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From the Fall 2015 Issue "Food Fight"
By Francesco Galietti
ROME—Books about China’s penetration into the Italian market are becoming hot commodities. Take Story of My People, a bestseller by Edoardo Nesi, an entrepreneur turned politician from Prato. Nesi’s narrative is pretty straightforward. Only one generation ago, Prato was a thriving industrial center that prided itself on craftsmanship and quality. But during the last decade, cheaply made goods—produced in China or in Italy by poorly paid Chinese immigrants—saturated the market, making it impossible for Italian companies to compete. And yet Story of My People is yesterday’s world. Today’s world is harder to decipher—and potentially far more sinister.
While China’s own stock markets have taken a huge beating as of late, the country as a collective investor is still on the prowl. Any country with the kind of surplus China regularly posts must, inevitably, ship capital abroad. Italy is where China’s ability to reconcile tactical opportunism with strategic depth can be seen at work. “Everything under heaven is in utter chaos; the situation is excellent,” the founder of the Chinese Communist state Mao Zedong wrote in his Little Red Book. At the time, Mao was not thinking of Europe, certainly not Italy. Yet, today, Italy’s economy is weak, as its elite struggle to maintain order, but its geography and its assets attract a great deal of interest from China.
Italy is a paradox—with the world’s third largest public debt and significant growth problems, but little private debt and many pockets of unevenly distributed wealth. Meanwhile, China is stepping in as a mysterious saviour of sorts. If Italy is being invaded, due to the scarcity of local risk capital, or is merely being flattered, then in either case foreign investment can be excellent, catalyzing growth in a weak end market due to demographics and crushing public debt. But there is a broader risk—that Italy is playing, consciously or not, an old Greek card and serving as China’s Trojan horse into Europe.
Italy is now China’s number two investment destination in Europe after Britain, according to Dagong Global Credit Rating. It spent a record high $18 billion in Italy last year alone. Dagong Europe is the Beijing-headquartered agency that recently set up regional headquarters in Milan. Its name can be translated as “impartial and without prejudice.” Foreign investment is, of course, something Italy’s elite love to say they want. Yet it hardly seems plausible that China doesn’t have a plan for its sudden deep interest in Italy as a southern gateway into Europe.
FADED GLORY & POWER KEG
What little GDP growth Italy has—0.7 percent—is largely a tribute to non-recurring boosts such as low oil prices, quantitative easing by the European Central Bank, as well as huge tourist events such as the Expo and the Catholic Holy Year. Still, Italy remains plagued by unprecedented youth unemployment, combined with the strong and largely uncontrolled inflow of illegal immigrants and a growing sense of insecurity among vast sectors of the population. According to a November 2014 report by Italian statistics institute ISTAT, Italy’s official unemployment rate reached 13.2 percent in October—the highest since 1977, when the count began. Other measures suggest that today’s unemployment among young people, half of whom are believed to be without work, is the highest in Italy’s history, even higher than the levels experienced in 1929 and 1861 (the year of Italy’s unification).
Indeed, family solidarity—grandpa sharing his pension with his unemployed grandson—provides the only lifeline to hundreds of thousands of workers, somewhat easing the financial blow. But even these safety nets are wearing thin. A generational divide is also looming, with the Italian government ineffectually engaging in public spending review. So far, Prime Minister Renzi publicly denied that cuts would affect pensions. Still, the government’s popularity has been declining sharply after 18 months in office. And, at the same time, the southern rim of the Mediterranean is on fire. The uncontrolled flow of migrants from North Africa toward Italy is only adding to Italy’s economic and social burden.
Against this backdrop, Italy is quickly becoming a top destination for investments by foreign sovereign investors. According to a recent study released by Italy’s securities monitoring agency, more than one third of Italian-listed companies have a sovereign entity among their shareholders, far higher than the EU average (between 15 percent and 25 percent). Historically, Italy had been a recipient of investments by sovereign investors long before sovereign wealth funds became fashionable. Libyan state entities famously invested in Fiat and Juventus back in the 1970s.
