Who Benefits from China’s “One Belt, One Road” Initiative?

Silk Road Economic Belt and the 21st-Century Maritime Silk Road
China’s Silk Road Economic Belt and the 21st-Century Maritime Silk Road

Under its Silk Road Economic Belt and the 21st-Century Maritime Silk Road (commonly known as the “One Belt, One Road” initiative) China has sought to build a network of infrastructure projects across Eurasia to encourage trade.  At first glance, it seems that all those involved should benefit.  Chinese loans would kick start the construction of the infrastructure projects.  Developing countries, in which the projects are built, would profit as transshipment points and from the development of new industries that could plug into international supply chains.  Revenues from the resultant economic growth would then repay the Chinese loans, with interest.

That all sounds rosy.  That is, if the new infrastructure network is used.  The mere existence of roads and ports does not ensure that trade will flourish.  Certainly economic growth at either end of the network would help.  But at the moment the economies of both China and Europe are slowing.  Indeed, global economic activity is slowing.  If there is not enough trade to make the new infrastructure profitable, then the benefits from the “One Belt, One Road” initiative only flows in one direction: China.

The operative word in the “One Belt, One Road” initiative’s financing is “loans.”  Chinese loans may have laxer requirements and carry a lower interest rate than those of commercial banks.  But they are loans.  China expects them to be repaid.  Plus, Chinese loans for infrastructure projects are often made with the understanding that the developing countries award construction contracts to Chinese companies.  In short, China benefits from both the financing and construction of infrastructure projects, while developing countries must bear all of the financial risk.  When trade is booming, that may not matter much.  But when it is not, that should be a concern.

In the past, many developing countries became heavily indebted as a result of infrastructure projects that fizzled.  Lenders ultimately had to forgive many of their debts, recognizing that their borrowers could never repay them.  China has forgiven some of its loans to developing countries too, about $3.9 billion in all.  But that is a small fraction of the total debts that developing countries owe it.  For example, in 2015 China cancelled $40 million in debt from Zimbabwe.  But Zimbabwe still owes China over $1 billion.  Moreover, at the time of China’s modest debt cancellation, Zimbabwe pledged that it would increase its use of the Chinese yuan in its foreign exchange reserves.[1]  To outside observers, it seemed that China had used its debt cancellation to achieve its larger foreign policy goals.

Still, several developing counties have welcomed Chinese financing.  Sri Lanka’s former President Mahinda Rajapaksa happily accepted Chinese loans to build a new port facility and airport at Hambantota.  When completed, the port facility will be the largest of its kind in South Asia.  But with slowing seaborne trade, Sri Lanka’s new government has been left with the burden of servicing the country’s $1.1 billion debt to China.  Despite the new government’s criticism of Rajapaksa’s acceptance of Chinese loans and the shortcomings of Chinese construction work, it had little choice but to finish the port and airport, lest it default on the country’s loans.  Indeed, China may believe that borrowers will be forced to repay their loans, because an outright default would severely curtail any developing country’s future access to credit.

Lately, however, some Asian countries have been playing harder to get with China.  That was the case with Indonesia last year.  When a Chinese-led consortium sought a contract to build a high-speed railway between Jakarta and Bandung, Indonesia leveraged the consortium’s eagerness to beat a Japanese-led rival to win a major concession: the consortium would drop its requirement for the Indonesian government to backstop China’s loans.  The consortium won the contract in the end.  But Indonesia offloaded the project’s financial risk onto China.

Thailand has been cautious too.  For years, China has talked about the construction of a long-distance, high-speed railway between Kunming and Bangkok.  After Thailand’s military coup in 2014, the two countries accelerated their talks over such a railway, as they developed closer ties.  But the terms that China offered disappointed Thai leaders.  They balked at China’s desired interest rate, its proposed ownership structure, and its request for development rights along the railway’s right of way.  So, Thailand shelved the project’s original plan.  Instead, it financed its own construction of a much shorter railway from Bangkok to Nakhon Ratchasima, only 250 km away.  While China would still supply the technology and oversee procurement, Thailand would use Thai construction companies to build the railway, not Chinese ones.

The two railway cases are telling.  China may believe that the thirst for low-interest loans in developing countries should make its “One Belt, One Road” initiative an easy sell.  But the leaders of those countries, at least those among them who are observant, know that China’s domestic economy is slowing and that China is increasingly concerned about keeping its construction companies working.  They also know what happened in places like Sri Lanka, Indonesia, and Thailand.  That knowledge gives them leverage to negotiate better terms from China.  If more developing countries do so, China’s “One Belt, One Road” initiative will be quite a bit tougher to realize.

[1] “Zimbabwe says China to cancel $40 million debt, increase yuan use,” Reuters, Dec. 21, 2015.

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China’s Encirclement Concerns

For almost two decades, Chinese strategists have worried about what they regard as the geopolitical encirclement of China. At various times, they have attributed that encirclement to the United States, then India, and most recently Japan.[1] No doubt last week’s large-scale naval exercise in the western Pacific did little to dispel their concerns. For the first time warships from India, Japan, and the United States jointly conducted anti-air and anti-submarine drills in the Philippine Sea, an area directly adjacent to the Chinese-claimed waters of the East and South China Seas.

China's Encirclement Concerns
China’s Encirclement Concerns

Events over the past month likely added to China’s concerns. Last Friday, Indian Prime Minister Narendra Modi visited Bangkok in part to expand his country’s defense and maritime security cooperation with Thailand. A week earlier, he met with President Barack Obama at the White House, highlighting India’s closer ties with the United States. At a summit in late May, the United States and Japan, along with other Group of Seven countries, openly voiced their concern over China’s maritime actions. Days before the summit, Obama flew to Hanoi where he lifted the long-standing U.S. arms embargo against Vietnam, one of China’s South China Sea antagonists. Then after the summit, Japanese Prime Minister Shinzō Abe welcomed a Vietnamese delegation to discuss how they could enhance their military cooperation.

Certainly Chinese concerns over encirclement are not new. During the Cold War, China worried about the Soviet Union pursuing a similar geopolitical strategy. Even earlier, the Chinese Communist Party faced several all too real “encirclement campaigns” during China’s long civil war. Those experiences could have left an imprint may have left their imprint on China’s strategic thinking ever since.

What is clear is that Asia-Pacific countries have begun to prepare for what could be an era of heightened tensions. Such hedging has recently accelerated, as Chinese behavior in the East China Sea, South China Sea, and on its border with India has grown increasingly muscular. The United States has pursued its “pivot” or “rebalance” toward Asia, which shifted the bulk of American naval might to the Pacific. India and Japan have boosted their diplomatic and economic engagement in Southeast Asia and strengthened their military postures. Other countries have begun to do the same. As Australia’s 2016 defense white paper warned, “competing claims for territory and natural resources [in the region]… could undermine stability.”[2] But does such hedging constitute an encirclement of China?

