Wednesday 21 Feb 2018 | 00:58 | SYDNEY
Wednesday 21 Feb 2018 | 00:58 | SYDNEY


Key Findings

  • Foreign policy will not be a priority of China's new leaders.
  • Regional stability is at risk if China's new leaders merely react as events unfold, as has too often been the case in recent years.
  • Xi Jinping will strive toward constructive relations with the United States.

。China’s foreign policy dilemma*


The international community assumes that China is on the rise. Stunning economic growth and rapid military modernisation reflect the ascent of this huge and populous nation to world-power status.

Chinese, on the other hand, regardless of whether they are policymakers, businessmen or intellectuals, are deeply worried about the future of their country. They question China’s ability to continue to rise because of daunting domestic problems, many of which can only be tackled by bold reform of the one-party state. The leaders of the Communist Party of China (CPC) are aware that far-reaching legal reform and major structural changes in the financial sector are prerequisites for continued economic growth. The establishment of the rule of law would also curb corruption and social injustice, causes of widespread public dissatisfaction. While there is general consensus among Chinese officials that reform is necessary, there are significant disagreements on the specifics of reform. Powerful interest groups, upon which the Party relies for political support, do not want to see their privileges eroded.

This gulf between the outside world’s perceptions of China as a rising power and the preoccupation of Chinese leaders with internal problems complicates attempts to understand China’s foreign policy. On the one hand, China’s rise causes jitters in the international community, especially since China in recent years has become more assertive internationally. No one knows with certainty how a rising China will use its power. In private, many Chinese policymakers and analysts concede that they do not know either, despite China’s assurances in public that its rise will be peaceful.[1] On the other hand, China’s international role is not the foremost concern of the country’s leaders. Time and again over the course of 2012, in discussions with officials working on foreign policy, China’s serious domestic challenges were the main topic of conversation.[2] These officials highlighted the amount of effort that China’s top leader, Xi Jinping, will need to devote to tackling domestic problems. Only about one-tenth of the lengthy work report of the 18th CPC Party Congress, a policy guidance document for the next five years, dealt with external issues.

Due to these domestic pressures, China’s foreign policy will continue to be reactive. Foreign policy, while important, will not be a top priority of Xi Jinping or any of the other six members of the Politburo Standing Committee (PSC), the ultimate decision-making body of the Communist Party. No one on the PSC is specifically in charge of foreign policy. In addition, like all decisions in the PSC, key foreign policy positions are determined on the basis of a consensus-building process. As a result, both official foreign policy actors and those on the margins of the policy establishment can try to influence the process by lobbying any given PSC member.[3] As chair of the PSC, Xi Jinping has the last word when pressing foreign and security policy decisions need to be made, but he has multiple responsibilities.

In China, rank and influence are determined according to one’s position in the Communist Party. For the past five years State Counsellor Dai Bingguo, who has been in charge of the day-to-day management of China’s diplomacy, and Foreign Minister Yang Jiechi have been mere members of the 204-member Central Committee, the third-level power structure of the Party, under the PSC and Politburo. Hence, all of the Politburo’s 25 members outranked both Dai and Yang.[4] Dai is retiring and is expected to again be replaced by a Central Committee member, another reflection of the relatively low importance of foreign policy on the leadership’s agenda. Whoever succeeds Dai and Yang in the government realignment in March 2013 will continue to serve as key managers of China’s diplomacy, not its crafters.

This Analysis assesses China’s most imminent foreign policy challenges against the background of a pressing domestic agenda. It begins with an overview of China’s foreign policy objectives. The next section discusses the major foreign policy issues facing China’s new leaders: relations with the United States, Japan, Southeast Asia, and North Korea. The paper concludes by discussing the factors that will shape China’s foreign policy in the next few years.


China’s foreign policy objectives


Officially, China defines its foreign policy objectives as follows: first, domestic political stability; second, sovereign security, territorial integrity and national unification; and third, China’s sustainable economic and social development.[5] It is noteworthy that the primary objective is domestic stability – which means ensuring that the Communist Party stays in power and the socialist system remains intact.[6] At the same time, China’s leaders acknowledge that a stable external environment is conducive to achieving these three main goals.

An underlying, although unstated, objective is that China seeks respect as a major power and wishes to be seen as a responsible member of the international community. Ever since the founding of the People’s Republic of China in 1949, the Communist Party has emphasised the need for China to regain respect and dignity as a great nation after being humiliated by foreign invaders for over a century. Today, after three decades of rapid economic growth, Chinese officials feel that China no longer needs to acquiesce to outsiders’ demands, something that they feel China has been compelled to do in the past for the sake of the country’s modernisation. At the same time, they crave recognition for China’s increasing contributions to global stability and prosperity. China has a dual identity, in the words of scholar Jing Men: a strange combination of self-superiority and self-inferiority.[7] This dichotomy is evident in Chinese foreign policy thinking despite the country’s increased power and standing in the international arena.

Xi’s first public activity after becoming China’s top leader was to tour an exhibition entitled ‘The Road to Revival’ at the National Museum in Beijing. During the visit Xi spoke about the renewal of the Chinese nation and the ‘China Dream’, usually a reference to the need for domestic reform to ensure that China continues to modernise. Xi’s remarks were, however, seen by some observers as a signal that he wants to be viewed as a leader who will support China taking assertive measures internationally.[8] Others point to a remark Xi made in 2009 while visiting Mexico City as proof of a supposedly nationalist streak. In a taped broadcast on Hong Kong television, Xi said: ‘There are a few foreigners, with full bellies, who have nothing better to do than try to point fingers at our country. China does not export revolution, hunger, poverty nor does China cause you any headaches. Just what else do you want?’[9]

Regardless of how these events are interpreted, Xi must consider the strong nationalist sentiments amongst Chinese elites and establish his credentials as a Communist Party leader who will defend China’s national interests. He cannot risk being perceived as a leader who allows China to be humiliated by foreigners, in particular by Japan or by Western countries.

The 18th Party Congress work report, the single most important public document outlining the Party’s strategy over the next five years, also hints at a more assertive Chinese foreign policy. It pledges to ‘never yield to outside pressure’, a phrase which was not in the 2007 work report. Another new addition was the promise to ‘protect China’s legitimate rights and interests overseas’ when working to promote public diplomacy.[10]


China’s key foreign policy challenges


China’s new leaders face pressing foreign policy challenges. They must maintain a constructive relationship with the United States, find a way to defuse tensions over sovereignty disputes with Japan and Southeast Asian nations, and manage ties with North Korea.

Relations with the United States

Xi Jinping can be expected to strive toward constructive ties with Washington. The two countries are highly interdependent. A deterioration in China’s most important bilateral relationship would seriously undermine the imperative of ensuring economic growth and initiating major structural reform. Nevertheless, in the China-US relationship the tension between China’s focus on domestic reform and its desire to be respected internationally is especially acute. Therefore, maintaining cooperative relations with Washington will continue to be a major challenge for China’s leaders.

