China and the EU find common ground on investments: the CAI

Differences in time zone and the epidemiological emergency still underway at the global level have not prevented the signing of an epochal agreement for economic relations between China and the EU. On 30 December 2020, the online meeting between Chinese leader Xi Jinping, the President of the European Commission Ursula von der Leyen, the German Chancellor Angela Merkel, and the French President Emmanuel Macron, officially marked the signing of the Comprehensive Agreement on Investment (CAI), a bilateral agreement, in the works since 2013, for investments between China and the EU that opens the Chinese market to companies from the Eurozone countries.[1] After negotiations that lasted seven years, although it is still necessary to work on the details, Beijing and Brussels seem to have finally reached an agreement about the framework of this pact aimed at ensuring greater reciprocity and interdependence between the two economic blocs.[2] Although the approval of the European Parliament is still required, the agreement was welcomed as a success by both sides and comes at the very appropriate time, in time for the end of the German EU presidency semester, 45 years of China-EU diplomatic relations, and three weeks since the new Joe Biden administration took office.[3]

As reported in an EU note, this agreement has great economic significance, binds the two parties to a value-based investment relationship based on the principles of sustainable development.[4] Among the key sectors covered by the CAI, stands out the automotive sector, as well as that of electric and hybrid cars, to which the Asian power would be willing to open up with greater transparency and ease. Health, energy, and telecommunications would also experience substantial removal of obstacles. European companies interested in competing in the Chinese market will be able to do so independently, without necessarily join a local partner (joint venture); furthermore, there won’t be technology transfer from European companies.[5] The Eurozone countries have always denounced the severe restrictions imposed by Beijing on entering its market, especially in terms of high-tech sectors’ forced transfer of know-how and technologies to obtain the necessary administrative authorizations from the Chinese authorities.[6] China, therefore, has ensured unprecedented opportunities and conditions for its European counterparts in return for accessing the European energy market. Furthermore, renewed importance has been given to the adjustment of regulatory contexts related to the transparency, predictability, and legal certainty of investment conditions, just as environmental standards.[7] In this perspective, the CAI could represent the first step towards a broader free trade agreement with the inclusion of commitments in the sectors of public procurement and industrial overproduction.[8]

For Beijing, the signing of the CAI constitutes a reconfirmation of the openings already permitted with the introduction, in January, of the Foreign Investment Law.[9] Also, from a European perspective, the agreement lays the foundations for further strengthening the economic interdependence between the two players. According to Eurostat, in 2019 the EU exported goods worth € 198 billion to China and imported goods worth € 362 billion, with bilateral trade worth € 560 billion. In the first 10 months of 2020, the volume of EU-China trade settled at € 477 billion, 2.2% more than in the same period of the previous year. The Asian power, therefore, still represents an essential destination for European FDI, especially those of a commercial nature and in support of market action, characterized by a strong penetration capacity in foreign markets.

Beyond strictly economic reasons, the importance of the CAI also sinks into the ground of geopolitics: the signing of the pact, in fact, follows the conclusion of another important commercial agreement, the Regional Comprehensive Economic Partnership – signed between the Association of South-East Asian Nations (ASEAN) plus China, Japan, South Korea, Australia, and New Zealand.[10] The greater commercial, financial, and investment influence guaranteed by these two agreements in their regional areas clearly has a strong impact also on global geopolitics. The detente of relations that China has started – first with the ASEAN bloc and then, in the specific case of the CAI, with the Eurozone countries – not only puts Beijing back at the center of economic dynamics but above all increases its political weight. This is even more true in terms of competition with the United States;[11] the Biden-Harris administration has publicly expressed its opposition to the conclusion of the agreement, as well as reluctance about Chinese economic practices, urging “European partners to discuss US concerns more[12]. The controversial support of the European part to the agreement, therefore, seems to underline the different views with which the EU and the US have approached the Chinese dossier: Brussels while remaining within a transatlantic framework, is well aware that the center of the world growth has now moved to the East.[13] The conclusion of the CAI, therefore, is a very important diplomatic achievement for China: the Asian giant, despite being considered a “systemic rival”, remains an essential European partner, not only in the fight against Covid19 and climate change.[14]

Beijing’s enduring human rights violations have been one of the main obstacles to concluding the investment agreement. The European Parliament recently voted a resolution[15] so that the CAI would induce greater respect for international conventions against forced labor. The reference to the Xinjiang’s Uyghurs Muslim minority, concentrated in detention centers and subjected to forced labor and degrading treatments is clear right away – although Beijing defends itself by speaking of “vocational training centers”, useful to hold back poverty and extremism, considered as the main threats to national stability and security. In this regard, China has agreed to “make continuous and sustained efforts” to carry out the ratification of the fundamental conventions of the International Labor Organization against forced labor but without any specific commitment, it is therefore not excluded that, in the future, the EU can introduce new sanctions for violations carried out by the regime in question.[16]