Imagined Encirclements

In the early 2000s, China agonized over a possible American encirclement on its western border as U.S. forces streamed into Afghanistan and Central Asia. But a decade later, a persistent insurgency had worn down the United States and its allies. U.S. military bases in Kyrgyzstan and Uzbekistan were closed; America’s once-close relationship with Pakistan became acrimonious; and U.S. forces began their long withdrawal. China’s concern never materialized.

Now Beijing fears an even wider encirclement by the countries along the Asia-Pacific periphery, as they hedge against China’s assertive behavior. But most of them are still in the early stages of building up their strength. Although Australia has launched an ambitious military modernization program, its forces remain small. India’s defense bureaucracy continues to frustrate its military’s modernization and expansion plans. While Japan fields highly capable forces, its fragile economy constrains its military’s ability to grow. Even America’s “pivot” toward Asia may not be as weighty as it sounds, as the Obama administration has trimmed the overall size of the U.S. Navy. Hence, one could argue that China’s concern over an encirclement is, at least for the moment, not wholly warranted.

Undermine the Encirclement

Besides, the countries that China fears will encircle it are not yet a cohesive bunch. Officially non-aligned, India remains skittish about is relationship with the United States. And while Australia and Japan have security treaties with the United States, they do not have strong ties with each other. That was evident when Australia, at the last minute, chose to purchase France’s Scorpene-class submarine over Japan’s Sōryū-class submarine for its next-generation submarine fleet. India’s security relationships with Australia and Japan are equally tenuous. China could use bilateral deals to weaken those relationships and hinder a nascent encirclement from coalescing any further.

Breakout of the Encirclement

But even if China’s fear was to manifest itself, Beijing is already developing the means to break out of it. In late 2013, China turned heads across Asia with its “One Belt, One Road” initiative. Among the many infrastructure projects it has financed in Southeast Asia are a special economic zone in Cambodia, hydroelectric dams in Laos, and energy and railway projects in Malaysia. While China’s “yuan diplomacy” has not always been successful, it has had an impact. Cambodia and Laos have become reliable advocates for China within ASEAN. Malaysia largely remains on the sidelines of the South China Sea dispute, despite a rising number of Chinese infringements of its exclusive economic zone. China’s initiative may prove useful even in the Philippines, which has been a thorn in Beijing’s side. The Philippines’ new president, Rodridgo Duterte, has indicated that he would undertake the bilateral dialogue that China has long sought in exchange for Chinese economic development assistance.

Benefit of the Encirclement

Still, Beijing may have reason to play up its fears of encirclement. Despite its remarkable economic achievements, China faces a host of problems. Today, Chinese leaders must manage their country’s difficult transition from investment-led growth to expansion by private consumption, while dealing with its various debt-fueled bubbles. Even under the best conditions, those challenges are bound to be volatile. So some may see fears of encirclement as a way to rally public sentiment and maintain the “social stability” needed to ensure the longevity of communist rule. In any case, whether the “encirclement of China” is imagined or real, effective or not, one can expect the phrase to remain in Beijing’s lexicon for years to come.

NOTES

[1] Zhang Yunbi, “Tokyo urged not to stir tension in the South China Sea,” China Daily, Mar. 10, 2016, http://www.chinadaily.com.cn/world/2016-03/10/content_23806572.htm; “Tokyo’s move to encircle China will lead nowhere,” Global Times, Nov. 23, 2015, www.globaltimes.cn/content/954471.shtml; Hu Qingyun, “US to increase troops stationed in Australia: Deal seen as move to ‘encircle’ China,” Global Times, Aug. 13, 2014, http://www.globaltimes.cn/content/875836.shtml; Li Hongmei, “India’s ‘Look East Policy’ means to encircle China,” People’s Daily Online, Oct. 27, 2010, http://en.people.cn/90002/96417/7179404.html; Dai Xu, “U.S. building ‘Asian NATO’ to encircle China,” China.org.cn, Aug. 11, 2010, http://www.china.org.cn/opinion/2010-08/11/content_20687335.htm; “China feels encircled,” Economist, Jun. 6, 2002.

[2] Australian Department of Defence, 2016 Defence White Paper (Canberra: Commonwealth of Australia, 2016), p. 57.

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China’s ADIZ over the South China Sea: Whole, Partial, or None

Ever since China declared an air defense identification zone (ADIZ) over the East China Sea in late 2013, many wondered whether China would do the same over its claims in the South China Sea. Early this year, the United States began to publicly warn China that it would not recognize a Chinese ADIZ over the South China Sea. Given the timing of its admonition, Washington seemed like it was preparing for a Chinese reaction to a ruling by the Permanent Court of Arbitration on a Philippine case against China’s South China Sea claims, which is expected in May.

South China Sea Claims
South China Sea Claims

China’s declaration of an ADIZ over the East China Sea caught many off guard. Perhaps to prevent a recurrence, the United States chose to signal China in advance. Naturally, China’s defense ministry retorted that Beijing had every right to establish an ADIZ over the South China Sea. After all, Beijing considers the area within its “nine-dash line” claim to be sovereign Chinese territory. Yet the ministry’s spokesman was quick to add that China had no plans to set up such an ADIZ.[1]

Apart from placating the United States, there are other reasons why China might hold off from establishing an ADIZ over the South China Sea. They deal with Malaysia and Indonesia, two of the Association of Southeast Asian Nations’ (ASEAN) most influential members. Whereas China’s ADIZ over the East China Sea could narrowly target Japan, a Chinese ADIZ over the South China Sea would impact not only China’s two main antagonists there, namely the Philippines and Vietnam, but also all of the other disputants in the region, including Malaysia and Indonesia.

For decades, Malaysia has played down its dispute with China over the Spratly Islands in the South China Sea. Rather than confront China, as the Philippines and Vietnam have, Malaysia has tried to use quiet diplomacy to persuade China of the benefits of a multilateral resolution to the region’s conflicting claims. That strategy reached its high point in 2002 when China signed ASEAN’s non-binding declaration of conduct in the South China Sea. Although China has since violated the declaration’s terms, Malaysia has stuck to its strategy. Even after China twice held amphibious exercises off Malaysian-claimed James Shoal, only 80 km from Malaysia’s coast, Malaysia chose not to escalate tensions with China.

Similarly, Indonesia has minimized its dispute with China. So much so that Indonesian diplomats routinely repeat that their country has no territorial dispute with China. Though technically true—the two countries have no land features in dispute—what they do have is a maritime dispute. China’s nine-dash line claim encompasses some of Indonesia’s richest offshore oil and natural gas fields. (See hatched area on map.) Plus, China has increasingly made its presence known in the area. Just last month, two Chinese coast guard vessels again clashed with an Indonesian fishing boat. Such incidents have alarmed the Indonesian military. But Jakarta has hesitated from providing it with the resources needed to strengthen its defenses near the Natuna Islands.