When visiting Washington as vice-president in early 2012 Xi Jinping spoke about the need for both countries to respect each other’s ‘core interests’. Chinese officials have in recent years stressed this point, suggesting there are certain ‘lines’ that cannot be crossed in relations with China. In 2009 Hu Jintao broadly defined China’s core interests as safeguarding ‘sovereignty, security, and development’. But these core interests are sometimes in tension with each other, and the definition of what constitutes core interests is constantly debated among Chinese analysts. These debates in turn give rise to speculation among foreign observers that, as its power grows, China is contemplating an expansion of its ‘core interests’. Wang Jisi, an authoritative Chinese foreign policy specialist, dismisses this. He notes that apart from the issue of Taiwan, ‘the Chinese government has never officially identified any single foreign policy issue as one of the country’s core interests.’[11]

In China, Barack Obama’s speech to the Australian Parliament in 2011 has been interpreted as being aimed unequivocally at China.[12]  From Beijing’s perspective, Washington’s ‘rebalancing’ to Asia is overwhelmingly seen as an effort by the United States to slow down China’s rise to limit its rightful role as a major regional power. After Obama’s speech it has become difficult for even the most moderate Chinese analysts to claim that US intentions toward China are benign.[16]


How international are China's new leaders?

It is remarkable, but at the same time troubling, that so little is known about the international outlook of the leaders in the world's second largest economy. Contrary to leaders-in-waiting in Western countries, Xi Jinping did not publicly expound on his vision of China’s international role before becoming the top leader.  Despite the dramatic changes which the Communist Party has overseen in China during the past 30 years, the personal views of senior leaders remain as opaque as the decision-making processes in China.

The current Politburo Standing Committee has more international experience than the previous PSC had at the time of its appointment. Nonetheless, its members do not have the same kind of first-hand knowledge of the outside world as millions of Chinese who have studied and worked abroad over the past three decades. Only one member of the current PSC has studied abroad – Zhang Dejiang attended university in Pyongyang.

What we know about Xi Jinping's international outlook is what the Chinese authorities want us to know. Any assessment is based on official Chinese media sources, other open analysis, a handful of his own public statements, private discussions with Chinese officials who have had dealings with Xi, and the 18th Party Congress work report that Xi had a role in crafting.[13]

Xi's official biography does not mention command of a foreign language. He was an adolescent during the Cultural Revolution when China was closed to the outside world.

Nevertheless, over the past five years Xi has travelled extensively. He is also regarded as being somewhat familiar with life in the West because his daughter studies at Harvard University and his sister has lived in Canada.

Like Xi, Li Keqiang, second in CPC hierarchy and China's future premier, has made dozens of overseas visits in preparation for his senior position. Li gives speeches in English. He is expected to be principally responsible for the economy and the key senior leader in charge of relations with the European Union, China's largest trading partner.

Wang Qishan is the current PSC's foreign affairs heavyweight, having served as China's delegation leader at the US-China Strategic and Economic Dialogue since 2009. Though Wang has been tasked with heading the new leadership's anti-corruption drive, his long experience in the financial sector means he will weigh in on economic decisions and financial reform, alongside Li; he will also serve as Xi's right-hand man on China-US relations. Several US officials, among them former treasury secretaries Hank Paulson and Timothy Geithner, speak highly of Wang. Paulson has said Wang, an 'avid historian' with a 'wicked sense of humour', 'understands the U.S. and knows that each of our two countries benefits from the other's economic success'.[14] Geithner has called Wang China’s 'pre-eminent problem solver.'[15]


Obama’s Canberra speech drew particular ire in Beijing because it was seen as advocating regime change in China. Obama’s exact words were: ‘Other models have been tried and they have failed – fascism and communism, rule by one man and rule by committee. And they failed for the same simple reason: They ignore the ultimate source of power and legitimacy – the will of the people.’[17] The paramount goal of the CPC leadership is regime survival. Obama even took a swipe at China’s spectacular economic progress by stating that ‘prosperity without freedom is just another form of poverty’.[18]

The closest that the Chinese government has come to responding to Washington’s rebalancing strategy is to state the need for a ‘new type of major power relationship’. Xi Jinping mentioned this concept when visiting Washington in 2012 and it is included as a goal in the Party Congress work report.[19] It recognises that China, as the rising power, and the United States, as the dominant power, have conflicting views of security. It acknowledges that there is a need to avoid the kind of havoc that has historically accompanied global power transitions. To date, the concept has mostly been used by Chinese analysts to advocate changes in US behaviour toward China rather than to suggest that both sides must adjust their stances toward each other.

Outside of the Chinese government, a wide spectrum of opinion exists as to how China should respond to US rebalancing. A common thread among Chinese foreign policy experts is the belief that ‘time is on China’s side’. Chu Shulong of Tsinghua University writes: ‘China should not ... utilise any pointed strategy to counter the US and Japan’s ...unconstructive regional strategy. This is not because China is fearful, but because the US and Japan ... can no longer do as they please.’[20] A second theme is that China needs a stronger strategic focus on Asia. Cui Liru, who heads one of China’s most influential security policy think tanks, believes China should place the Asia-Pacific at the heart of a ‘diplomacy-first’ strategy.[21]

There are numerous issues on which Beijing and Washington do not see eye to eye, ranging from China’s trade practices and human rights abuses to how to deal with Iran, North Korea and Syria. One of the most sensitive and contentious issues is US intelligence gathering in China’s exclusive economic zone (EEZ). According to Bonnie Glaser, a leading American specialist on South China Sea disputes, the most likely and dangerous contingency involving the United States in the South China Sea is a clash stemming from US military operations within China’s EEZ that provokes an armed Chinese response.[22] In Washington’s view, the United Nations Convention on the Law of the Sea (UNCLOS) does not prevent military forces of any country from conducting military activities in EEZs without the coastal state’s notice or consent. In Beijing’s view, reconnaissance activities undertaken without prior notification and without permission of the coastal state violate Chinese domestic law and international law. Operations by China’s growing fleet of submarines as well as routine interceptions of US reconnaissance flights increase the risk of an incident.

Despite the pessimism expressed by both Chinese and American analysts about deepening China-US strategic mistrust, there are signs of growing maturity in the relationship.[23] One example was the manner in which two potentially destabilising crises in 2012 were defused by Chinese and American diplomats. Even five years ago these two crises – an asylum request by Bo Xilai’s police chief on the eve of Xi’s Washington visit and the flight of blind activist Chen Guangcheng to the US Embassy in Beijing just before the US-China Strategic and Economic Dialogue – might have derailed relations. This time they did not. It reflects growing recognition by senior officials in both countries that they must find the means to get along.

Relations with Japan

Xi Jinping’s immediate foreign policy test will be his ability to ease tensions with Japan over disputed islands in the East China Sea, called Senkaku in Japanese and Diaoyu in Chinese (see map on last page). The situation is explosive. In the event that a collision – either accidental or intentional – between Japanese and Chinese vessels or aircraft leads to a loss of life, an armed conflict could erupt between the two countries. Emotionally charged nationalist sentiment among Chinese and Japanese citizens and officials makes it extremely difficult for senior leaders of either country to put forward a proposal which would stabilise the fraught situation.

