond purchases are a double-edged sword, though. Many argue that China wants to preserve the euro to diversify its holdings of US dollars. But China is faced with a dilemma: the treasury bonds that it owns help prop up the dollar, against which the yuan is pegged at a rate some say is undervalued in order to boost exports. Diminishing its dollar holdings would lead to a further strengthening of the yuan and depreciation of the US currency, which the Federal Reserve is forcing upon the world through quantitative easing.

The precarious fate of the euro worsens Europe's already grim prospects for this year. The European Commission forecasts 1.5% growth for 2011, compared with 1.7% in 2010. Most of this will be driven by Germany, while the slump in other euro countries will persist.

China may not have been affected by the financial crisis, but it might well have to accept a longer-term slowdown of exports to Europe. Recent IMF research reveals that after a major banking and financial crisis imports by affected countries take about 10 years to return to normal. Recent analysis by the World Bank says the crisis has pushed advanced countries to a lower growth trajectory. This will hurt export-oriented countries, such as China.

Although China now exports more sophisticated products than a few years ago, such as iPads, it doesn't control the technology. It only takes charge of the final product assembly for re-export. This happens in large-scale plants that employ millions of workers the Chinese government needs to keep happy and employed. China still needs investment in large-scale labour-intensive manufacturing to put its masses to work. Two-fifths of its labour force is still rural and needs to be shifted to better jobs, namely in factories.

Such massive investment is possible only with the help of foreign companies operating in China. South Korean, Japanese, Taiwanese – not so much European – companies may be the top investors in China. But these Asian investments are plants that assemble for re-export to the West. If domestic demand in Europe slows, then foreign investment in China will also suffer.

These harsh realities are the backdrop to China's charm offensive deployed during its recent roadshow in European capitals. It is responding to the frustration of European investors over practices such as forced technology transfers in joint ventures, and to a rising protectionist sentiment. At the moment, China simply can't dump its dollars, so Europe's leaders shouldn't expect much more than symbolic Chinese support for the common currency.

Iana Dreyer is an independent trade and economic-policy analyst. The opinions expressed are her own