A Chinese ADIZ over the whole South China Sea would definitely infringe on the claims of both Malaysia and Indonesia. That would be difficult for China to explain away. It would also run counter to China’s long-time strategy in the South China Sea. For years, China has sought to divide its Southeast Asian opponents and convince them to individually settle their disputes with it. A Chinese ADIZ over the whole South China Sea does little to achieve those ends. Rather, it could do the opposite. It would put Malaysia and Indonesia in the same boat as the Philippines and Vietnam, pushing them together. Moreover, such an ADIZ would undercut those who believe that by taking a less combative approach toward China their countries can avoid its assertiveness in the region.

On the other hand, if China declared an ADIZ over the northern half of the South China Sea—overlapping only the claims of the Philippines and Vietnam—it could reasonably argue that its aim was only to protect itself from airborne intrusions from those two countries. Both are building stronger air forces to counter China. That would at least encourage some in Malaysia and Indonesia. Still, a partial Chinese ADIZ would likely make many others uneasy that China could someday extend its ADIZ further.

Given the potential for an ADIZ (whether whole or partial) to unify ASEAN’s core states against it, China has good reason to be cautious. Ultimately, a Chinese ADIZ could create more problems for China than it solves. It could push Malaysia off the fence or turn Indonesia into a full-fledged disputant. It could also make it harder for surrounding countries, like Australia and Japan, to give China the benefit of the doubt. Finally, it would likely undermine the goodwill that China has been trying to generate across Southeast Asia through its “One Belt, One Road” initiative.

More broadly, a Chinese ADIZ over the South China Sea would mark a real change in China’s approach to not only its maritime dispute, but also East Asia. It means that China has become confident enough to act, regardless of the international consequences. If so, China will have indeed stood up. But it might learn that standing up can expose one to stiffer headwinds.

[1] “China says no need to ‘gesticulate’ over South China Sea plans,” Reuters, Mar. 31, 2016.

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China’s “One Belt, One Road” to Where?

During visits to Central and Southeast Asia in 2013, Chinese President Xi Jinping unveiled Beijing’s aspiration to create what it called the Silk Road Economic Belt and the 21st-Century Maritime Silk Road.  Both would entail the construction of new infrastructure to better connect the present-day countries along what was once the ancient Silk Road between China and Europe.  The former would do so over land with roads, railways, and airports; the latter across the ocean with seaports.  China’s two-part aspiration is now commonly referred to as its “One Belt, One Road” initiative.

China One Belt, One Road Initiative

At the time of Xi’s unveiling, China was near the zenith of its economic power.  Not even the 2008 global financial crisis seemed able to derail China’s economic ascent.  Some saw the “One Belt, One Road” initiative as a way for China to extend not only its economic, but also its political reach across Eurasia.  India had begun to worry about what it considered to be China’s “string of pearls,” a series of Chinese-built seaports across the Indian Ocean.  Others viewed the initiative even more broadly as an ambitious effort to reorient global commerce towards China.

But since then the air of invincibility surrounding China’s economy has dissipated.  China’s engines of growth—export manufacturing and infrastructure construction—have sputtered, as the debt that fueled them and the overcapacity that they created have ballooned.  Over the last year and half, Chinese leaders have been forced to repeatedly “fine tune” their economy to keep it growing.  They boosted China’s government spending, devalued its currency, cut its interest rates six times, lowered its bank reserve ratio seven times, and even directly intervened in its stock market.  Still, China’s economy continues to slow.

That slowdown has spurred Chinese leaders to seriously begin to shift their export and infrastructure-led economy to one that is driven by consumers.  How successful that transition will be is uncertain.  But one thing is clear, the “social stability” so prized by the Chinese Communist Party has begun to fray.  Popular unrest is on the rise.  The number of labor protests in China has soared from about 100 in 2010 to almost 2,500 in 2015.[1]

Thus, Beijing has every incentive to keep its giant manufacturing and infrastructure-construction state-owned enterprises (SOE) humming, as its economy makes the transition.  Seen in that light, China’s “One Belt, One Road” initiative looks less like a well-planned strategy and more like a scramble to keep the order books of its SOEs full.  New infrastructure contracts abroad would help do that; and once built that new infrastructure might help Chinese manufacturers export at a lower cost.

One can see China’s push to build more infrastructure projects from Indonesia to Pakistan.  In September, a Chinese-led consortium won approval from Indonesia to build a $5.5-billion high-speed railway in Jakarta.  But the consortium won only after it agreed that the Indonesian government would not have to guarantee the Chinese loans needed to finance the railway’s construction.  While that concession may have secured the approval, it also increased the potential financial losses that the consortium would have to bear if anything goes wrong.  With such large and complex construction projects, it is hard to ensure that will not happen.

Surely, China expected a different outcome after its construction companies built a port at Gwadar for Pakistan in 2007.  Despite a total investment of over $1 billion, the port has remained virtually idle.  Now China is doubling down on the Gwadar project.  It has promised $45.7 billion in fresh financing to build the China-Pakistan Economic Corridor, a series of energy, road, railway, and pipeline projects that will more closely tie Gwadar to China.

Of course, China can still benefit from such infrastructure projects even if they turn out to be unprofitable.  The new road, rail, and pipeline routes through Pakistan will enable China to import strategic resources, like oil, natural gas, and minerals, from the Middle East without being reliant on sea routes through the Indian Ocean.  The projects could also deepen China’s “all-weather” friendship with Pakistan by creating new constituencies within Pakistan that benefit from the economic activity that the trade routes to China could foster.

Other land-based links to China could do the same. The Kunming-to-Bangkok railway is another example.  The portion of it in China is already finished; the portion in Laos broke ground in December; and the final portion in Thailand is slated to begin construction in May 2016.  Given the massive scale of Chinese trade, even if a small portion of it is redirected over the railway, it could reshape the economic interests of a small country like Laos.  Indeed, China may hope to use the railway to pry Laos away from its traditional ally, Vietnam, and gain another friend in ASEAN.  On the other hand, China would not benefit to the same degree from Chinese-built seaports and airports that are not directly connected to it.  While they may boost trade in the host country, the course of that trade could be redirected elsewhere, if trade with China does not evolve as expected.

That is now a real possibility.  If the Chinese economy continues to soften, it means that China will need to import fewer raw materials and export fewer finished goods.  In the second half of 2015 China’s monthly imports fell 10 to 20 percent from a year earlier; and its exports slipped too.  Unless global demand revives or Chinese consumers pick up the slack, Beijing might well expect its “One Belt, One Road” initiative to yield more long-lasting political than economic benefits.

[1] “Number of strikes and worker protests in China hits record high in November,” China Labour Bulletin, Dec. 3, 2015.