One Belt One Road China EU
The OBOR project was connecting China with some European countries, leaving some others out. Wikimedia Commons Attribution-ShareAlike 3.0 Unported (CC BY-SA 3.0) https://creativecommons.org/licenses/by-sa/3.0/

All that glitters is not gold: the agreement between China and the EU may cause a controversy within the European Union

Net of the historical importance of the agreement, Italy has been excluded from the negotiating table. Despite signing of the 2019 Memorandum of Understanding to join the New Silk Road – Italy is the first and only G7 country to take part in the One Belt One Road (OBOR) – and the hope for future stronger Sino-Italian relations, today Italy is just a spectator and the negotiations are led by the Franco-German format.[17] Despite having invited France and Germany to greater transparency by sharing the draft agreement, Italy has not achieved any results. Above all, the presence of Macron, said Undersecretary for Foreign Affairs Ivan Scalfarotto, was considered a real setback: if the Chancellor Merkel was able to attend the videoconference as President of the EU Council, the presence of the French leader, on the other hand, has shattered the European protocol, bypassing the other member countries. The CAI thus seems to cast the specter of failure also regarding the agreement on the Silk Road concluded in 2019: “a failure – said Scalfarotto – both commercially and politically. If the Italian logic behind the signature was to increase commercial and economic relations with China, this consideration turned out to be at least optimistic, if not completely fallacious, depriving our country also of the necessary credibility to play the leading role in the negotiations”.[18] The prevailing fear is that new power relationships are emerging and Italy is seriously in danger of being ousted, especially considering the opportunities deriving from its participation in the CAI – the automotive sector constitutes 7% of Italian GDP, just as the leading companies Enel and Eni could benefit from the greater opening in Beijing.[19]

Antonella Iavazzo

[1]  http://www.xinhuanet.com/english/2020-12/30/c_139630412.htm

[2]  http://www.xinhuanet.com/english/2020-12/30/c_139630735.htm

[3]  http://www.xinhuanet.com/english/2020-12/30/c_139630412.htm

[4]  https://www.ispionline.it/it/pubblicazione/ue-cina-il-super-accordo-sugli-investimenti-28820

[5]  https://www.money.it/market-mover-della-settimana-4-8-gennaio-2021

[6]  https://www.ilsole24ore.com/art/cresce-sfiducia-le-aziende-europee-cina-allarme-i-contraccolpi-guerra-dazi-ACjg82E

[7]  https://www.china-files.com/intesa-cina-ue-su-latteso-accordo-di-investimento-bilaterale/

[8]  https://aspeniaonline.it/ue-cina-un-accordo-parziale-e-molte-questioni-geopolitiche-aperte/

[9] The “Foreign Investment Law” is a law aimed at protecting the interests of foreign investors in Chinese territory. Among the measures, it allows foreign companies to access public procurements through fair competition and the inability to use administrative sanctions and licenses for technology transfer. More info on http://www.xinhuanet.com/english/2020-01/01/c_138670986.htm

[10]  https://www.ispionline.it/it/pubblicazione/rcep-il-nuovo-motore-della-crescita-asiatica-28345

[11] ibid.

[12]  https://twitter.com/jakejsullivan/status/1341180109118726144

[13]  https://aspeniaonline.it/ue-cina-un-accordo-parziale-e-molte-questioni-geopolitiche-aperte/

[14]  https://www.china-files.com/intesa-cina-ue-su-latteso-accordo-di-investimento-bilaterale/

[15]  https://www.europarl.europa.eu/doceo/document/RC-9-2019-0246_IT.html

[16]  https://formiche.net/2020/12/accordo-ue-cina-ghiretti/

[17] https://it.insideover.com/economia/ue-cina-via-libera-a-un-accordo-storico-ma-litalia-e-stata-estromessa-dalle-trattative.html

[18]  https://formiche.net/2020/12/accordo-ue-cina-italia/

[19]  https://it.insideover.com/economia/ue-cina-via-libera-a-un-accordo-storico-ma-litalia-e-stata-estromessa-dalle-trattative.html

The pitfalls back of market growth

Financial markets continue their unstoppable growth. After the impressive recovery of April, also May disappointed the expectations of many short sellers[1] who were betting on a downward correction in the market. After a prolonged period of lockdown, the opening in all countries have generated a great euphoria on the financial markets, making the run-up to pre-coronavirus levels continue.

For a long time, we have relied on earnings as the main value driver in the stock market. Wasn’t the price / earnings (P/E)[2] ratio one of the main multiples for valuing stocks? So far, although most companies have reported earnings well below the levels provided by both guidance and analyst forecasts (except those in the technology sector, communications and stay-at home stocks[3]), the market is slowly returning to its pre-crisis level. The Nasdaq composite has returned to very few percentage points from the historical highs.