Today the money is coming from Beijing, and the number of Chinese investments in Italy has risen exponentially over the past 18 months. Italy appears on the cusp of becoming the target of a Chinese “charm offensive”—a combination of hard cash and “soft power,” money and influence. So it should hardly be surprising that Italy—arguably the sick man of Europe—has itself earmarked a substantial investment to follow Britain’s lead and join the China-dominated Asian Infrastructure Investment Bank (AIIB). Italy’s share in AIIB is 2.62 percent of the capital, whose starting figure is $50 billion.
Multiple and converging evidence can be found to make the case that indeed Italy is at the center of Beijing’s charm offensive—and that more is yet to come. Presumably the skillful folk behind China’s financial foreign policy know their diplomatic protocol. Alberto Forchielli, managing partner at Mandarin Capital Partners and founder of the Sino-European research center, Osservatorio Asia, believes that Chinese investments in listed companies are actually meant to be visible because they exceed the thresholds for mandatory disclosure. In Forchielli’s view, Chinese investors want to be noticed, because “a study published by the Pew institute last July on how public opinion in several countries views China […] revealed that 70 percent of Italians see Beijing in a bad light. This is a staggering percentage, higher than that of all Western countries. China is sending a message of friendship and power. In their view, acts like these that involve minimum investments should endear China to Italy.”
Beijing is interested in Italy on any number of levels. A large volume of attractive assets is on sale, and with deep discounts. But geography is probably a better way to understand Beijing’s interest in Italy. After all, Italy was the final destination of the Silk Road linking European traders with Asia for centuries. For a growing, assertive power like China, securing a strong foothold in Venice—where Marco Polo began his journey more than seven centuries ago—is imperative. So it was hardly surprising when a group of managers of China’s Silk Road Fund were sighted in Venice, eyeing an investment in a cutting edge offshore cargo platform designed to connect the northern Adriatic with continental Europe.
On July 23, 2015, Foreign Minister Paolo Gentiloni welcomed a large delegation from China to an unprecedented gala at the destination of the historic Silk Road in Venice. The upper Adriatic is close to Europe’s affluent manufacturing heartland. So an offshore port of the type the United States is building to serve its East Coast is hardly preposterous—as long as someone else finances it and binds themselves to using it.
The Port of Venice is planning an offshore platform some eight miles off the mouth of the port of Malamocco, where the seabed has a natural depth of 60 feet. The offshore terminal will allow today and tomorrow’s ultra-large ships to call at the Port of Venice without having to further dredge the existing lagoon channels. Thanks to the offshore platform, Venice will be among the few ports in Italy where 20,000 twenty foot equivalent units [TEUs]-ships will be able to berth. It will also be possible to distribute goods to the European and Italian markets exploiting the most convenient land port. The terminal is expected to become the central link between existing shipping routes and the maritime traffic generated by global trade. The project is also designed to exploit the potential of the waterway system along the Po River and the connected canals, by offering through the ports of Venice, Chioggia, Porto Levante, and the inland port of Mantua, other possible points of sea/river and river/land transfers. The waterway system of the Po River may thus act as a connection between the Po Valley and the ocean maritime services, functioning not unlike the Flanders waterway system in Antwerp.
Geography is not the only way to make sense of China’s charm offensive. Indeed, it is sometimes difficult to get a sense of Italy’s overall foreign policy without studying the strategy of its state-owned companies on an international scale. Through this lens, one cannot help noticing that Italy and China have gotten considerably closer in recent months. Chinese state-owned companies are strengthening their foothold in Italy through flagship deals with Italian state lender Cassa Depositi e Prestiti (CDP). In the summer of 2014, CDP agreed to underwrite the sale to the State Grid Corporation of China of a 35 percent stake in CDP Reti, a holding company that controls Italy’s electricity grid operator (Terna) and the gas distribution operator.
