Flashpoint South China Sea

S P SETH

In the midst of so many crisis points in the world, the potential of a sudden flare up in the South China Sea is not as seriously recognized, as it should be. This flash point arises from China’s sovereignty claims to a cluster of Islands in the South China Sea and the waters surrounding them, with some regional countries, like the Philippines and Vietnam, contesting these claims. China says that this region has always belonged to it historically and hence it is not subject to any kind of negotiations, international arbitration or the UN Convention on the Law of the Sea. And the islands and much of the South China Sea being China’s sovereign territory and waters, it has the right to build up military bases and structures on these and other artificial islands/reefs it has dredged up.

Beijing particularly objects to US military involvement in the region by strengthening its security ties with other countries that contest and challenge China’s sovereignty claims.  Washington, on the other hand, claims a legitimate role in the region arising from significant economic, political and strategic interests in the region, and is worried about China’s destabilizing and threatening role It, therefore, favours a peaceful negotiated settlement of the disputed issues between concerned countries based on international law to ensure a stable regional environment. It has security treaties with some of the regional states and is developing still closer relations with others. It is against China unilaterally declaring the South China Sea islands and waters around them as its sovereign territory, giving it the authority and power, if it chooses to do so, to restrict freedom of navigation through these waters.  About $5 trillion worth of international trade is carried through South China Sea lanes---not to speak of naval movements through these international waters. And the US is not going to let China restrict passage through theses waters and has sought to assert this right by sending a ship or two through, what China regards as, its sovereign territory. Beijing regards this as provocative.

Lately, there has been an uptake in regional tensions with the strengthening of the US-Philippines security ties, including joint naval and air patrols and stationing of US military assets in the Philippines. During his recent visit to the Philippines, US Defence Secretary, Ashton Carter, reportedly said that the initial US air contingent will “conduct flight operations in the area, including the South China Sea, and lay the foundation for joint air patrols to complement ongoing maritime patrols.” The US will also establish a command-and-control centre in the Philippines to co-ordinate the joint operations.

China hasn’t taken kindly to it. Reacting to it, China’s defence ministry said that,  “A strengthening of the US-Philippine military alliance--- is a manifestation of the Cold War mentality and is not conducive to peace and stability in the South China Sea.” And it added: “ The Chinese army will monitor this trend closely, and will resolutely safeguard China’s territorial sovereignty as well as maritime rights and interests.”

President Obama announced the US’s “pivot” to Asia policy in November 2011 during his Australia visit. In the decade before that the US had been engaged militarily with two ongoing wars in Afghanistan and Iraq and was now seeking to disengage from that region. With the US occupied in the Middle East, China was successfully expanding its political, economic and military space in the Asia Pacific region. It had never made secret of its sovereign claims in the region but, under President Xi Jinping’s regime, a process of assertive control of the South China Sea area by way of building artificial islands and military structures was put in place to test, as if, the limits of US power in the region. And that now is happening seriously, as indicated by the upgrading of the US-Philippines military ties.

The US has other friends and allies in the region. Among them, Australia is one of its most loyal allies going back to WW 11. Therefore, the choice of Canberra to announce the ‘pivot’ to Asia seemed deliberate to assure Australia and other others in the region Washington’s resolve to stay engaged and not leave China to do as it pleased. It was followed up with a further upgrading of US-Australia security ties with the announcement of rotation of US troops through northern Australia and access to other facilities. China reacted strongly to this, and Canberra’s criticism of its South China policy. Beijing claims that the region has historically been part of China. And in any case, Australia is not a disputant and should stay out of it.

Australia, more or less, follows the US position that Beijing’s actions are destabilizing the region and that it is against China’s own interests, because a stable Asia Pacific region in the last few decades has worked to its advantage by fostering its economic growth. Hence, it is in China’s interest to work through these issues peacefully with its regional neighbours within the framework of international law. China finds these arguments, by its proponents, self-serving to perpetuate status quo designed to contain China’s rise. And it apparently wants to break through this ‘containment’ ring.