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Boosting Indonesia’s Naval and Air Defenses in the South China Sea

Until September, Indonesia seemed sure to increase its defense budget in the coming year.  Rising concern over Chinese actions in the South China Sea had already prompted Indonesian leaders to pledge themselves to do more to safeguard Indonesia’s maritime claims in the region.  Indonesian President Joko “Jokowi” Widodo promised to turn the Indonesian military into “a regional maritime force respected by countries in the East Asia region.”  A senior Indonesian military official was more direct—putting China on notice that Indonesia would defend its maritime space around the Natuna Islands, including those parts that fall within China’s nine-dash claim line in the South China Sea.[1]

Indonesia China Claims in the South China Sea

But to properly defend Indonesia’s maritime interests, the Indonesian military has had to reorient itself onto what it calls a “maritime axis.”  That process was formalized in its 2010 Strategic Defense Plan.  It detailed what Indonesia would need to do to modernize its long-neglected navy and air force.  Since 2011, both have begun to procure newer equipment.  The navy ordered three Type 209/1400 diesel-electric attack submarines from South Korea, two Sigma-class corvettes from the Netherlands, and a number of fast attack craft from Indonesian shipyards.  It also acquired three small British-built frigates.  Meanwhile, the air force acquired the first of 24 retired American F-16C/D fighters, which will be refurbished and outfitted with new radar systems to give them better maritime and strike capabilities.

However, the momentum of Indonesia’s military procurement seemed to have faltered in September, when Joko’s government submitted its proposed 2016 state budget to the Indonesian People’s Representative Council (DPR).  In that budget, the government cut the defense allocation by 6.3% from Rp 102.3 trillion ($7 billion) to Rp 95.8 trillion ($6.5 billion).  A few weeks later, the government awarded a $5 billion high-speed railway contract to a giant Chinese state-owned enterprise.  Some wondered whether Indonesia had chosen to take a softer line towards China.[2]

More likely, though, Indonesia’s weakening economy drove both decisions, rather than any easing of its concerns over the South China Sea.  Joko’s government has argued that it needed to shift resources away from military spending to fund a series of stimulus packages to revive the Indonesian economy, which has suffered as the country’s raw material exports have fallen, a problem deepened by the government’s ill-timed reforms of Indonesia’s mining industry.  With respect to the contract award, the Chinese bid was sweetened at the last minute with a financial package for the proposed railway’s construction that did not require any loan guarantees from the Indonesian government, freeing it from any liabilities if the expensive project failed to meet expectations.  That was something Japan’s competing offer could not match.[3]

Whatever the reason for the lower defense allocation, it will hinder the modernization of Indonesia’s naval and air forces.  During budgetary testimony in October, General Gatot Nurmantyo, the commander of Indonesian armed forces, told the DPR’s defense commission that the lower defense allocation would force him to delay or scrap a number of procurement programs.  That prompted some on the DPR defense commission to worry whether the Indonesian military would have enough resources to achieve its “Minimum Essential Force,” the minimum requirements needed to defend Indonesia’s maritime interests.  Hence, the commission adopted a new proposal to add Rp 37.1 trillion ($2.5 billion) to the defense budget.  Ultimately, the DPR’s budget commission pared back that proposal, but still boosted the defense budget to Rp 99.5 trillion ($6.7 billion).[4]

While the new budget still represents a decrease from a year earlier, the small increase over the government’s proposal will help to keep some procurement programs on track and offset the falling value of the Indonesian rupiah against the U.S. dollar, which has made purchases of foreign military equipment more expensive.  In any case, Indonesia has also pursued other financing means to support its military procurement.  In early September, the Indonesian Ministry of Finance arranged for PT Bank Negara Indonesia to provide credit worth Rp 980 billion ($666 million) to the military for a variety of acquisitions.  Soon thereafter, the DPR’s defense commission revealed that Jakarta was seeking to secure a $3 billion loan from Moscow to fund major acquisitions.[5]  If the loan is finalized, Indonesia’s Ministry of Defense will most likely use it to acquire Russian Su-35 fighters and Kilo-class submarines, both of which the DPR’s defense commission has already endorsed.  As the one commission member said of Indonesia: “[we are] a maritime country… so sea security must be prioritized.”[6]

Yet, even with such support for new kit, the Indonesian military will have to stretch its resources to set up adequate defenses in the South China Sea.  The military has already listed a number of infrastructure improvements on and around the Natuna Islands that need to be completed before it can station more forces there.  The improvements include the construction of facilities for 2,000 additional troops; expansion of a naval base at Pontianak; and upgrade of Ranai air base with new hangars, radar, and a longer runway.  In September, Minister of Defense Ryamizard Ryacudu visited Natuna Island to draw attention to Indonesia’s efforts to beef up defenses in the area.  He noted plans to deploy three ships and four fighter aircraft on the island.[7]

In the near future, Indonesia is expected to publish a new defense white paper.  It will likely detail the growing maritime threats to Indonesian security.  Along with Jakarta’s ongoing attempts to strengthen its navy and air force, it reflects the intent of Indonesian leaders to better protect their country’s interests in the South China Sea.  But how quickly those leaders can do so is an open question.  They have a long way to go before they can bring to fruition the robust force structure envisioned in the 2010 Strategic Defense Plan.  Despite the progress made over the last five years, the defenses on the Natuna Islands are only just beginning to improve.  For now, Ranai air base still has the air of a remote outpost, operating a single 1980s-era radar set.  Perhaps in the coming years more military hardware will finally reach it.

[1] “Jokowi wants RI to be respected maritime force by 2020,” Jakarta Post, Oct. 5, 2015; Moeldoko, “China’s Dismaying New Claims in the South China Sea,” Wall Street Journal, Apr. 24, 2014.

[2] Kanupriya Kapoor and Cindy Silviana, “UPDATE 2-Indonesia rewards China’s ‘courage’ with high-profile rail contract,” Reuters, Sep. 30, 2015; Nani Afrida, “The TNI to cut back on weapons procurement,” Jakarta Post, Sep. 9, 2015.

[3] Robin Harding, Avantika Chilkoti, and Tom Mitchell, “Tokyo furious after Jakarta awards rail contract to Beijing,” Financial Times, Oct. 2, 2015, p. 6; Avantika Chilkoti and Taufan Hidayat, “Indonesia rolls out next stimulus phase in effort to lift economy,” Financial Times, Sep. 29, 2015.

[4] Lili Sunardi Senin, Kementerian, “PU Dapat Anggaran Terbanyak Dari APBN 2016,” Bisnis.com, Nov. 2, 2015; Jon Grevatt, “Indonesian parliamentary commission approves defence spending increase,” Jane’s Defence Weekly, Sep. 28, 2015.

[5] Ibid.

[6] “National scene: House support plans to buy Russian submarine,” Jakarta Post, Sep. 30, 2015.

[7] “Indonesia: Islanders on Alert,” NHK World, Nov. 11, 2015; “Indonesia’s Defense Ministry to focus on improving infrastructure in Natuna,” Antaranews.com, Sep. 21, 2015; “Indonesian military adds two thousand personnel to guard Natuna waters,” Antaranews.com, Sep. 16, 2015; Ridzwan Rahmat, “Indonesia to upgrade naval base near disputed South China Sea waters,” Jane’s Defence Weekly, May 9, 2014.

