The head of China's giant sovereign-wealth fund sees mounting risks of a breakup of the euro zone, and says the fund has scaled back its holdings of stocks and bonds across the continent.
The comments by Lou Jiwei, chairman of China Investment Corp., are among the most bearish pronouncements yet on Europe by a senior Chinese official.
They reflect growing dismay in Beijing at how European leaders are handling the escalating crisis in China's largest export market, and anxiety over the potential for global contagion.
"There is a risk that the euro zone may fall apart and that risk is rising," Mr. Lou said in an interview—his first with a Western media organization in five years.
The pullback by CIC, whose moves are widely watched by market participants, could further dampen investors' interest in holding European securities, analysts say, potentially contributing to even higher funding costs for the debt-laden countries.
With about $410 billion in assets under management, CIC is the fifth-largest sovereign fund in the world.
It was founded by the Chinese government in 2007 to seek better returns for China's currency reserves, which were typically parked in low-yielding securities such as U.S. Treasurys.
Chinese leaders have singled out better management of China's $3.3 trillion foreign-exchange reserves, the world's largest, as a priority for the financial sector.
Mr. Lou also called for China to release controls on its capital account, a move that would free up cross-border investment flows and loosen reins on the Chinese yuan free.
After the euro-zone crisis ebbs, it might be time to "open up the capital account," Mr. Lou said, adding his voice to a growing chorus of calls from China's reformers to revamp the country's financial system in a bid to rebalance China's economy.
Global investors have been scrutinizing CIC's investment strategy lately because of frequent market speculation about the potential for China to come to the aid of the euro zone by purchasing European debt.
CIC officials have stressed that the fund is a commercial investor and won't be part of any coordinated Chinese investment push.
Mr. Lou said CIC had sold down its exposure to the "peripheral" European countries a long time ago, before incurring any loss, and has reduced its holdings of European stocks and bonds.
"Right now we find there is too much risk in Europe's public markets," he said.
Mr. Lou didn't specify which peripheral countries he was referring to, but such countries, as defined by analyst firms, generally include Greece, Portugal and Ireland, which have been forced to take international bailouts, as well as the much bigger Italy and Spain, where bond yields have surged to levels that many in the markets consider unsustainably high.
Meanwhile, CIC is unlikely to be an investor in any euro bonds created to support the debt-laden euro bloc.
Some European officials have floated the idea of creating a form of collective debt to help support larger European countries whose soaring borrowing costs have raised doubts about their ability to overhaul their economies.
Mr. Lou, a computer-scientist-turned-economist, doesn't think Europe is ready to launch such debt yet.
"Europe hasn't formed necessary fiscal discipline and hasn't got the right policies in place," he offered, adding that such bonds may not be a suitable investment for CIC.
"The risk is too big, and the return too low," Mr. Lou said.
Still, CIC will continue to invest in the continent by focusing on private equity and direct investment, including infrastructure, Mr. Lou said.
"Right now, we're underweighting on developed countries, and overweighting on emerging markets," Mr. Lou said.
The European financial crisis has intensified in recent weeks amid fears that Greece will withdraw from the euro.
European officials have appealed to Beijing to help resolve the euro-zone debt crisis by offering financial support through fresh investments and increased purchases of European debt.
Chinese leaders so far have expressed confidence in the future of Europe but also have refrained from making any firm financial commitment.
In addition, Chinese leaders including Premier Wen Jiabao have also called on Europe to push ahead with badly-needed structural economic and financial reforms.
Mr. Lou said the rest of the world will be vulnerable to the European debt crisis, though its impact on Asia is likely to be relatively small.
Still, the debt woes in Europe have caused a sharp slowdown in China's exports, a pillar of China's economy, Mr. Lou said.
"Nobody can keep their powder dry if everyone else's is wet," Mr. Lou said.
In the interview, Mr. Lou also expressed confidence in China's economic growth.
"The one economy we have the most confidence in is China," Mr. Lou said, adding that CIC is looking for overseas investments opportunities with "a China angle or a China factor."
As a result, CIC is focusing on China's neighboring countries such as Russia and is bullish on Africa and Latin America whose growth is driven by domestic consumption as well as Chinese demand.
On Tuesday, CIC signed an agreement with Russia's sovereign fund to form a vehicle to mainly invest in Russia and former Soviet Republics.
The joint fund will start out with $2 billion in capital and is expected to go up to $4 billion.
But Mr. Lou also acknowledged the challenges facing China's economy, the world's second-largest after the U.S. Chinese leaders have recognized that to make China's economic growth sustainable, it must readjust the country's growth model from one driven by export and investment to one that relies more on domestic consumption.
The rebalancing will "take fundamental and painful reforms over a long period of time," Mr. Lou said.
One of the much-needed reforms, many have argued, is to boost Chinese people's buying power by opening up the capital account and making the yuan a fully convertible currency.
"From an observer's point of view, it's time to open up," Mr. Lou said.
"But today may not be the right timing," he added. "There is a crisis going on. But after the crisis, it might be time."
Liberalizing the capital account, Mr. Lou said, would lead to "natural diversification" of China's foreign-exchange reserves, a stated goal of the country's currency watchdog...
Source: Argentine Beef Packers S.A.
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