During his recent high-powered visit to China, with a large delegation of  business people, Australia’s Prime Minister, Malcolm Turnbull, repeated the usual message of the need for peaceful resolution of the sovereignty issue in the South China Sea, while emphasizing the importance of their bilateral economic relationship. China is now Australia’s largest trading partner with a healthy trade balance in Australia’s favour. However, Beijing is unhappy about Australia’s even stronger strategic nexus with the US against the backdrop of tensions in the South China Sea, attributed to China’s muscular policy. But Beijing apparently believes that its increasing economic leverage from Australia’s dependent trade relationship would dent this nexus. Which is also worrying some in the US, as well as Australia’s strategic community invested in the US-Australia security alliance. Canberra, on the other hand, is equally hopeful that it can continue to have the best of both worlds—an expanding trade relationship with China as well as the security umbrella of the US alliance.

In a recent column in the Sydney Morning Herald, its international editor, Peter Hartcher, was pleased with the way Canberra has so far successfully done this balancing act. He, however, acknowledged that, “It is possible that Australia could one day be forced to choose, but only if China and the US break out into open war.” Which doesn’t bear thinking but the way things are going, there is always of a danger of things just getting out of control.

Note: This article was first published in the Daily Times.

Troubled times ahead for China

S P SETH

The state of China’s economy, and its impact on the country’s social and political stability, continues to figure prominently, even more so in the context of the recent National People’s Congress (NPC) meeting. China’s economy has slowed down from its double-digit growth some years ago to just under 7 per cent. There are even suggestions that the real growth might be much lower, probably as low as half of that. At around 7 per cent, though, China’s economy comparatively is doing much better than most other countries. However, there are serious problems emerging and some of it were acknowledged by Prime Minister Li Keqiang in his annual state-of-the-nation report to the NPC. For instance, talking of economy in general, Premier Li said in his report that, “Domestically, problems and risks that have been building up over the years are becoming more evident.” As a result, “Downward pressure on the economy is increasing.” He, however, maintained that, with appropriate adjustments, it would be possible for China to achieve an average annual growth rate of 6.5 per cent in the next 5 years.

And what are these problems? A major problem is that over the years some crucial industries have built up overcapacity that is weighing down on the general economy. For instance, there is now a glut of coal, cement, steel and other industrial commodities. Even as these industries have created high level of pollution, their profits have declined and some are even losing money. These and other industrial enterprises would need to be overhauled/closed, leading to massive loss of jobs. And it is already happening. As Li put it, “We will focus on addressing the overcapacity in the steel, coal and other industries facing difficulties.” Besides: “We will address the issue of ‘zombie enterprises’ proactively yet prudently by using measures such as mergers, reorganizations, debt restructurings and bankruptcy liquidations.” In other words, the economy will undergo a severe shake up and the resultant loss of jobs will not be without social unrest.

The legitimacy of China’s ruling system is largely based on an implied compact between the regime and China’s masses where its people abide by the Communist Party’s monopoly power in return for a progressive improvement in their economic conditions. The government is not unaware of the social problems that might arise from loss of millions of jobs and is setting aside about $15 billion to support laid-off workers. But such economic disruptions are never easy and inevitably cause social unrest. Already, protests are happening in some regions and industries--mining for instance-- over loss of jobs and unpaid wages. The scale and management of such unrest will be an important challenge for the political system. The economic turbulence recently experienced by China’s stock market, affecting millions of small investors earlier encouraged by the government to make good money through this seemingly ever-expanding channel, is another example of the general malaise. At the same time, its exports sector, once an important source of economic growth has slowed down, which has also caused unemployment.

Faced with slow economic growth and its inevitable social consequences, the Chinese government is easing its credit policy, though it is till not sure how far to go with injecting more liquidity. Such ambivalence is the result of a mountain of debt that has piled up following the stimulation of the economy after the 2008-9 global economic crisis. The total debt is said to be 2.5 years of its economic output, and there are questions being asked about its manageability. The views on this are varied. One view is that with its monopoly power, the ruling Communist Party of China (CPC) will not allow things to get out of control in any and all spheres of national life. Which is true but we have seen that its instruments of control didn’t help much when the stock market went berserk. If anything, it tended to aggravate the situation.