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Decline in Oil Prices, Currency Pairs, and National Power

Last autumn, headlines began to declare national “winners and losers” from the precipitous drop in oil prices over the second half of the year.[1]  They contended that the United States and its friends would benefit from the fall in oil prices; and that its most strident adversaries would not.  While largely true, the headlines did not capture the whole story.

Since international prices for oil are quoted in U.S. dollars, the exchange rate between the U.S. dollar and another country’s currency (a currency pair) also matters when calculating the real impact of a change in oil prices on that country.  Take Russia for example.  Much has been made of the fact that half of Russia’s government budget is based on revenues from oil.  One might suppose, because oil prices have fallen about 50 percent over the last six months, that Russia’s government budget would be pinched by about 25 percent (reflecting the 50 percent fall in oil revenues on half its budget).  Such a contraction would be catastrophic for the Russian government and Russia’s economy, given its high dependence on government spending.  That might lead Western policymakers to believe they can easily wait out Russian President Vladimir Putin’s aggressive designs.

But one must remember that the Russian government does not pay for domestic goods and services in U.S. dollars, but rather in Russian rubles.  Any drop in the value of the Russian ruble against the U.S. dollar allows Russia to reap more rubles for its dollar-based oil revenues.  (Even so, a sudden devaluation in a country’s currency can still wreak havoc on that country’s wider economy, because it fails to let people adjust to the benefits of devaluation, before they feel its negative impacts.)  Given the devaluation in the Russian ruble (which has fallen in tandem with oil prices), the real impact of the fall in oil prices is closer to only 8 percent, rather than 25 percent. While that is still a big challenge for the Russian government’s budget, it is a lower hurdle for Putin to surmount.

Similarly, one might expect that Japan, a key American ally in Asia, to unreservedly benefit from the decline in oil prices.  As a country completely dependent on oil imports, any decline in oil prices should boost its economy.  Given that oil prices have fallen about 50 percent over the last six months and that Japan imported about 1.6 billion barrels of oil in 2014, one may naturally assume that Japan is now saving a vast sum that would act as a fiscal stimulus to its economy, making it a stronger country and one better prepared to cope with a rising China.

That has happened, but not to the degree that the halving of oil prices would suggest.  That is because the value of the Japanese yen against the U.S. dollar has fallen too.  During the second half of 2014, the yen devalued about 15 percent, as a result of the Japanese central bank’s quantitative easing policy.   That shaved one-fifth off the benefit from the decrease in oil prices to 40 percent in yen terms.  Ironically, the lower energy input prices had made it more difficult for the Japanese government to achieve its 2 percent inflation target, which Tokyo believes will help lift the country out of its decades-long deflationary economic stagnation. 

As the cases of Russia and Japan have shown, changes in currency exchange rates can make a real difference on the impact that changes in oil prices have on a national economy, whether they are net oil importers (those shaded in blue in the chart below) or net oil exporters (those shaded in red).

Effect of Exchange Rate Movements on the Decline in Oil Prices in Local Currencies

 

As a region, Asia has benefited from the drop in oil prices.  Almost every country in the region is a net oil importer.  Chief among them is China, whose slightly appreciating yuan against the U.S. dollar, has allowed it to fully benefit from the lower oil prices.  In fact, Beijing has taken advantage of them to less expensively fill its strategic petroleum reserve.[2]  But not far behind have been India and Indonesia.  The currencies of neither country have devalued by more than 6 percent, allowing them to realize almost all of the benefit from the decline in oil prices.  That, in turn, has allowed their central banks to cut their interest rates to spur their economies without having to worry as much about inflation.  Lower oil prices have also enabled Indian Prime Minister Narendra Modi and Indonesian President Joko “Jokowi” Widodo to slash fuel subsidies, which had been draining government coffers in the past, without a public outcry.  That has freed up resources that they can devote to infrastructure and defense, as both national leaders have promised.

However, the fall in oil prices has also pinched some American allies.  One such country is Australia.  Though it is a net importer of oil, Australia has ambitions to become among the world’s leading exporters of liquefied natural gas (LNG).  But LNG prices, which are often linked to those of oil, have followed oil’s prices downward.  That has put into jeopardy Australia’s new round of offshore LNG development.  According to the Australian government, it will likely miss out on about AUS$750 million in petroleum resource rent tax over the next four years—about the cost for one of the new diesel-electric submarines that its navy wants.  The situation would have been even worse had the Australian dollar not devalued by 13 percent against the U.S. dollar.[3]

Finally, some countries, like Venezuela, whose currencies are effectively pegged to the U.S. dollar, have felt the full impact of the decline in oil prices.  Unfortunately for Venezuela, it imports most of its consumer and industrial goods—including food, clothing, machinery, vehicles, etc.—and it holds debts mainly denominated in U.S. dollars.  Thus, any devaluation of the Venezuelan bolívar to temper the impact of lower oil prices would also cause the costs of goods to soar and make its U.S.-dollar debts crushing.  To avoid a financial crisis, Venezuelan President Nicolas Maduro has travelled to China this week.  In the past China has agreed to oil-for-loan agreements, in which China provides immediate financing to Venezuela in exchange for future deliveries of Venezuelan oil.  Already existing deals with China have begun to squeeze out Venezuela’s ability to use its oil to bring Latin American countries into its orbit.  Rather, new deals are more likely to move Venezuela close to China’s orbit.[4]

By the first week of January 2015, the benchmark prices for Brent and West Texas Intermediate crude oil had fallen to $51 and $48 per barrel, respectively.  As long as these conditions persist, oil-exporting countries will suffer and oil-importing ones will benefit.  But to really understand whether these countries are weakening or strengthening to the extent that the decline in oil prices suggest, one would be wise to also consider the trajectories of their national currencies.

[1] “Winners and Losers,” Economist, Oct. 25, 2014.

[2] Abheek Bhattacharya, “China’s Petroleum Reserve Builds Shaky Floor for Oil,” Wall Street Journal, Sep. 3, 2014.

[3] Australia is considering a Japanese submarine design for its next-generation submarine fleet.  The most recently launched Japanese Sōryū-class submarine cost $540 million and AUS$750 million converts to $615 million at today’s exchange rate.  John Hofilena, “Japan launches newest submarine Kokuryu amid party atmosphere,” Japan Daily Press, Nov. 04, 2013, Eric Yep, “Falling Oil Spells Boon for Most of Asia’s Economies,” Wall Street Journal, Jan. 4, 2015; Max Mason, “Oil price plunge sends petrol to four-year lows as Australia feels it at the pumps,” Sydney Morning Herald, Dec. 22, 2014; James Paton, “Plunging Oil Threatens to Spoil Australia’s Next Gas Boon,” Bloomberg News, Nov 27, 2014.