Genuine acrimony lingers between the two nations despite over 40 years of comprehensive economic and societal ties. Strong anti-Japanese sentiment amongst Chinese people stems in part from the perception that Japan has never fully atoned for World War II atrocities and in part from the Communist Party’s continuous emphasis on the victimisation of Chinese at the hands of the Japanese prior to 1949. Japanese people, in turn, are apprehensive about China’s growing power and assertiveness. Over the past decade, ties between China and Japan have deteriorated on several occasions, often as a result of inflammatory statements and visits to the controversial Yasukuni war shrine by right-wing Japanese politicians.

In recent years, incidents around the Senkaku/Diaoyu islands have become the main source of tension between the two countries.[24] The governments in Beijing, Taipei and Tokyo all claim sovereignty over what are basically large uninhabited rock islets, which were annexed by Japan in 1895. The United States occupied them in 1945 and handed over the administrative rights of the islands to Japan in 1972 although they were privately owned.[25] There are potentially large oil and gas deposits in the seabed near the islands.[26]

The current stand-off over the Senkaku/Diaoyu islands came to a head in September 2012 when Japan’s central government purchased three of the five disputed islands from a Japanese family who had owned them for decades. According to Japanese officials, the government’s decision was made to deter Tokyo’s right-wing governor Shintaro Ishihara from fulfilling his publicly announced plan to purchase the islands. Ishihara is notorious for his nationalist outbursts. He refers to the People’s Republic of China as ‘Shina’, a derogatory term associated with Japan’s 1937-1945 occupation of parts of China. Ishihara has also said that the Rape of Nanking, in which the Imperial Japanese Army killed more than 200,000 Chinese civilians, ‘is a story made up by the Chinese.’[27]

From Beijing’s perspective, the change in ownership of the disputed islands signalled an unacceptable change in the status quo. Some observers, writing in Chinese-language overseas publications, claimed that the timing of the Japanese government’s purchase was intentionally chosen to coincide with the politically sensitive period ahead of the CPC leadership change at the Party Congress.[28] Whether intentional or not, the Japanese government could not have purchased the islands at a more volatile time. Even some Japanese diplomats privately criticised the timing of the decision by former Prime Minister Noda, who later acknowledged that he had underestimated the Beijing government’s reaction to the purchase.[29]

Beijing condemned the purchase as a gross violation of China’s sovereignty. Subsequently, the Chinese authorities gave their blessing to an outpouring of anti-Japanese sentiment in massive demonstrations across China. This led to attacks on Japanese companies and citizens. Furthermore, vessels under the command of China’s maritime law enforcement agencies started to regularly patrol the area around the Senkaku/Diaoyu islands, crossing into the 12-nautical-mile territorial zone around the islands, with the intention of ‘protecting’ China’s sovereignty.[30]  In December 2012 a Chinese civilian surveillance plane conducted an aerial patrol of the islands for the first time, entering what Japan regards as its air space. Japan responded by sending F-15 fighter jets to intercept the Chinese aircraft.[31] The risk of an incident further increased in early 2013 after China also began scrambling air force fighter jets in response to flights over the islands by Japanese aircraft..[32]

Prior to the change in ownership of the islands, China’s law enforcement agency vessels had already been involved in numerous incidents in disputed waters in the East and South China Seas. Initially, a plausible explanation for the increasing assertiveness of Chinese civilian agency vessels was an overzealous pursuit of their mandate to defend China’s sovereignty in disputed waters combined with a lack of attention to these activities by the senior Chinese leadership. However, this is no longer necessarily the case. In mid-2012 Xi Jinping was reportedly put in charge of a new senior leaders group tasked to focus on maritime security. In September 2012, soon after the Japanese government’s purchase of the disputed islands, Xi was also made head of a new ‘Office to Respond to the Diaoyu Crisis’.[33] Therefore, one can assume that Xi Jinping has been consulted about the patrols.

In January 2013 a Chinese official involved in the standoff with Japan said in private conversation that ‘it would be inaccurate to say that Xi Jinping is not aware of the dangers related to the Diaoyu issue, but at times he is intentionally given exaggerated assessments by those who want him to take a tough stance.’[34] The official added, ‘the maritime enforcement agencies are still left to independently enforce senior-level directives, and once these agencies have acted, it is very difficult for a senior leader to criticise actions, which were taken in the spirit of defending China’s national interests.’

Xi Jinping has every reason to avoid a further deterioration of China-Japan ties. Those who claim that Xi might want to create a national crisis involving Japan to divert public attention away from domestic problems ignore the importance of Japan to China’s continued economic growth. Xi’s foremost concern is stability, achieved by ensuring a robust economy. Trade between China and Japan was worth US$329 billion in 2012. Japanese companies employ millions of Chinese.[35]

China’s economy has already been hurt by recent anti-Japanese sentiment in China. As Hu Shuli, an influential business editor, pointed out when she advocated a cooling of emotions during the 2012 anti-Japanese protests in China: ‘A boycott of Japanese products would not only result in a block on the useful transfer of technology that comes with the import of [Japanese]... products, it would cause massive job losses. This would be disastrous in a shaky Chinese economy.’[36] Japanese direct investment in October 2012 decreased 32.4 per cent from 2011 levels. The United States has, at least for the time being, displaced China as Japan’s largest export market.[37] A military conflict would have even graver economic consequences for both sides.

An escalation of tensions between China and Japan would also cause serious problems in China-US ties, which Xi does not desire. While American officials have publicly said that the United States does not take sides on the dispute regarding sovereignty of the islands, they have also confirmed that the Japan-US defence treaty covers the Senkaku Islands.[38] An armed attack on Japan would invoke the defence treaty, thereby obligating the United States to assist Japan in defending the islands.

It is worth noting that according to a senior Japanese military official a collision between maritime law enforcement vessels or aircraft would not constitute an ‘attack on Japan’ by the terms of the treaty. Only a deliberate act by units of the People’s Liberation Army (PLA) may qualify as such an attack.[39]

Although media reports often fail to recognise the difference, patrols of disputed waters are almost always undertaken by vessels of China’s civilian law enforcement agencies, not the PLA Navy. While the PLA has consistently supported China defending its territorial claims, it is likely to have been consulted on the decision to use civilian agencies in disputed waters as a way to decrease the risk of military escalation. There are tight linkages between the PLA and the civilian maritime agencies, whose personnel the PLA trains.[40]  It is important to remember, however, that the PLA does not speak with one voice. A handful of PLA officers regularly express uncompromising views about China’s territorial claims in the Chinese media, which in turn has spurred belligerent commentary among media commentators and netizens.[41] These well-known military commentators would not be able to express publicly such views without the support of at least one high-ranking PLA leader.

In sum, while Xi will try to manage tensions with Japan, he will have to tread extremely carefully to avoid creating a perception amongst Chinese that he is weak in defending China’s national interests. One option would be to use diplomatic channels to reach an understanding that each country would send patrols to the Senkaku/Diaoyu area on alternate days. This would require the tacit acknowledgement by Japan that the sovereignty of the islands is disputed, something Japan does not currently concede. According to Tokyo, no dispute exists – the islands belong to Japan. In the short term it would be equally essential to reach an agreement to share fishing rights in the disputed waters because confrontations between fishermen have sparked many of the recent incidents.