Gas and electricity distribution are highly sensitive areas, and other European countries have refused to allow foreign investors into their grids, at the same time they were welcoming foreign investments into some manufacturing plants. The CDP Reti deal is but a single episode of China’s comprehensive charm offensive in the Italian energy sector, giving China State Grid unprecedented access to Italy’s energy technology and networks, as well as a chance to gain first-hand knowledge of how deregulated power markets function. Moreover, in a hyperconnected space like energy distribution, Italy represents a gateway to the pan-European electricity grid.
But electricity seems to be only one corner of China’s master plan and Italian shopping spree. In 2014, the People’s Bank of China bought stakes topping 2 percent in Italian oil and gas giant ENI (controlled by CDP) and the electricity and natural gas distributor ENEL (controlled directly by the Italian Treasury). Moreover, ENI sold a 20 percent stake in its Mozambique offshore oil project to Chinese oil company CNPC, while ENEL signed a Memorandum of Understanding on smart grid technologies cooperation with Liu Zhenya, chairman of China State Grid. Finally, Shanghai Electric agreed to buy a 40 percent stake in Ansaldo Energia, the Italian power equipment maker, from CDP’s Fondo Strategico Italiano. Moreover, the Chinese have made non-binding offers for both rail and mass transit vehicle manufacturer Ansaldo Breda, which operates at a loss, and profitable rail signalling company Ansaldo STS. Both bids were examined by their owners—Italy’s state-owned defense group Finmeccanica—only to be outbid by archrival Hitachi in a breakneck last minute auction.
Even some of Italy’s crown jewels are not immune from Chinese interest. Pirelli, founded in Milan in 1872, and the counterpart to France’s Michelin, supplies every racing tire for Formula 1 autos. This summer Pirelli was purchased by China National Chemical Corp. for €7.1 billion ($7.8 billion).
While no sale to Chinese buyers has been blocked so far, a 10-page report by the Prime Minister’s Office for Information and Security, the coordinating group of the intelligence community, containing strong caveats on inbound Chinese investments, was leaked to Italy’s leading daily Corriere della Sera during the negotiations for Ansaldo STS and Ansaldo Breda. The leak suggests the existence of friction between the China-friendly politicians and Italy’s powerful permanent bureaucracy, known as the “deep state,” which includes senior civil servants as well as members of the security apparatus.
By now, the People’s Bank of China (PBC) has steadily amassed stakes above 2 percent (the disclosure threshold in Italy) in a slew of Italy’s largest shareholder-owned companies, including FCA (the Fiat Chrysler group of companies whose CEO, Sergio Marchionne, is arguably the most powerful industrialist in Italy), Telecom Italia, and Generali Group, Italy’s largest insurer. Moreover, large Chinese companies have quietly acquired some 300 mid-sized Italian manufacturing jewels. But public attention has been especially focused on Chinese buying smaller, but highly visible boutique fashion and food firms, a pattern that ironically seems to have generated substantial goodwill, as these investments seem to applaud Italian culture.
The purchase by China’s Wanda group of Infront Sports & Media, a Swiss leader of the sports industry controlling sporting events broadcasting and marketing rights, with a third of its revenue generated in Italy, would seem to fit this pattern. Interestingly, Wanda’s founder and CEO, billionaire Wang Jianlin, is close to China’s political elite, while presenting himself as the pragmatic face of big business in China. Harvard’s Joseph Nye, who coined the term “soft power,” and clashed with Wang at last year’s World Economic Forum in Davos, believes Wang is China’s ultimate soft power instrument. After broadcast rights, acquisition of Italian football clubs may be next. Club ownership has long been a social duty of Italy’s rich, who have struggled to show the financial heft to stay in the game.
Branching into the Italian financial sector, the PBC has hit the disclosure threshold and revealed it owns 2 percent of Unicredit and Monte dei Paschi, the world’s oldest banking institution dating back to 1472. Each is also a sanctuary of the traditional local power bases of Italy’s hybrid political and financial elite.
