Doubts Cast on Whether China will Help Out Italy

Reports that the Italian government has held talks with the Chinese sovereign wealth fund about investing in its debt-laden economy spurred a stock market rally and a boost to the euro Monday.

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As the European markets opened for business on Tuesday, doubts were being cast on whether China would want to invest more of its wealth in Italy.

Italian Economy Minister Giulio Tremonti met Chinese officials last week, a Treasury spokesman said on Tuesday. The statement followed a report in the Financial Times that Tremonti had met Lou Jiwei, chairman of China Investment Corp, one of the world’s largest sovereign wealth funds and representatives of Italian Cassa Depositi e Prestiti, a state-controlled entity which runs a 4 billion euros ($5.43 billion) Italian Strategic Fund open to foreign investors, last week.

China Investment Corp has so far declined to comment on the report.

"Don't forget this is Italy telling us, not China. We're not hearing anything from China," Simon Derrick, chief currency strategist at BNY Mellon, told CNBC Tuesday.

"First, we already know that China has concerns about the euro zone, so do you really think they will start buying peripherals at the moment?"

"Second, Italy is the biggest market in Southern Europe, so you can't expect it (Chinese intervention) to have the same impact as it would in Portugal or Greece," he added.

"And finally, why would you expect China to start ploughing into Italy when Germany or Switzerland have little or no interest in buying in?"

The Chinese took part in the Portugal bond auctions earlier this year, and may have had their fingers burned as Portuguese bonds have fallen further since then.

One possibility is that China, the biggest foreign holder of US debt, is looking for alternatives to the dollar as a reserve currency and might be prepared to shore up the euro in light of this.

"China obviously has an intention over a long period to increase its exposure to the euro and it has a vested interest in supporting it," Eric Wand, fixed income strategist at Lloyds, told CNBC Tuesday.

"I think they will seek to pick up bonds along the way but I don't think they will be standing behind the auction today or any in the near future."

A new five-year treasury bond will be auctioned by the Italian treasury later Tuesday.

Italy is struggling with a high debt-to-GDP ratio, second only to Greece in the euro zone. Its debt totals around 1.9 trillion euros.

The government is currently debating a crucial 54 billion austerity package and considering the sale of some of its stakes in Italian companies.

While peripheral euro zone economies such as Greece and Portugal are viewed as small enough to be bailed out, Italy is the euro zone's third-largest economy.

"The reality is there's not enough money to bail out Italy, therefore Italy is vulnerable," Chris Watling, chief executive of Longview Economics, told CNBC Tuesday.

"It's gone from being not on radar screens to being on radar screens, so if I'm a holder of Italian debt, I want to reduce my holding, there's no one out there who wants to buy it, and therefore it's vulnerable."

The European Central Bank (ECB) stepped in to the Italian bond market last month after Rome's borrowing costs threatened to rise to out of control levels.

Juergen Stark, one of Germany’s representatives on the ECB's governing council, walked out in protest at the bank's actions on Friday, sending markets down again.

"The Italians want to send a positive message ahead of the series of auctions coming up," said Derrick.

"Why wouldn't China just wait for the story to resolve itself and then go in?"

On Monday, the cost of insuring Italian debt against default hit a record high, with five-year Italian CDS scaling 505 bps, up 38 bps on the day, according to Markit.