[4] Eyanir Chinea and Brian Ellsworth, “Venezuela’s Maduro to visit China, OPEC nations amid cash crunch,” Reuters, Jan. 5, 2015; Nicole Hong and Kejal Vyas, “Oil Shakes Venezuelan Debt to Its Foundations,” Wall Street Journal, Dec. 22, 2014; “Inside U.S. Oil,” Thomson Reuters, Aug. 22, 2014, pp. 7-8.

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China Details Argument in South China Sea Dispute: China’s Position Paper and Philippine Diplomatic Gains

Yesterday, China’s foreign ministry released a position paper related to its maritime dispute with the Philippines in the South China Sea.  The paper laid out the justification for China’s refusal to take part in the arbitration proceedings that the Philippines initiated at the Permanent Court of Arbitration in January 2013.  It comes a week before the court’s six-month deadline for a response from China.  While China’s refusal to participate should surprise no one, the paper detailed three broad reasons why it chose not to:

  • China claimed that the “subject-matter” that the Philippines submitted for arbitration is beyond the scope of the United Nations Convention on the Law of the Sea and, thus, the jurisdiction of the Permanent Court of Arbitration.  In short, China argued that the court can hardly arbitrate China’s claims, when the extent of China’s territorial sovereignty in the South China Sea has not yet been determined.  (Ironically, in bringing the “subject-matter” to court, the Philippines hoped to compel China into explaining the basis for its claims under the Convention—something that it has been reluctant to do.)
  • China claimed that the Philippines had violated its earlier agreements with Beijing as well as the Conduct of Parties in the South China Sea (the oft-mentioned “code of conduct”), when it unilaterally initiated the arbitration proceedings.  China argued that in those agreements the Philippines pledged itself to resolve the maritime disputes through negotiation, a process that involves consent, which China clearly did not give.
  • China claimed that, in any case, it was not bound by any arbitration related to the Convention.  It reminded observers that in 2006 China filed a declaration with the United Nations in which it exempted itself from compulsory arbitration and other dispute settlement procedures.

South China Sea - China and Philippines Claims

Beijing’s position paper also appeared to lay the groundwork for a rejection of any judgment that the Permanent Court of Arbitration might render.  Certainly, over the course of the last year, China has been entrenching (literally) its position on the Spratly Islands in the South China Sea through land reclamation.  It has been building up a number of islands, including Johnson South Reef, Hughes Reef, Cuateron Reef, and Gaven Reefs.  On Fiery Cross Reef, it has expanded what was once a tiny atoll into one capable of supporting an airstrip and a small harbor.  Even when Manila brought its case to the Permanent Court of Arbitration, it had to know that it was unlikely to change China’s behavior.

So, what did the Philippines achieve?  First, it forced China to further delineate its views on the South China Sea, a feat that years of Southeast Asian prodding had failed to do.  Second, it helped to change the tenor of the maritime dispute in the region.  By forcing China to put its claims into sharper relief, the Philippines helped to show its fellow Southeast Asian claimants just how little room they have to negotiate with China.  Even Malaysia and Indonesia, which had been the most reticent about confronting China, have become firmer in asserting their own claims.  Finally, and most tangibly, the Philippines gained greater cooperation with other ASEAN countries, most notably Vietnam.  In November, Vietnam’s two Gepard-class guided-missile frigates, the newest and largest ships in the Vietnamese navy, visited Manila for the first time.  Though Southeast Asia is still far from taking a unified stand, the visit was a signal that the Philippines may not stand alone.

It is remarkable what the Philippines has achieved diplomatically, given the limited resources at its disposal and the disproportionate power of China.  But diplomacy alone cannot change the facts on the ground.  China knows that.  As an op-ed from China’s Xinhua’s news agency, released alongside Beijing’s position paper, cautioned: “it is advisable that the Philippines return as soon as possible to the right track of negotiation to settle the disputes.”  The “right track” apparently means acceptance of China’s preference for bilateral negotiations.  But the editorial went onto state that China “will not give up an inch of its land.”  That suggests that the best the Philippines (or any of the South China Sea claimants) can hope for is cooperation with China “to manage resources and protect free navigation in the South China Sea.”[1]  That is hardly an enticement to the Philippines to negotiate.

[1] Huang Yinjiazi, “Commentary: Manila’s unilateral move on South China Sea dispute unhelpful,” Xinhua, Dec. 7, 2014.

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Game On: Southeast Asian Cooperation in the South China Sea?

It is easy for a serviceman stationed on one of the tiny islands that comprise the Spratly group in the South China Sea to feel lonely.  But sometime in early June, the Philippines hopes to send 40 of its naval personnel to visit their Vietnamese counterparts on Southwest Cay for a day of beach volleyball, food, and music.  Even so, the history that the two sides share over the island was not so amiable.  South Vietnam slyly seized the island from the Philippines in 1975 and then communist Vietnamese forces replaced those of South Vietnam, after Saigon fell.  An impasse has existed ever since.[1]

South China Sea - Spratly Islands

While intermural events between island garrisons are not new, they have become scarce over the last decade or more.  With Chinese naval and coast guard patrols on the rise, tensions have increased across the South China Sea.  And so if the event on Southwest Cay occurs, it would carry with it some significance as a signal that the Philippines and Vietnam, two of the six countries that contest parts of the South China Sea, may have warmed to the notion of greater cooperation in the region.

In recent years, China has become more assertive, particularly against Philippine claims.  Notably, it blocked Philippine access to Scarborough Shoal in a months-long standoff in 2012.  And, in March 2014, China mounted a quasi-maritime blockade around Second Thomas Shoal (which China calls Ren’ai and the Philippines calls Ayungin), preventing the Philippines from resupplying its small garrison there aboard a grounded landing ship, tank (LST).  Eventually, the Philippines air dropped supplies to its contingent of marines.

Vietnam has also experienced Chinese harassment.  Over the last few years, Chinese patrol boats have repeatedly interfered with Vietnamese exploration vessels operating in the South China Sea, cutting their towed cables from time to time.  As a result, Vietnam has heavily invested in beefing up its navy, spending about $3 billion (equivalent to almost its entire 2011 defense budget) on six new Kilo-class submarines and four new Gephard-class frigates to help defend its waters.

With Manila seemingly serious about its own military buildup for the first time in decades, Vietnam may have begun to see the Philippines as a credible partner in the dispute in the South China Sea.  If nothing else, Vietnam knows that the event would irritate China, which has tried to divide its adversaries in the dispute and deal with them bilaterally.  For the Philippines, which has borne the brunt of Chinese ire over the last half decade alone, the event would be a step in the right direction for its efforts to encourage Southeast Asian cooperation.

Of course, Philippine hopes for cooperation extend further than an island sporting event.  In September 2012, Philippine Secretary of National Defense Voltaire Gazmin revealed plans for “tripartite patrols” across a swath of ocean from the southern Spratly Islands to the Celebes Sea.  The patrols would involve naval forces from Indonesia, Malaysia, and the Philippines.  He hoped that the three countries could expand their existing cooperative agreements in order to better coordinate their maritime patrols and, thus, enhance their collective situational awareness in the region.  (Clearly there is much room for improvement, given that in February 2013 nearly 200 gunmen from the Philippines, under the banner of the Sultanate of Sulu, sailed across the area and occupied a Malaysian town for three weeks.)