It has, of course, large foreign exchange reserves of over $3 trillion. Which might seem huge, but once the draw down begins they might not last long. China has already spent some of these reserves to support its currency from falling too precipitously. Then there is the flight of capital, caused by nervousness about the economy. As one American fund manager is quoted to say in the Sydney Morning Herald, “There are 1.3 billion people in China. If 4 per cent of the population took out their $50,000 limit, the $3.3 trillion in foreign reserves is gone…” At the same time, there are said to be a trillion dollar worth of seriously bad debts on Chinese banks’ books. Developing his argument about serious risk for China’s economy, Kyle Bass, the fund manager at Hayman Capital Hedge Fund, based in Dallas, USA is quoted to say, “The Chinese financial system is overstretched [likely to be further overstretched with more easy money]. China let the banking system grow 1000 per cent in 10 years.” And he adds, “China’s [ratio of] bank deposits to resources is one of the worst in the world.” And this cannot continue without causing economic tremors.

It is not a pretty picture. Its implications are quite bad for both global and domestic economies. China’s growth is now quite enmeshed into global economy. Its stimulation after the 2008-09 global financial crisis helped to mitigate the financial meltdown. In commodity-based economies like Australia, Canada, Brazil and others, it even ushered in a period of great prosperity. And its slowdown and stock market gyrations are causing great economic distress in parts of the world because of falling demand from China for commodities like iron ore, coal, oil and gas. There is a great need for China to stabilize its economy through sensible transition from exports and construction-led phase, which is almost all it has known in the last few decades, to a consumption-led domestic growth. The government knows this but it is not working as well and as fast.

And in the interim period, the restructuring of the economy leading to massive unemployment is creating unrest. And dealing with it through rough and ready and top heavy exercise of power, that has been the feature of the system, will be quite challenging. Indeed, President Xi Jinping is busy further consolidating his power, being christened as the ‘core’ leader in the tradition of Mao Zedong.   Does it mean, by any chance, that China’s ‘supreme’ leader is gearing for uncertain times ahead?

It doesn’t’ however, mean that China’s economy or system is going to crumble. What it means is that the seriousness of its economic problems might set in motion a process over a period of time that might erode the legitimacy and durability of the communist regime and all that underpins it. 

Note: The above article was first published in the Daily Times.

South China Sea: storm clouds gathering

S P SETH

Australia is not a high roller internationally, except by virtue of its delicate position as China’s biggest trading partner and one of the US’ closest allies. Which makes Canberra tread warily between the two in the midst of the storm clouds gathering over South China Sea slands, where China is expanding its territorial control and strategic influence and the US is now seriously seeking to challenge it. The point, though, is that however much Canberra might try to appear even-handed, it simply can’t because its strategic priorities by virtue of its US alliance leave no scope for any ambiguity.

Australia’s white paper on defense, which formulates a large expansion and modernization of all elements of its defence forces, is largely couched against a backdrop of regional tensions from China’s activities in the South China Sea, including building military facilities on a whole swath of reclaimed land from reefs and shoals. In a broad statement, it says that “while it is natural for newly powerful countries [read China] to seek greater influence” but the problem is that some (China) “sought to challenge the rules that govern actions in the global commons of the high seas, cyberspace and space in unhelpful ways, leading to uncertainty and tension.”  As US allies, Australia, along with Japan, would hate to see China dominate and control the Asia-Pacific region. Other regional countries, like Vietnam and the Philippines, contest China’s sovereignty claims over South China Sea Islands. It is, therefore, a highly charged matter and has the potential of becoming a regional powder keg. Compounding it is the disputed sovereignty issue between China and Japan over the Senkaku islands in the East China Sea.

China’s rising economic and military power, and US’s diminishing but still considerable power, is creating a situation where they both are now competing and contending, particularly in the Asia Pacific region. The US’ preoccupation with Middle Eastern wars and turmoil enabled China to expand its political and strategic space in the region, causing nervousness and fear among some of its neighbors as Beijing laid sovereignty claim and control of island chains in South China Sea, which they too claimed and their claims seemed more valid by virtue of their proximity to these islands.  