An agreement to jointly develop fossil resources would require a significant decrease in tensions between the two countries. Such an agreement was reached between Xi Jinping’s predecessor, Hu Jintao, and then-Prime Minister Yasuo Fukuda in 2008 in an area (Pinghu Trough) of the East China Sea in which Japan acknowledges the existence of a territorial dispute. But the agreement was never implemented, in part due to renewed friction between China and Japan and in part because of strong resistance by Chinese resource companies.[42] As for the underlying dispute over sovereignty of the islands, ultimately the only feasible option is for the two governments to ‘lay aside these issues’ as the late Deng Xiaoping advocated in 1978, and defer a final resolution to future generations.[43]

Relations with Southeast Asia

Another major challenge for China’s new leadership is how to manage the risk of conflict in the South China Sea (see map on last page). One of the major successes of China’s foreign policy after the 1997 Asian financial crisis was Beijing’s skillful diplomacy in Southeast Asia. China signed the Treaty of Amity and Cooperation with the Association of Southeast Asian Nations (ASEAN), joined with Japan and South Korea in ASEAN +3, and initiated more joint projects in the region than either the United States or Japan.[44]

However, since 2010 the reservoir of goodwill which China had built up in Southeast Asia over more than a decade has all but evaporated. States in the region fear Beijing is using its growing military, political and economic power to coerce Vietnam and the Philippines, in particular, to accept China’s territorial claims in the South China Sea. China, in turn, views fishing and resource exploration activities by Vietnam and the Philippines in what it regards as its territorial waters as infringing on its sovereignty. Beijing fears that anything less than a forceful response would be interpreted – both domestically and internationally – as a forfeiture of its sovereign rights. Chinese commentators routinely warn that China cannot idly stand by and tolerate encroachment on China’s rights by other countries.[45]

The situation in the South China Sea is further complicated by the fact that Taiwan, Malaysia and Brunei, in addition to China, Vietnam, and the Philippines, also have longstanding territorial and jurisdictional claims in various parts of the South China Sea. This affects their right to fish and exploit oil, gas and mineral deposits in the region. Several factors have increased tensions in recent years: first, rising nationalism across the region has put pressure on leaders to defend territorial integrity; second, the exploration activities of national and multinational resource companies in disputed waters have intensified; and third, the actions of maritime law enforcement vessels from China, the Philippines and Vietnam in harassing those deemed as violators have become more assertive and audacious.

China’s actions over the last few years are at odds with its pledge, reiterated in the 18th Party Congress work report, to ‘consolidate friendly relations and deepen mutually beneficial cooperation’ with its neighbours.[46] Beijing further alienates its Southeast Asian neighbours by opposing multilateral conflict resolution mechanisms and insisting on bilateral negotiations to resolve or manage the disputes. Beijing vehemently protests what it sees as ‘meddling’ by the United States in the South China Sea and refuses to involve non-claimants in any negotiation framework.

The growing anxiety that China’s rise evokes in countries both near and far is a serious challenge for China. ‘Hedging’ has become a more prominent aspect of managing relations with China in capitals across the region. Beijing has not a single genuine friend in its neighbourhood. Although governments across the region are taking steps to align themselves closer to the United States as a result of tensions in the South China Sea, they do not want to end up in a situation in which they have to choose between Beijing and Washington.[47]

The most feasible way to reduce tensions in the South China Sea would be for Xi Jinping to adopt a multilateral approach to manage conflicting interests. This would be a game changer. Even if China moved slowly before committing to binding resolutions, China’s acceptance of multilateral talks would be welcomed by Southeast Asian governments.

Chinese Southeast Asia experts are aware that China has lost political credibility in many Southeast Asian capitals because of the South China Sea disputes. But, as with any discussion of China’s policies toward its neighbours, the experts emphasise Xi Jinping’s need to avoid looking as if he were making a concession. Xi must first rally support among diverse domestic constituencies by initiating bold domestic reform and must consolidate his power base before embarking on new initiatives in the international domain. Thus, tensions in the South China Sea will continue.

If Xi Jinping fails to fend off demands by nationalists to display China’s determination to defend its sovereignty, a limited armed conflict with either the Philippines or Vietnam cannot be ruled out. China is not only the stronger party in terms of military capabilities. In economic terms, the damage for China would be nowhere near as substantial as it would be vis-à-vis Japan if ties seriously deteriorated, and it would be almost negligible compared to the huge setback Vietnam’s and the Philippine’s economies are liable to suffer.[48]

Relations with North Korea

Finally, North Korea will remain a key challenge for the Chinese leadership. China’s new leaders will struggle to manage relations with Kim Jong-un. The young North Korean leader has already shown his intent to develop the country’s missile and nuclear capabilities, despite China’s opposition. Further North Korean nuclear testing cannot be ruled out, which would complicate China’s relations with key regional nations such as Japan, South Korea and the United States.[49] China’s inability to deter Pyongyang from acquiring nuclear weapons would also dent Beijing’s hopes of being viewed as a responsible major power.

China’s long-standing North Korea policy of ‘no war, no instability, no nukes’, makes clear Beijing’s priorities. ‘No war’ and ‘no instability’ outrank ‘no nukes’. China is unlikely to change this policy, despite pressure from the international community. Chinese officials are extremely frustrated by North Korea’s development of its nuclear program and its refusal to open up and adopt economic reforms. But China’s leaders fear that a regime collapse in Pyongyang would set off massive refugee flows with serious economic and social consequences in China’s northeast provinces.[50] Beijing is also concerned about the possibility of US troops on its border, which could be the consequence of a sudden North Korean collapse and establishment of a unified Korea. Additionally, China’s military opposes turning its back on its comrade-in-arms from the Korean War.[51]

China’s support of the decision by the United Nations Security Council in January 2013 to expand sanctions against North Korea following Pyongyang’s rocket launch may have been a signal of Beijing’s frustration reaching the point of exasperation. Nevertheless, Beijing is unlikely to fundamentally alter its present approach and seriously pressure Pyongyang by cutting off cash and food flows to its neighbour.

Two of the seven PSC members, Li Keqiang and Zhang Dejiang, have held high-ranking positions in northeast China. They are bound to be wary of risking stability in an area with which they are familiar. They support China’s making every effort to expand economic ties with North Korea in the hope that it will deter a collapse of the country into anarchy. Furthermore, Wang Jiarui, a leading Chinese official on North Korea, continues to be a Central Committee member. Whatever job he is assigned in March 2013 when the new government positions are unveiled, he will remain involved in decision-making on North Korea. Among senior civilian officials, Wang Jiarui in particular opposed any public criticism by Beijing of Pyongyang in 2010 following the sinking of the South Korean corvette Cheonan and North Korean shelling of South Korea’s Yeonpyong Island.[52]

North Korea is viewed by Chinese analysts as ‘the most divisive of foreign policy issues among Chinese senior leaders’.[53] In private, Chinese officials admit that they do not have an effective North Korea policy. But they do not see an alternative to their current approach.[54]


Managing multiple pressures


Although the 18th Party Congress work report decreed that domestic issues, rather than foreign relations, will determine China’s development, the new leaders are aware that they need to ensure a stable external environment conducive to economic growth. They will also have to take note of and respond to broader trends which directly affect China’s modernisation drive; for example, its dependency on imported resources and open sea lines of communication.