In 2012, the Philippines and Vietnam also mooted the possibility of holding joint naval exercises near Southwest Cay.  Later this year, naval officials from the Philippines and Vietnam will visit each other’s capitals to discuss further naval cooperation in the region.  Collaboration around situational awareness is likely to be on the agenda.  For the Philippines, its efforts will be aided by an integrated coastal monitoring radar system that it recently received from the United States.  Since then, it has worked with the U.S. Navy to bring it into full operational use, testing it during their joint Coast Watch South Capability Exercise.

Nonetheless, just how much cooperation can be expected to develop among Southeast Asian countries remains unclear.  They still harbor reservations about one another.  Even the effort to establish “tripartite patrols” was limited—aimed at coordinating naval activities, rather than mounting joint patrols.  Yet, they have all gradually come to see that the stronger China has become, the less willing it has been to negotiate.  Even Malaysia, which has been the most willing to give China the benefit of the doubt, has edged closer to the Philippine view.  As early as 2010, Malaysian officials began to express their concerns.  Then, in March 2013, the Chinese navy held an amphibious exercise in the waters off James Shoal, a Malaysian-claimed island; Kuala Lumpur responded with a rare protest to China.  By late that year, Malaysia announced that it would establish a marine corps and build a new naval base in Sarawak, near the disputed shoal.  But to little avail, China sent another three warships to the island in February 2014.[2]  Meanwhile, the Philippines continues to do what it can do alone.  That has included strengthening its alliance with the United States and bringing its dispute with China to the Permanent Court of Arbitration in The Hague.

For the moment, beach volleyball on Southwest Cay merely means an opportunity for Philippine and Vietnamese personnel posted in the Spratly Islands to take a break from their daily duties.  But it would be better for them if their governments could start looking at each other as something other than rivals in the South China Sea.  Then, perhaps life among the Spratly Islands may truly become a little bit less lonely.



[1] Manuel Mogato and Greg Torode, “Philippine, Vietnamese navies to unite against China over beers and volleyball,” Reuters, Apr. 10, 2014.

[2] Stuart Grudgings, “Insight – China’s assertiveness hardens Malaysian stance in sea dispute,” Reuters, Feb. 26, 2014; Dzirhan Mahadzir, “Malaysia to establish marine corps, naval base close to James Shoal,” Jane’s Defence Weekly, Oct. 16, 2013.

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Where Will It End?: China’s East China Sea Air Defense Identification Zone

More lines were drawn in the East China Sea (or rather in the skies above it).  With very little notice, China declared a sweeping air defense identification zone (ADIZ) over much of the East China Sea as of November 23 at 10:00 a.m. (local time).  Countries typically use such zones to expand their early warning against potential airborne threats.  Aircraft that fly within those zones are required to file flight plans and identify themselves to the appropriate authorities; otherwise those authorities may dispatch combat aircraft to intercept them.  China’s new ADIZ covers an area that contains two disputed maritime territories.  The first consists of islands, called Diaoyu in China and Senkaku in Japan, that are claimed by both Beijing and Tokyo.  The second is a small submerged rock, called Suyan in China and Ieodo in South Korea, which is claimed by both Beijing and Seoul.  South Korea has operated a small research station there for the last decade.  Shortly after China’s new ADIZ went into effect, its air force mounted its first patrol of the area; Japan spotted a Y-8 maritime patrol aircraft and a Tu-154 electronic intelligence aircraft over the East China Sea.

China’s demarcation follows a widely-publicized 18-day Japanese military exercise across southern Japan.  The exercise was one of an annual series that is normally held in November.  In 2011, a similar exercise was held that involved 35,000 Japanese personnel and the U.S. aircraft carrier George Washington.  After tensions were ratcheted up between China and Japan over the disputed Senkaku Islands in September 2012, Tokyo shelved that year’s exercise.  This year’s iteration involved 34,000 military personnel, six ships, and 360 aircraft.  The exercise featured air defense missile battery drills on Okinawa as well as an amphibious landing, supported by a Japanese helicopter carrier, on the uninhabited atoll of Okidaitōjima, about 250 miles southeast of Okinawa.

China’s new ADIZ requires aircraft operating within the zone to register flight plan, radio, transponder, and logo information with its Civil Aviation Administration.  But the Ministry of National Defense is the “administrative organ” responsible for the zone.  Aircraft that violate the rules of the ADIZ could prompt the Chinese air force to adopt “emergency measures.”  Japan maintains a similar zone around its nearby islands.

Certainly China’s action has reverberated across the Asia-Pacific.  As one South Korean official noted, the focus of South Korea’s upcoming talks with China will likely shift from strengthening trust and cooperation to the ADIZ controversy.  Even Australia summoned the Chinese ambassador in Canberra to express its concern.  But those that could ultimately end up facing a similar situation might be the countries of Southeast Asia.  In announcing the ADIZ, the Chinese Ministry of National Defense referred to its authority over “the area enclosed by China’s outer limit of the territorial sea.”  Of course, there is another “territorial sea” that China claims—the South China Sea.  Within that sea, China has many other maritime disputes.  The most recently visible one is between China and the Philippines over Scarborough Shoal, which led Manila to challenge China’s maritime claims before a United Nations tribunal earlier this year.  There are also the long-running disputes between China and Vietnam over the Paracel Islands as well as among China, Brunei, Malaysia, the Philippines, and Vietnam over the Spratly Islands.  But by mentioning the “outer limit of the territorial sea” China also revives a long-dormant dispute between it and Indonesia over the waters along the northern edge of Indonesia’s Natuna Islands, which have offshore natural gas fields.  China’s use of an ADIZ to strengthen its sovereignty claims in the East China Sea suggests that it might try a similar approach in the South China Sea too.  China’s Ministry of National Defense spokesman, Colonel Yang Yujun, failed to dispel such notions when he said that China would establish additional zones “at the right moment after necessary preparations are completed.”

More practically dangerous for the United States is that China’s ADIZ creates a situation in which American reconnaissance aircraft, which regularly patrol the East China Sea, may increasingly encounter Chinese fighter jets.  (Such patrols have long annoyed China.)  To appreciate the danger, one needs only to recall the April 2001 incident when a Chinese J-8 fighter jet collided with a U.S. Navy EP-3 reconnaissance aircraft over the South China Sea.  The EP-3 was forced to land on China’s Hainan Island where it was interned, triggering a two-week long crisis between China and the United States.

Little surprise, then, that China’s demarcation drew an immediate response from the United States.  Secretary of State John Kerry commented that he was “deeply concerned” and that China’s “unilateral action constitutes an attempt to change the status quo in the East China Sea”; Secretary of Defense Chuck Hagel flatly stated that the United States would not recognize China’s control over the zone.  To make that point clear, the United States ordered two B-52 bombers to make an unannounced transit of the East China Sea on November 26.  No doubt, Washington also wanted to set a precedent for American combat aircraft to operate within the zone without notifying Chinese authorities.