The regional tensions over South China Sea show no sign of easing. If anything, it is getting worse. China has built military structures on new and old islands. It regards the expanse of waters around them as its exclusive zone for exploring and extracting minerals, and it is feared that it might start to regulate and interfere with the free movement of commercial shipping, and right of passage. And to assert the principle of freedom of navigation through these waters, the US has lately sent a naval ship or two to test China’s intentions. Australia is also being urged to assert its right of “freedom of navigation” and Canberra agrees with it in principle. The US is keen that other regional countries should be part of such ‘right to freedom navigation’. Vice-Admiral Jose Aucoin, Commander of the Japan-based US 7^th Fleet reportedly said in Sydney recently that it would be valuable for other countries, including Australia, to challenge Beijing’s assertiveness than leave it to the US to be “portrayed as the US versus China” issue. He emphasized that, “The scale and the speed of the reclamation of China has been alarming…but… we’re [the US] going to sail, fly, operate in these waters and be prepared for any contingency.” In other words, the US, preferably with its regional friends and allies, is determined to challenge China’s unilateral claims in South China Sea.

China, of course, regards the US as an outside power bent on creating mischief and trouble and would like to edge it out of the region. While neither the US nor China is seeking conflict, they both seem to not only hold their ground but also to press ahead to assert their respective position. Beijing simply wants the US and other regional countries to accept its claim and assertion of sovereignty as a historical fact, a kind of Monroe Doctrine that the US proclaimed in 1823 declaring domination of the American continent. China, it appears, hopes to establish domination of the Asia Pacific region with its growing power.  

Even as Beijing is laying down its regional strategic architecture, it has contended that its installations on newly reclaimed lands are for humanitarian reasons, for search and rescue and so on. But the latest satellite imagery showed that China has deployed surface-to-air missiles on Woody Island, part of the Paracel chain claimed also by Vietnam. This is said to be in clear breach of President Xi Jinping’s commitment/assurance that China wouldn’t militarize the island chains. And the US Secretary of State, John Kerry, was quick to point out that he would make “very serious” representations with Beijing over the deployment. He reportedly said, “When President Xi was here [on a US visit], he stood in the Rose Garden with President Obama and said that China will not militarize in the South China Sea.” Kerry went on, “But there is every evidence, every day, that there has been an increase of militarization of one kind or another. It’s of serious concern.”

There are now reports of stationing of radar systems and fighter aircraft and all sorts of military facilities on the islands. China is reported to have reclaimed more than 1200 hectares of artificial land on reefs and shoals in the area. This has led Admiral Harry Harris, head of the US Pacific Command, to say that China is “clearly militarizing” the disputed waters of the South China Sea, and he quipped, seriously though, that, “You’d have to believe in a flat Earth to think otherwise.” Pointing to the dangers ahead, he said that, “Regrettably there are missiles and fighter aircraft and guns and other things that have been placed into the South China Sea and this [is] of great concern to everyone who transits and relies on the South China Sea for peaceful trade.” In other words, China’s activities in the South China Sea are a threat to global trade.

But China is steadfast. A Chinese foreign ministry spokeswoman has said that, “China’s deployment of limited, necessary defence facilities on its own territory [islands in the South China Sea] is its exercise of its right of self-defence to which a sovereign state is entitled under international law.” The problem, though, is that it is contested sovereignty. But such semantics are lost in international power play. And China feels pretty confident that it will have its way. When asked at a press conference if Australia and Japan, together with the US, were intent on containing China, its Foreign Minister Wang Yi said with a straight face, “… I also don’t think that any country or power in the world can stop that rise.”

Note: This article was first published in the Daily Times.