The focus of China’s new leaders on domestic concerns increases the risk that the country’s foreign policy will be reactive. This is especially relevant in the case of ongoing tensions over various island disputes. Inattention by China’s senior leaders to these islands disputes is a recipe for disaster. Once a maritime or aerial incident occurs, domestic pressure will further narrow the room for manoeuvre of leaders in each of the countries involved in the incident. There are numerous foreign and security policy actors within China who favour Beijing taking a more forceful stance on sovereignty issues. They can only be managed by close attention of the senior leadership to developments related to the islands disputes. Regional stability is at risk if China’s senior leadership merely reacts as events unfold, as has too often been the case in Beijing in recent years.

Two decisions taken in late 2012, one by the Hainan provincial government and the other by the Ministry of Public Security, are worrying reminders of the dysfunctionality of decision-making in China. They also underline the damage a single government entity can cause to China’s international relations. In November, the Ministry of Public Security issued new passports with maps including disputed islands as Chinese territory. Predictably, this caused an outcry in neighbouring countries. The Foreign Ministry was not consulted on this decision ahead of time, and Foreign Minister Yang Jiechi was described as being ‘furious’ upon hearing the news.[55] In December, the Hainan provincial government announced that China’s maritime law enforcement agency vessels would stop and search ships in contested areas of the South China Sea. No central government approval was sought.[56]

In both cases, the senior leadership was caught unaware by decisions taken at a lower level. Only a senior leader with solid authority and one confident of his power base would be in a position to publicly retract the new policies after the fact. China does after all officially claim these disputed waters as its own territory, so issuing a directive to nullify these new policies would be interpreted as China bowing to outside pressure. As a new leader, Xi’s power base is yet to be consolidated. He must balance among various interest groups, who often have competing agendas but on whom Xi relies for political support.

It is not uncommon for Chinese officials to appeal to foreigners about the need to understand China’s shortcomings in the realm of foreign policy. Outsiders often struggle with the notion that China’s leadership is still unfamiliar with how to use its power. Sometimes this is what Chinese authorities want others to think; sometimes it is also accurate. China has burst onto the global stage faster than the Chinese themselves expected, and policymakers often lack sufficient experience and expertise in managing complex international relations as a major power.

Chinese leaders are still uncertain of what their position on many issues should be. They do not want to unleash self-destructive nationalist forces, but at the same time they seek respect and want China to be treated as a major power. Moreover, they struggle to manage pressure from an increasingly diverse society, in which multiple actors strive to influence foreign policy amidst fierce competition for government funding and, ultimately, power within the system. In that sense, many of China’s foreign policy challenges are not ‘foreign policy’-related at all.[57] Rather the challenge stems from the deficiencies of China’s present system of governance.










* The author is grateful to Anthony Bubalo, Dr Michael Fullilove, Dr Bates Gill, Dr Dave McRae, Rory Medcalf and Dr Zha Daojiong for their comments on the first draft of this Analysis. She also thanks Joel Wing-Lun and Harrison Palmer for their research assistance.

[1] Author’s conversations with Chinese officials and academics, May, July, August, November, December 2012. See also Meng Yan and Zhou Yong, 海洋强国等于海洋霸权? [Does maritime power equal maritime hegemony?] People’s Daily (overseas edition), 13 November 2012:

[2] Author’s conversations with Chinese officials and academics, May, July, August, November, December 2012.

[3] Linda Jakobson and Dean Knox, New foreign policy actors in China. Stockholm, Stockholm International Peace Research Institute, SIPRI Policy Paper, 26/2010, p 5.

[4] The 17th CPC Politburo (2007-2012) had 25 members until Bo Xilai was removed in April 2012.

[5] Dai Bingguo, 坚持走和平发展道路(全文) [Adhering to the path of peaceful development (full text)]. China News Service, 7 December 2010:

[6] Wang Jisi, China's search for a grand strategy? Foreign Affairs, March/April 2011.

[7] Jing Men, China’s peaceful rise? Studia Diplomatica 56 (6) 2003, p 17.

[8] Leslie Hook and Simon Rabinovitch, Xi stokes economic reform hopes in China. Financial Times, 11 December 2012:; Ana Marie Pamintuan, The Chinese dream. The Philippine Star, 4 January 2013:; author’s interviews with three international relations scholars in Beijing, January 2013.

[9] Malcolm Moore, China’s ‘next leader’ in hardline rant. The Telegraph, 16 February 2009:

[10] Hu Jintao, Full text of Hu Jintao's report at 18th Party Congress. Section XI, Xinhua, 18 November 2012:

[11] Wang Jisi, China's search for a grand strategy? Foreign Affairs, March/April 2011.

[12] For an overview of interpretations in China of the US pivot, see 10位专家:中国崛起须严防战略失误 [Ten experts: China’s rise must avoid grave strategic errors]. Global Times Online (Chinese edition), 11 May 2011: For a Chinese perception of the pivot's military component, see Zhu Feng,  美国‘亚太政势’为何如此扎眼   [Why is the US ‘Asia Pacific offensive’ so conspicuous?]. People’s Daily Online, 8 December 2011: For a Chinese view of the pivot as a threat but not as a move designed with China in mind, see Wang Jisi, 美国是否将以中国为敌 [Does the US see China as an enemy?]. Oriental Morning Post, 7 September 2011:

[13] Xi Jinping – General Secretary of CPC Central Committee. Xinhua, 15 November 2012:

[15] Geithner, ‘Uncle’ Wang to spar over Yuan in China. Bloomberg News, 24 May 2010:

[16] Author’s discussions in Beijing with Chinese officials and academics, May 2012.

[17] Text of Obama's speech to Parliament. The Sydney Morning Herald, 17 November 2011:

[18] Ibid.

[19] 习近平为期5天正式访美:共创新型大国关系 [Xi Jinping on his 5-day formal visit to the US: create a new kind of major power relationship together]. Legal Daily, 14 February 2012:

[20] Chu Shulong, 东北亚战略形势与中国 [The strategic situation in North East Asia and China]. 现代国际关系 [Modern International Relations] (1) 2012, pp 20-21.

[21] Cui Liru, 和平崛起:中国追求现代化的旅程 [Peaceful Rise: China's Modernisation Trajectory]. 现代国际关系 [Modern International Relations] (7) 2012, p 2. Cui Liru is President of China Institutes for Contemporary International Relations (CICIR), administered by the Ministry of State Security.

[22] Bonnie S. Glaser, Armed clash in the South China Sea. Contingency Planning Memorandum No. 14, New York, Council on Foreign Relations, April 2012.

[23] Jin Canrong, 中美需形成‘功能性伙伴’关系 [China and the US must form a ‘functional partner’ relationship]. 观察者 [The Observer], 20 December 2012:; Robert S. Ross, The problem with the pivot. Foreign Affairs, November/December 2012.

[24] Jim Garamone, Chinese vessels shadow, harass unarmed US survey ship. American Forces Press Service, 9 March 2009:

[25] Timeline: Senkaku/Diaoyu dispute. The Globe and Mail, 23 August 2012:

[26] Carlos Ramos-Mrosovsky, International law’s unhelpful role in the Senkaku Islands. University of Pennsylvania Journal of International Law 29 (4) 2008, 903-946, p 917.