The numerous negative macroeconomic data amplify the paradox of this overview, almost one-way upwards. The International Monetary Fund estimates[4] predict negative GDP projections in almost all countries of the world, with rare exceptions such as China and India (respectively + 1.2% and + 1.9% in 2020) which in turn are far from the standard growth rate. In 2020, a 7.5% drop is expected in the Euro area with a 4.7% rebound in 2021. We wonder  how long it will take to return to the levels of GDP before the coronavirus.

 20202021
United States-5.94.7
Germany-7.04.7
France-7.25.2
Italy-9.14.5
Spain-8.04.8
Japan-5.24.3
United Kingdom-6.54.0
China1.29.2
India1.97.4
 20202021
United States-5.94.7
Germany-7.04.7
France-7.25.2
Italy-9.14.5
Spain-8.04.8
Japan-5.24.3
United Kingdom-6.54.0
China1.29.2
India1.97.4
Source: IMF. Pil outlook in percent change.

Additionally, the estimates on unemployment  in the United States reached 14.7% in April, more than triple from 4.4% in March[5]. We must keep in mind that about 70% of the consumption in the United States is due to the US families themselves. Who will consume in the USA considering that unemployment increases?

Together with the macroeconomic assessments there is  the total uncertainty concerning the vaccine too. Although some (few) trials have been successful, an effective vaccine seems to be far from being achieved. Nowadays, the most promising vaccines are being tested. However, it seems that investors have recently forgotten the main uncertainties that this health and economic crisis has caused: there are no effective treatments, we do not know if, and possibly when, profits will return to pre-covid 19 levels, we do not know the consequences of the reopening or if the autumn period could lead to a new wave. And I could continue with many other uncertainties.

So, where does all this optimism come from? The real question is to wonder if perhaps ‘there is no alternative’ market. In fact, alongside all these uncertainties, we have unquestionable certainties: the central banks continue and will continue to print money unceasingly, guaranteeing unlimited stimuli (two examples are the Federal Reserve and the Bank of Japan). The decisions of the main central banks to provide disproportionate liquidity on the market have probably favored a recovery in the short term, but its sustainability will have to be assessed. Inevitably, all these interventions have brought the returns on cash and bonds to such low levels as to generate an implicit investors’ willingness to expose themselves more on the stock market, in order to obtain a more satisfactory risk-return. Added to this is the so-called ‘fear of missing out’ (FOMO) by investors, or the fear of missing the opportunity at the time of the bullish trend to take advantage of the rally[6], which in turn feeds further rises. The problem remains, however, the macroeconomic context, which could lead to an upward trend only in the short term.

Another factor of extreme importance is the possible cold war between the United States and China which could further fuel uncertainty on the markets. The immediate reaction was naturally negative. Such contexts increase the risk-premium and endanger global development. Obviously, an increase in the risk-premium[7] leads, in most cases, to a decrease in the share price. Bear in mind that we are talking about the two major powers in terms of global GDP, and serious repercussions could, with a chain effect, involve all markets.

As for the European market and in particular the Eurozone, the main news concerns the Recovery Fund proposed by the European Commission which should guarantee 750 billion with an issue of thirty-year securities guaranteed by all countries, with a mix of loans and grants. Very complicated negotiations will open in the following months. We are finally approaching a debt mutualization at the European level (eurobond). The problem is that the funds will be accessible no earlier than 2021. Consequently, the instruments available in European countries will be, at least until the end of 2020, the Sure, the Esm and the purchases of government securities by the European Central Bank. These initiatives were taken with great euphoria on the markets, above all that of government bonds which saw a narrowing of spreads[8].

We cannot predict whether the stock rally will last much longer since we are in a truly anomalous market. In this context, investor sentiment seems to count far more than macroeconomic and microeconomic fundamentals. However, there is a crucial principle of the economy: in order to be sustainable in the long term, growth must be based on solid structures  and these, nowadays, seem to be very fragile. In the extreme case, there is the risk of creating a bubble which, if it explodes, would cause further negative consequences on the market.

Gianlorenzo Zeccolella


[1] https://en.wikipedia.org/wiki/Short_(finance)

[2] Price over earnings is one of the most important multiples, used to assess the equity value of a company. When P/E = 15x, the stock price is 15 times its earnings per share.

[3]  Typical examples for stay-at-home stocks are Netflix or Zoom.

[4] https://www.imf.org/external/index.htm

[5] https://www.bbc.com/news/business-52591262

[6] In finance, a rally is a period of sustained increase in the price of an asset. https://en.wikipedia.org/wiki/Rally_(stock_market)

[7] https://www.investopedia.com/terms/r/riskpremium.asp

[8] The spread is the differential between the returns of two securities with the same maturity (typically 10 years). One of the securities compared is considered as a benchmark.

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