China’s economic travails

S P SETH

Even as President Xi Jinping strengthens his political grip by way of further asserting the monopoly control of the Communist Party of China (CPC), the country’s economy is refusing to exactly follow the political dictates. The middle of last year saw turbulence in China’s stock market raising questions about the health of the economy. The arbitrary measures taken to dampen down such turbulence by directing institutional (state owned/controlled) investors to buy or not to buy stocks might have worked for a while but they failed to address the real problem. Which is that Chinese stocks are over valued with inbuilt bubbles waiting to bust as soon as there is an opportunity. And the opportunity arrived early in January when the economic data about weakness in the manufacturing sector was revealed. At about the same time, Chinese authorities depreciated their currency to give them an advantage in export sector. Whether or not that will translate into more exports is an open question because this can lead to competitive devaluation of competing economies. However, this tends to frighten investors leading to the flight of capital from China. Subsequently, though, the Chinese authorities sought to support the currency by buying it.  All in all, this tends to raise doubts about the health of the Chinese economy, which has not been performing as well as in the past when averaging a growth rate of over 10 per cent. At present, its growth rate is around 7 per cent, and there are fears that it might continue to fall. China’s economy is still growing well by comparative standards but there are serious problems and bottlenecks that, unless resolved, could create social and economic issues at home.

After the 2008 global recession, China’s economy continued to perform well with an expansive economic stimulus programme. This was not only good for China at the time but was also good for the world, particularly the resource rich countries like Australia, Canada, Brazil and South Africa. Under its stimulus programme, money poured into infrastructure projects, real estate, steel plants, high speed railways and so on. At the same time, the feel good effect of all the investment activity and construction pushed up the value of Chinese stocks, with the government even encouraging small mom and dad investors to invest in the market. Though many people felt rich and invested not only their savings but even borrowed money to play the market, the hype about the stock market was too good to be true.

And in the middle of the last year, the market tumbled with the authorities trying to create stability through diktat forcing large institutional investors to buy more stocks to create a semblance of normalcy. At the same time, the authorities tended to suspend trading when there was too much downward pressure. And when the stock market turbulence kicked again this month the authorities tried the same old method of imposing order but it didn’t seem to work. It was clear that what worked in the political domain, which is ruling by diktat, was not working in dealing with market fluctuations.

And there are good reasons for it. First, there is a large overhang of debt that funded the stimulus programme at local, regional and federal levels. All levels of governance vied with each other to spend borrowed money to grow the economy, as it was the guiding principle of all agencies. There was an unstated compact between the party/government that as long as economy was growing with people benefitting from it, people didn’t care much about the exercise of monopoly power by the CPC. In the process, corruption became rampant with, among other things, the arbitrary acquisition of land as long as it led to building of more apartments. Which led to a glut in the real estate market with rows of expensive unoccupied apartments. In the same way, over capacity built up in manufacturing sector, like the steel industry, with inadequate demand for construction material.

The upshot of it all was that much of the new infrastructure, real estate construction and the like, didn’t generate enough income to pay off the debts that kept piling up. At the same time, with very little real information available to the public about the state of the economy, especially the mountain of debt, the stock market continued to operate as if there was no tomorrow to settle the accounts. And that tomorrow appears to be happening sooner than expected. The overhang of debt has to be sorted out and it can no longer be wished away.

This economic necessity of fixing the economy and, at the same time, ensuring a healthy rate of growth to maintain the social compact with the people, has created a complex situation. China is at a transition period when exports that had been the vehicle of its rapid economic growth have slowed down, and to maintain a healthy growth rate of the past or close to it will need a growing internal market based on domestic consumer demand and growth in services’ sectors. Both have still to catch up and would need a radical reorientation of the Chinese economy. And with the overhang of the debt and people used to saving (and not spending as much), this is going to be a difficult task, particularly as markets do not respond well to political dictates.

As for the debt overhang, much of it is internal debt and hence not subject as much to external compulsions as foreign debt would be. But it would need to be sorted out sooner, rather than later. Otherwise, as has happened in Japan burdened with heavy internal debt, the country is in a deflationary spiral for more than 20 years after its stock market crashed. If that were to happen to China, this might rupture the social compact between the CPC and the Chinese people ensuring them a constant improvement of their economic life while they tolerate monopoly rule of the ruling communist regime.

A slowing Chinese economy is not only bad for China; it has been causing serious economic ripples in global markets.  For instance, the international resources and commodity markets have nosedived, as demand from China has shrunk to levels not seen for a long time. And, as things stand, there is not much prospect for any improvement as the global over supply from investments in these sectors, planned/undertaken when demand for these commodities/resources was high, keeps piling up.

Note: This article was first published in the Daily Times.