Deep hole

While some believe that direct investment links are the best way to mitigate political conflicts between countries, the case of China and Australia appears to illustrate the opposite. At present, diplomatic relations between the two are dismal, and direct investment is largely to blame.

The fracas began over a failed bid by Aluminum Corp of China (Chinalco) to up its stake in Anglo-Australian mining giant Rio Tinto to 18%. Still smarting from the Rio rejection, Beijing was further angered by its failure to renegotiate price contracts for iron ore with Rio and other suppliers, which left the world’s largest customer for the commodity paying nearly twice as much as Japan and South Korea.

Disappointment brought forth less polite forms of negotiation.

First, Beijing announced that it would investigate Rio Tinto’s joint venture with BHP Billiton under its anti-monopoly law. Then Stern Hu, Rio’s top iron-ore price negotiator, and three of his associates were detained for alleged industrial espionage, bribery, and stealing state secrets (although the latter never appeared on the charge sheet). Jiang Ruiqin, ex-director of a state secrets bureau in Jiangsu, accused Rio of ripping off Chinese steel mills to the tune of US$100 billion. He was quoted in state media saying China is engaged in a new era of "commercial espionage warfare."

Stuck in a rut

Tensions rose even higher following Chinese cyber-attacks against the Melbourne International Film Festival for screening a biography of Rebiya Kadeer, head of the World Uighur Congress. Negotiations over a proposed Sino-Australian free trade agreement, perhaps unsurprisingly, appear to have stalled.

However, Sam Farrands, a partner at law firm Minter Ellison who has worked with Chinese firms on acquisitions, believes the scope of the crisis is overhyped.

"This is newspapers selling newspapers," he said. "Most Australians have no problem with the state-owned enterprises (SOEs) investing in upstream energy and resources in Australia. The Japanese did it, the Koreans did it; this kind of investment is far from new … If you are looking for precedent, you’d have to say the pattern is in favor of Chinese investment, not against it."

Indeed, the Sino-Australian investment relationship is 22 years old, and for the most part has been uneventful. Iron ore trade between the two nations stands at US$14 billion per year, and investment proceeds apace. In the first quarter of 2009, Chinese firms accounted for 70% of the total value of Australia’s M&A activity, doing deals collectively worth US$17.5 billion. 

Chinese industry needs the coal, bauxite and other minerals that Australia has in abundance. Australian firms need cash, which China has in abundance. The relationship should be win-win. What happened?

Finger pointing

Assignment of blame varies on the Australian side. Colin Barnett, premier of Western Australia, believes that Canberra has unnecessarily antagonized Beijing. "China is more important to Australia than Australia is to China," he told the media. Other politicians argue that China does not allow Australian firms to invest in its domestic mining assets, so why should Australia?

One of the most contentious issues is the nature of Australia’s Foreign Investment Review Board (FIRB), which assesses inbound deals. An official from the Chinese embassy in Australia who works directly with the FIRB said that the institution needs to become more transparent and do deeper research on Chinese companies that seek to invest. Meanwhile, a report by the Organization for Economic Cooperation and Development (OECD) found that Australia is the sixth-most restrictive nation when it comes to regulating FDI. The FIRB, claims the report, is opaque and subject to political manipulation, specifically through its mandate to protect the "national interest." This interest is not defined, leaving the FIRB wide interpretive leeway.

However, Mark Thirlwell, program director of international economy at the Lowy Institute for International Policy, an Australian think-tank, argued in a paper that the vagueness of the "national interest" term is not resolvable. "In a rapidly changing international investment environment, trying to … codify the national interest would difficult to achieve and potentially counterproductive."

Regardless, there is plenty of ammunition for Australians who believe that Chinese investment in the country is intended to serve Chinese national interests at their expense. For one thing, while the application process was slowed by the state-owned nature of Chinalco, it was ultimately rejected by Rio Tinto, not the FIRB. The Chinese response relied on brute-force policy leverage, not business negotiation, thereby reinforcing the impression that the country’s outbound investment projects are part of a wider, hidden geopolitical strategy.

The reaction in the Chinese media and blogosphere has been similarly inclined to paint with a geopolitical brush. Commentators have largely failed to discriminate between the commercial interests of Chinalco, the political interests of the government, and the welfare of the Chinese people – or consider that the attitudes of foreign businesses, governments and populations might be separable.

Guo Chunmei of the China Institute of Contemporary International Relations, writing in China Daily, claimed the Melbourne International Film Festival acted as agent provocateur of the Australian government. "If the Australian focus on Chinalco in February was downplayed in China and the spying by Rio Tinto Shanghai representative Stern Hu treated as an individual case, Australia’s over-use of Rebiya Kadeer to say something else apparently lifted the disputes to the diplomatic field," he wrote. "Such escalation echoed the unfriendly noises of anti-China forces inside Australia."

Despite all this, there are still Australians who prefer to deal with the Chinese. Western Australian officials, for example, aren’t convinced that the Rio-BHP joint venture is an improvement on the Chinalco deal  as it concentrates the buying power of the two industry giants.

"If you look at Western Australia as a seller, would you rather have one buyer or two?" said BJ Zhuang of the Western Australian Trade Office of China. 

Ultimately, China and Australia have to work together. But the core issues that led to the current mess have not been resolved, namely the state-led nature of outbound investment. SOEs have access to the best resources, human capital and credit, and they are able to grease the skids of the domestic approval process. When they go outward, however, they are automatically considered agents of the Chinese state – unfairly, in some cases.

At the same time, in many cases the SOEs’ loose budget constraints and politicized management cultures make them less, not more, competitive abroad. Whether deals are rejected on security grounds or simply fail to profit, the effect damages political relations.

A learning process

Farrands of Minter Ellison believes that Chinese SOEs, at least, are learning quickly. "I think they are much more cognizant that they are operating in a different environment, and are adjusting accordingly," he said.

After all, the Chinalco bid was only one of more than 30 Chinese acquisitions this year, most of which made little noise. Farrands points to China Non-Ferrous Metals as an example of a Chinese firm that has slipped under the radar by investing in assets directly through joint venture structures, instead of attempting to buy controlling stakes in Australian firms, thus circumventing the FIRB.

"They’ve been very successful," he said. "They haven’t gotten as much as they ideally would like, but at least they’ve got an interest in the asset that they want and are achieving their commercial objectives."

Even Chinalco is back on the lookout for deals in Australia, according to a recent announcement by the company’s chairman, Xiong Weiping. Sinosteel, China’s largest iron ore trader, has also been active. Company representatives met with Barnett in Western Australia and were encouraged to participate in a planned US$3.3 billion port and rail project.

Henry Wang, senior investment commissioner for Austrade, a government entity that facilitates foreign investment in Australia, believes that the long-term effect of the iron ore brawl will be minimal. "Chinese interest in investing in Australia is not slowing down," he said.

However, given the nature of that interest, there is no reason to believe this sort of conflict could not happen again.