[27] Mark Mackinnon, Tokyo’s hawkish governor stirs the pot. Foreign Policy, 14 August, 2012:

[28] Chinese official sources did not link the sale of the islands to the 18th Party Congress. The state-owned Global Times quotes from an article in the Hong Kong-based  亚洲周刊[Asia Weekly], but omits all references to the Party Congress: 日本声称‘9.11’购钓鱼岛 [Japan claims '9.11' to buy the Diaoyu Islands]. Global Times (Chinese edition), 8 September 2012:; Mao Feng, 日本钓岛战略曝光十八大前国有化 [Japan’s Diaoyu strategy exposed, nationalising before the 18th Party Congress]. 亚洲周刊 [Asia Weekly] 26 (37), 16 September 2012:

[29] Author’s conversations with Japanese diplomats, November, December 2012, January 2013; Ex-Japan envoy to China questions timing of Japan’s Senkaku purchase. The Mainichi, 21 December 2012:; Teddy Ng and Keith Zhai, Japanese Prime Minister Noda admits ‘miscalculations’ over Diaoyus, South China Morning Post, 21 September 2012:

[30] Xiong Zhengyan and Liu Hua, 中国维护钓鱼岛主权的举措理所当然 [China’s measures to protect the sovereignty of the Diaoyu Islands are only natural]. Xinhua, 30 October 2012:

[31] Mure Dickie, China flies aircraft over disputed islands. Financial Times, 13 December 2012:

[32] Jane Perlez, As dispute over islands escalates, Japan and China send fighter jets to the scene. The New York Times, 18 January 2013:

[33] Author’s conversations with two Chinese officials in Beijing, January 2013. The ‘group’ referred to is the CPC Maritime Security Leading Small Group.

[34] Author’s conversation with Chinese official, Beijing, January 2013. The conversation took place under the condition that the official be identified as a ‘Chinese official involved in the standoff with Japan’.

[35] Trade with China falls first time in three years. Japan Times, 11 January 2013:; China-Japan dispute takes rising toll on top Asian economies. Bloomberg News, 9 January 2012:

[36] Hu Shuli, 对日慎打‘经济牌’ [Be careful playing the ‘economic card’ against Japan]. Caixin, 24 September 2012:; in English:

[37] Ben McLannahan and Mure Dickie, Japanese investment in China falls sharply. Financial Times, 20 November 2012:; China-Japan dispute takes rising toll on top Asian economies. Bloomberg News, 9 January 2012:

[38] H.R. 4310: National Defense Authorization Act for Fiscal Year 2013, SEC. 1251. Sense of the Senate on the situation in the Senkaku Islands. U.S. Government Printing Office, 12 December 2012:; Hillary Clinton, Remarks with Japanese Foreign Minister Fumio Kishida after their meeting. U.S. Department of State, 18 January 2013:

[39] Lt. Gen. Noboru Yamaguchi, remarks at ASAN China Forum, Seoul, 10 December 2012, and author’s correspondence with Yamaguchi, 19 January 2013. See also Toshi Yoshihara, War by other means, China's political uses of sea power. In The Diplomat, 26 September 2012:

[40] 海监政委首次走进海军高等学府接受系统培训 [CMS commissars accepted into naval academy to receive systematic training for the first time]. 中国海洋报 [China Ocean News], 27 July 2011:

[41] 捍卫钓鱼岛主权 解放军厉兵秣马强势回应 [Protecting the Diaoyu Islands; the PLA responds strongly by ‘preparing for battle’]. Xinhua, 14 September 2012: For blog commentary, see 解放军宣布钓鱼岛为导弹靶杨 [The PLA announce that the Diaoyu Islands will be a missile range]. In 龙之梦的BLOG [Blog of the Dragon’s Dream], 12 September 2012:

[42] Jakobson and Knox, New foreign policy actors in China, p 29, 39.

[43]  邓小平谈钓鱼岛问题:先搁置它二三十年 [Deng Xiaoping on the Diaoyu Islands problem: lay it aside for twenty to thirty years]. Xinhua, 18 May 2012:; The Diaoyu Islands of China part 3: turbulence. CNTV, 10 September 2012: See also Nicholas Kristof, China’s new leader and the islands dispute. In On the Ground, 5 January 2012:

[44] Joshua Kurlantzick, China’s charm offensive in Southeast Asia. Current History, September 2006; Ian Storey, China’s missteps in Southeast Asia: less charm, more offensive. China Brief 10 (25), December 2010.

[45] Pan Guoping, 南海九段线是中国历史性权利 [The South Sea nine-dash line is China’s historical right]. Global Times Online (Chinese edition), 31 May 2012:; Zhong Sheng, 中国在南海问题上自有定力 [China has its own force in the South Sea issue]. People’s Daily, 26 July 2012:

[46] Hu Jintao, Full text of Hu Jintao's report at 18th Party Congress.

[47] Kenneth Lieberthal, The American pivot to Asia. Foreign Policy, 21 December 2011:,5.

[48] Trade with countries and regions in Asia (2010/04). Ministry of Commerce of the People’s Republic of China, May 2010:

[49] Rory Medcalf and Fiona Cunningham, Conclusion. In Disarming doubt: the future of extended nuclear deterrence in East Asia, edited by Rory Medcalf and Fiona Cunningham. Sydney, Lowy Institute for International Policy, 2012, p 134.

[50] International Crisis Group, North Korean succession and the risks of instability. Brussels, International Crisis Group, Asia Report No. 230, 25 July 2012:

[51] Author’s research interviews in Beijing, 2010. See also Zhu Feng, China’s North Korean contradictions. In Project Syndicate, 2 December 2010:

[52] Author’s research interviews in Beijing, 2010.

[53] Jakobson and Knox, New foreign policy actors in China, p 5.

[54] Author’s research interviews in Beijing, December 2012, January 2013. See also Scott Snyder’s appendix in Bonnie S. Glaser et al., Reordering Chinese priorities on the Korean Peninsula. Center for Strategic and International Studies, November 2012; Stephanie Kleine-Ahlbrandt, The Diminishing Returns of China’s North Korea Policy. In 38 North, 16 August 2012:

[55] Author’s separate conversations with three officials of China’s Ministry of Foreign Affairs, December 2012, January 2013. See also John Ruwitch, As China's clout grows, sea policy proves unfathomable. Reuters, 9 December 2012:

[56] Author’s conversation with Ministry of Foreign Affairs official, Beijing, January 2013.

[57] The author is grateful to Dr Bates Gill for making this point.


4/ Oct Thursday Location:Sydney

Distinguished Speaker Series: Address by International Atomic Energy Agency Director General, Yukiya Amano

When Yukiya Amano became Director General of the IAEA three years ago, the talk was of a nuclear renaissance. The Fukushima Daiichi accident in March 2011 put this vision into serious question. Eighteen months later, the demand for nuclear energy nevertheless continues, especially in Asia.