Removing any doubt about how authorities see this tsunami of investments that are beginning to arrive, Bank of Italy Governor Ignazio Visco casually noted recently that the central bank has purchased yuan, which while potentially a future international reserve currency is currently not freely convertible. The PBC doesn’t reveal its currency basket, so this was an asymmetrical message.
The depth to which China has burrowed into the Italian economy may be found in recent activities by China Investment Corporation (CIC), another Chinese government-controlled sovereign wealth fund. It has just acquired a significant stake in Italy’s F2I, a domestic infrastructure investor partly owned by CDP. F2I has a strong track record of infrastructure investments with local governments, and could represent a gateway into the heart of Italy’s “municipal capitalism”—a system that is both immense and highly dysfunctional. The timing of the deal is also quite interesting, as a 2011 bill requires municipalities to consolidate the debt of municipal-owned companies starting from 2015, which may prompt an unprecedented wave of privatizations and ensuing consolidations to avoid large-scale fiscal shocks at local levels across Italy. Such shocks could be far more intense even than municipal bankruptcies like those of Detroit. Any substantial injection of investment capital could prove to be an enormous support, neutralizing such potential shocks.
But of even greater potential interest for China, F2I, together with Italy’s own sovereign wealth vehicle, the Italian Strategic Fund (FSI), owns Metroweb—an ultra-broadband fiber provider frequently identified as a central player in the modernization of Italy’s fixed-line fiber network, either via an integration with Telecom Italia’s network or as standalone solution. Such a plan could also enlist another Chinese player like Hong-Kong based H3G (Hutchinson Whampoa), reportedly in talks with Russian telecoms giant Wind (Vimpelcom group) for a Sino-Russian merger.
While conspiracy theories are always dangerous, there inevitably is the issue of whether Italy is effectively becoming the laboratory of a gigantic Sino-Russian experiment involving two regional powers eager to push back against what the leadership of both nations perceive as U.S. hegemony. At the same time, Italy itself could be quietly seeking to maximize its own leading role in a future where China may be a much more substantial player in Europe. To be sure, most of this is being done in the light of day—a result of stringent financial disclosure rules on inbound investments that the Chinese are prepared to follow.
Until recently, the scale of all these slivers being assembled has attracted little attention. Now, suddenly, Italy, if not its European partners, is becoming aware that the fox has definitively entered the henhouse, having discovered the key to the previously locked door. Even now, though, there’s little in Italy, or more broadly in Europe, resembling the kind of strategic review that has become all but routine, and quite discouraging to many foreign investors. The U.S. Treasury has its Committee on Foreign Investment in the United States (CFIUS). While its mandate is to defend the national interest in reviewing foreign acquisitions of a broad range of American companies, the definition of its mandate has broadened immensely in a world where food security and proxy ownership by foreign governments have assumed at least equal weight with old-school weapons deals. Indeed, the trade deals currently being negotiated—the Trans-Pacific Partnership and Trans-Atlantic Trade and Investment Partnership—would allow, for example, a fracking company to sue for damages if local voters chose to ban its activity, so long as the company is foreign-owned. No fewer than seven cabinet departments and seven executive agencies sit on the CFIUS, which while no guarantee of transparency, certainly mitigates the risk of the kind of secret sweetheart deals that have on more than one occasion characterized the sale of Italy’s public assets and concessions.
The time has come for Italy to set up a similar mechanism—and enforce it. And, more broadly, a similar EU body needs very much to be established, though this would require each of Europe’s 28 independent nations to relinquish yet another sliver of control over its own affairs that each has so reluctantly ceded to the pan-European bureaucracy. But the alternative is almost too painful to contemplate. After all, China has nearly $4 trillion in hard currency holdings just waiting to be invested—nearly ten times the entire market cap of all companies listed on Italy’s main stock exchange, the Borsa Italiana.
Francesco Galietti is a former senior advisor to the Italian Minister of Finance and the CEO of Policy Sonar, a Rome-based political risk consultancy firm.
[Photo courtesy of Enkmarco Hilo]