Tokyo took an equally stern tone.  Prime Minister Shinzō Abe said that Japan would not recognize the zone.  He even persuaded Japan’s major airlines not to file flight plans with Chinese authorities on routes through the East China Sea.  Both Japan and South Korea flew military aircraft into the zone on November 27.  Soon after, China announced that it sent more aircraft to patrol the area, including a KJ-2000 early-warning aircraft and several J-11 and Su-30 fighters.

Most likely, China is trying to use the ADIZ to not only respond to Japan’s recent military exercise, but also enhance its sovereignty claims to the East China Sea (and the islands within it).  Earlier, it began maritime law enforcement patrols in the area to do the same.  Hopefully, China understands that it is setting the stage for future conflict if it pushes its claims too hard.  Already, China has chipped away at the credibility of its own diplomatic charm offensive in Southeast Asia, which Beijing just launched at the Asia-Pacific Economic Cooperation forum in October.  Even Southeast Asian countries with less-apprehensive views of China, like Indonesia and Malaysia, cannot help but take notice.

China’s establishment of its air defense information zone in the East China Sea raises another question: why take such a step now?  Is it because China feels the need to immediately respond to Japan’s recent military exercise; or because Beijing knows that the world’s attention is focused on the successful international negotiations in Geneva over Iran’s nuclear program rather than its actions in the East China Sea; or because China sees the Obama administration’s commitment to its Asian allies as fundamentally weak (and wants to test it)?  Thankfully, Beijing decided to declare its ADIZ after Japan concluded its military exercise.  At least, there will be a full year before Japan conducts its next set of military drills in the area.

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Diamond (Still) in the Rough: China’s New Charm Offensive in Southeast Asia

In early September, China hosted the 10th China-ASEAN Expo in southern Chinese city of Nanning.  There, Chinese Premier Li Keqiang glowingly characterized the last ten years as a “golden decade” of growing economic ties between China and the countries of Southeast Asia, all of which are members of the Association of Southeast Asian Nations (ASEAN).  He now foresaw that the next decade would be even better—a “diamond decade.”

Together with Chinese President Xi Jinping’s visits to Indonesia and Malaysia and his high-level meetings at the Asia-Pacific Economic Cooperation (APEC) forum that would soon follow, Li’s remarks appeared to mark the start of a new charm offensive in Southeast Asia.  China’s last charm offensive, despite Li’s depiction of a “golden decade,” had sputtered out at the end of that decade, overshadowed by China’s growing economic and political assertiveness on land and at sea.  Although China’s disputes with its maritime neighbors have drawn more attention, China also managed to irritate its neighbors across Indochina.  Its state-owned companies operating in the region have often been high-handed.  Their cavalier attitude towards displacing communities and destroying cultural relics contributed to Myanmar’s decision to halt the construction of the Myitsone dam in 2011—the first time any Southeast Asian country blocked a major Chinese-sponsored infrastructure project.  Meanwhile, China’s unrestrained hydroelectric development on its upstream stretch of the Mekong River has worried many downstream communities in Southeast Asia, even though their governments seldom voice their concerns.

Worse for China’s image is its maritime disputes with Southeast Asia, which were put under an international spotlight in 2010 when several ASEAN countries confronted China about its behavior in the South China Sea at the 17th ASEAN Regional Forum.  Regional concerns over Chinese intentions were further stoked by China’s increased interference of Vietnamese oil exploration ship; its months-long standoff with the Philippines over Scarborough Shoal in the spring of 2012; and its escalatory attitude toward Japan over the Senkaku/Diaoyu Islands since September of that year.  Finally, many believed that Chinese pressure directly contributed to rifts in ASEAN itself, when the 2012 ASEAN foreign ministers’ meeting failed to produce any progress on a multilateral code of conduct for the South China Sea or even issue a closing joint communiqué that mentioned one.  Surely such rising concerns have led the Philippines and Vietnam to accelerate the pace of their military buildups.

However, many Chinese believe they see the hand of the United States in China’s recently contentious relations with Southeast Asia.  They see American policy as either creating the environment that has allowed Southeast Asian countries to resist China’s interests or directly encouraging those countries to resist them.  In either case, they see the flare up of disagreements between China and its ASEAN neighbors as evidence of a larger American effort to contain China’s rise.  Hence, Beijing may believe that initiating a new charm offensive could not only capitalize on Southeast Asia’s continued view of China as a source of economic growth, but also diminish the effect of that American effort.  Whether Beijing’s new tack is momentary or longer lasting is too early to tell.

Yet China has already met with some success, perhaps enhanced as a result of President Barack Obama’s absence from the APEC meetings.  While it was not the first time an American president was absent, Obama’s absence came at a time when many Southeast Asians were looking for reassurance of American commitment.  At the very least, it allowed Xi to become the center of attention.  And Xi brought China’s “diamond decade” message with him.  He pointed out several areas of opportunity: upgrading China’s free-trade agreement with ASEAN, improving communications between China and Southeast Asian countries, strengthening financial cooperation across borders, developing maritime cooperation, and enhancing Chinese cultural exchanges with Southeast Asia.

Even before the APEC meetings, Xi visited Malaysia and Indonesia.  He heralded the advent of “strategic cooperative relationships” with those countries and was the first foreign leader to address the Indonesian parliament.  Then after the APEC meetings, Li arrived in Southeast Asia to continue China’s diplomatic efforts in Brunei, Thailand, and Vietnam.  In Brunei, Li discussed joint energy development.  In Thailand, he championed plans for a high-speed railway project connecting China to Singapore that has lain dormant for many years.  And in Vietnam—a country that has its share of maritime disputes with China—Li and his Vietnamese counterparts announced that the two countries would set up a joint maritime development working committee to ease the tensions in the South China Sea.

For their part, ASEAN countries seem to have responded positively (and possibly opportunistically).  Malaysia—perhaps sensing that the Philippines has, for the moment, halted China’s broader assertiveness in the South China Sea—may now view Chinese overtures as a chance to boost its own economy.  And while Thailand still sees the high-speed railway project as too expensive for it to undertake alone, it has encouraged China to contribute to the financing.

However, the one country in the region that China has not courted is the Philippines.  Instead, China seemed to go out of its way to isolate it.  Indeed, it is a strategy that some Chinese foreign policy scholars have advocated.  As if to underline the point, after China issued invitations to all the heads of state in Southeast Asia to attend the China-ASEAN Expo, it rescinded its invitation to Philippine President Benigno Aquino III.  And so, the Philippines was the only ASEAN country not represented at the event.  And so, even as China seeks to emphasize its kinder, gentler side, its steely side remains.  Relations between China and Southeast Asia may yet improve during the “diamond decade,” but mostly on Chinese terms.

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