Thursday,0715am - 0830am
5/ Oct Friday Location:Sydney

Lowy lecture Series: 2002 Bali bombing anniversary – Mick Keelty, Dave McRae

On 12 October Australians and Indonesians will commemorate the 10th anniversary of the 2002 Bali bombings. Please join us for a special panel discussion of the Bali bombing, its aftermath and its impact on Australian-Indonesian relations. Panelists will include Ric Smith AO PSM, Australia’s Ambassador to Indonesia at the time of the Bali bombing, and Dr Dave McRae, Research Fellow at the Lowy Institute for International Policy.

Friday,0230am - 0345am
9/ Oct Tuesday Location:Sydney

Lowy Lecture Series: Paper launch of ‘The Audacity of Reasonableness’ – Dr Michael Fullilove

On Tuesday 9 October, the Lowy Institute for International Policy's Executive Director, Dr Michael Fullilove, will launch his new paper on the presidential election, US foreign policy and Australia. "The Audacity of Reasonableness" charts the similarities and differences between the foreign policies of President Barack Obama and Governor Mitt Romney, and draws out the implications for Australia.

Dr Michael Fullilove is the Executive Director of the Lowy Institute for International Policy.

Tuesday,0230am - 0345am

Key Findings

  • The maritime security business in the Indian Ocean is booming as ships turn to private military security companies to help in the fight against piracy. Over 140 companies now provide armed protection for ships in the Indian Ocean. At least 2700 individual contractors are employed as armed guards on ships and 18 floating armouries are operating in waters near the Gulf of Aden.
  • 40 private armed patrol boats are now, or will soon be, operating in the Indian Ocean. The most sophisticated of these private navies is outfitting three large boats in Singapore - each with a crew of 20, capable of carrying 40 private marines, and equipped with a helicopter and drones. The use of these boats, and the aggressive tactics they employ, should be discouraged by governments and the International Maritime Organization.
  • Because of shipping company demands for armed teams and shrinking defence budgets, governments are now privately hiring out their soldiers to provide security onboard commercial ships as ‘vessel protection detachments’. The use of these teams potentially has serious legal and political consequences for states should they be involved in disputes.

Pirates and privateers: managing the Indian Ocean's private security boom


Concerns about Somali-based piracy are combining with global defence cuts to fuel a boom in the use of private military security companies (PMSCs) in the Indian Ocean. Over 140 recently launched PMSCs employ at least 2700 armed contractors onboard commercial ships, with more than a quarter of commercial ships now using armed security onboard. [1] A new development is the deployment of private armed patrol boats, essentially private navies operating in a legal vacuum. Additionally, there are plans for more than 2000 European military personnel to be privately hired to shipping as vessel protection detachments.  One way or another, the counter-piracy fight is becoming a private one.

Initial evidence suggests that private armed contractors have been effective in reducing successful pirate attacks upon shipping. Piracy attacks have decreased by 60 per cent thus far in 2012, and though it is too soon to conclusively establish why, some experts believe this is because of the use of private armed guards.[2] In recent months 9 out of 10 failed attacks by pirates on merchant ships were repelled by armed PMSCs.[3] Efficiently regulated PMSCs represent a cost-effective counter-piracy solution for shipping companies and allow navies to incur less cost operating counter-piracy flotillas.

However, there have also been problems. Though this boom is only 18 months old, already private contractors and vessel protection detachments have shot and killed suspected pirates. In February, Italian Marines onboard an Italian oil tanker killed two fishermen they suspected of piracy in waters off India. They now await trial for murder amidst worsened diplomatic relations between India and Italy.

All of this has troubling implications. Coordination with navies is difficult and accidental confrontations between different counter-piracy forces are possible. Industry regulation may be difficult and dispute resolution fractious. The potential for a mini-arms race between pirates and PMSCs is very real. And private counter-piracy forces are already changing the way pirates operate.

Government policy, international organisations and international law have failed to keep pace with the rapid changes happening in the shipping and maritime private security industries. Instead they are relying on industry self-regulation, goodwill, and a degree of luck to manage the new presence of so many armed players in the Indian Ocean.

A fresh set of problems, however, is likely to develop from the use of vessel protection detachments – a phenomenon that has little recent parallel on land.  This practice will involve militaries accepting new kinds of risk and could well distort traditional civil-military distinctions.

This Lowy Institute Analysis examines the origins, characteristics, problems and likely trajectory of the private security boom in the Indian Ocean. It concludes with some preliminary policy recommendations for governments and identifies areas warranting further research.


Surging Somali piracy, sparse resources, scant resolve

After foreign forces withdrew from Somalia in the mid 1990s, worsening security and economic conditions led to an increase in piracy in the Indian Ocean. Somali-based pirates were able to attack passing shipping traffic with impunity and began to take ships and crew hostage with increasing regularity. This grew into a global security challenge because the area at risk from Somali piracy sits astride the world’s second busiest trade route.[4] Since 2008, three UN Security Council Resolutions have addressed Somali piracy, providing a legal basis for anti-piracy patrols and escorts involving the navies of most of the world’s major maritime powers. Yet by and large the pirates have not been deterred. They have become increasingly brazen, with piracy incidents increasing between 2008 and 2011.[5] The piracy business model has been highly successful; last year pirates secured total ransoms of US$146m for hijacked ships and crew. The recovery of the shipping industry since the 2008 global financial crisis has also presented more opportunity for pirates and their own industry has become highly sophisticated. Pirates hire currency specialists to count ransom drops and test for counterfeit notes.  Local Somali investors finance start-up piracy operations in return for ransom shares, and piracy funds have driven a Somali housing boom.[6]

For reasons that are as yet unclear, the frequency of both attempted and successful hijackings has dropped significantly thus far in 2012.[7] One reason for the decline in Somali piracy may be the more frequent presence of PMSCs on Indian Ocean shipping. Certainly this perception pervades the shipping industry. But regardless of whether piracy continues to decrease or not, the utility of PMSCs at sea has been well established.  

The international military response to Somali piracy has been substantial. At any given time, three international maritime task forces contribute up to 40 warships and maritime patrol aircraft, and ten other national flotillas have operated in the piracy high-risk area.[8] Counter-piracy coordination has been remarkable given that is has involved a high degree of interaction between navies that do not commonly work together, including the Chinese, Japanese, Russian, Iranian, Pakistani, Indian, and United States navies.[9] Monthly meetings coordinate, or at least deconflict, patrols by the different forces, and three liaison offices monitor shipping traffic, provide piracy intelligence, and coordinate incident response.[10] An Internationally Recommended Transit Corridor in the Gulf of Aden provides the maritime equivalent of a well-lit path where warships are pre-positioned to assist transiting shipping convoys.[11] Yet, for all the shipping it has directly protected, one result of this traditional naval response has been for pirates to shift attacks further into the Indian Ocean.

The problem of Somali piracy, now spread over 8.3 million km2 of ocean, has become too big for naval forces to counter alone. Some estimates conclude that 83 coordinated warships with embarked helicopters, more than double the numbers currently deployed, would be needed to provide a 30-minute response time to any piracy incident in the high-risk area.[12] Even then, typical pirate attacks are over within 30 minutes. In the words of one observer, the counter-piracy efforts of the world’s navies have been akin to ‘a police car patrolling an area the size of France’.[13]

Facing resource constraints, the European and US navies have shown little willingness to provide additional counter-piracy forces. Maintaining warships and aircraft in the Indian Ocean is expensive – annual operating costs alone for the major counter-piracy fleets are US$1.5bn.[14] Salaries, logistical support, and wear and tear on warships and helicopters levy additional burdens on already strained defence budgets. The pressure on finite naval resources has also risen due to tensions elsewhere, including, for example, the Straits of Hormuz. European navies particularly are concerned about the impact of ongoing piracy operations on their defence budgets, and have either reduced their counter-piracy commitments or are looking to do so.[15]

Counter-piracy operations provide limited deterrence, as prosecution of pirates is mostly unsuccessful. Competing jurisdictions and difficulties in obtaining evidence make prosecutions difficult – even within NATO there is no common legal framework for the arrest and transfer of pirates. Judicial capacity constraints in African countries are problematic. More than 1000 pirates await trial in 20 countries.[16] Many navies simply release pirates after catching them. The US Navy has 71 pirates in semi-permanent detention on ships because there is no ‘repeatable international process to bring them to justice’.[17]

But the chief factor limiting international responses to piracy is an unwillingness to operate on land in Somalia – both to improve governance and development, but also to strike at ports and villages from which pirates operate. This is because of memories of previous failed interventions but also due to concerns about imperiling crews held hostage. The UN has refused six requests to blockade Somali seaports in the past two years.[18] The European Union only mandated its naval force to strike at pirate safe havens this year and has done so only once.[19]


Privateers into the breach

The limitations on counter-piracy naval forces have not only allowed Somali piracy to continue, but have also created the conditions for a private security response. The use of PMSCs has become prolific across the shipping industry. The Volvo Ocean race now uses them to secure its $10m yachts on their African coast transit.[20] Encounters between pirates and privateers are becoming increasingly common. One company reports over 90 encounters with pirates, 18 of which were resolved through the firing of shots.[21]

Maritime PMSCs have greatly expanded their operations protecting commercial shipping in the Indian Ocean in the past 18 months. Over 140 firms operate in the region, the bulk of those established last year.[22] No less than 26 per cent of civilian ships transiting the Gulf of Aden officially declare the use of armed PMSCs onboard.[23] Anecdotal reports suggest that a much larger proportion of ships, perhaps half, are carrying such teams. Up to 18 private ships operate as floating armouries in international waters – allowing contractors to arm themselves for transits and sidestep arms trafficking regulations enforced in ports. [24]

It is difficult to determine how many individual private security contractors are currently working in the Indian Ocean, as there is no central registry for their licensing or qualification. Based on the number of ships officially reporting the use of armed teams, and assuming a minimum team size of four, it is likely at least 2700 armed guards are operating onboard commercial ships.[25] And this number is increasing. A large British PMSC increased contractor employment by 150 per cent last year and plans to employ a total of 1000 this year.[26] Hundreds more staff are employed providing support services for the industry on land. Most contractors are British or American; however, contractors from Australia and New Zealand are common too because their military training is interoperable with the US and UK.

Maritime PMSCs are experiencing high annual revenue growth in counter-piracy and are signing larger contracts.[27] Listed security group G4S last year flagged piracy-related maritime security as a ‘big commercial opportunity’. [28] Some firms have been successful in raising tens of millions of dollars from investors to finance private navies.[29] The boom shows no signs of slowing and firms surveyed for this analysis are optimistic about growth prospects and hiring increases in the next 12 months.


Behind the boom: commercial imperatives and policy drift

The commercial imperatives of the shipping industry and lack of government leadership have fuelled the private counter-piracy boom. Until May last year, the shipping industry did not condone the use of armed PMSCs on ships. Typical concerns about their use included: the safety risk to ships’ crews; collateral damage risk to ships; the potential to provoke escalation by pirates; liability and insurance issues in the case of death or injury; and the legal complexities of employing potentially lethal force at sea.[30] Since then all major shipping industry groups have accepted that PMSCs are a key, if perhaps temporary, component of the global response to piracy.

The policy change occurred when industry groups belatedly accepted that many shipping companies were using PMSCs. Shipping companies began to demand policy guidance from governments and insurers on the legality of using armed teams. Two key factors drove the shift to armed PMSCs. First, the rising costs of insurance. Ships carry multiple insurance policies and piracy risk is largely covered by war risk premiums.[31] Since 2008 the Lloyd’s Joint War Committee, a coordinating body of Lloyds London underwriters, has designated Indian Ocean piracy regions as a ‘war-risk zone’, increasing insurance premiums for ships that transit.[32] Concurrently, underwriters have offered to reduce premiums for ships that hire private security and take out separate kidnap and ransom insurance.[33] In some cases, underwriters will not issue kidnap and ransom insurance unless a ship hires armed guards.[34]

The second factor was the escalating cost of capture by pirates. The average ransom is now $4.58m and captured ships and crew are held for an average 158 days. Shipping companies lose millions in foregone chartering income while their ship is held to ransom. They also incur high costs in hiring specialist ransom negotiators, ransom drop experts, and support for crews once released. Hiring a PMSC for $50, 000 is a comparatively small price to pay to substantially reduce these costs.[35]  Some ships can recoup this cost simple by slowing their speed through pirate-infested areas and saving on fuel.[36]

The response of governments to the use of armed PMSCs has largely been reactive. Although US and UK counter-piracy commanders have sometimes articulated a role for PMSCs, particularly after the 2009 defence of the ship Maersk Alabama by a private armed team, their employment was initially illegal in most countries.[37] The UK government flagged that it would reconsider the ban after industry guidelines on maritime PMSCS were released in May 2011, and changed its policy to allow their use five months later.[38] The US government began encouraging the use of armed PMSCs in November 2011, circulating talking points on their utility to diplomatic posts.[39] Ten other major shipping states have subsequently amended policy to allow private armed guards on shipping and several more are considering similar changes.[40]


How maritime PMSCs operate

Maritime PMSCs provide two types of service: armed contractors and armed convoy escort vessels. Contractors are typically ex-Navy personnel with shipping industry-accredited safety and training qualifications, and work in teams of 3-6.[41] Maritime PMSCs offer a full suite of counter-piracy services, including hardening of vessels in accordance with industry standards, crew counter-piracy training, and preparation of onboard citadels (panic rooms used during a pirate attack). Contractors embark with body armour, medical kits, satellite communications, night-vision equipment and weapons (usually small arms such as AK47s and RPK light machine guns).[42] Costs for PMSCs and their contractors vary greatly. Individual contractors earn up to $500 per day and companies can charge out contractors for $1000 per day.[43] A typical contractor will work on contract for up to one year and complete some pre-deployment training.

New service industries are emerging to support the needs of private armed teams. Shipping logistics agencies facilitate the movement of personnel, weapons, and equipment on and off ships. Companies collect piracy intelligence, and some run operations rooms tracking armed teams and providing constant piracy updates. Some PMSCs subcontract to medical evacuation companies and a small number maintain in-house medical evacuation services for their contractors. New companies provide bespoke insurance for armed teams, advise shipping industry clients on how to vet PMSCs, and offer certification for individual contractors.[44] A new online marketplace connects armed teams offloaded due to sudden shipping schedule changes with other ships seeking their services at short notice.[45]

PMSCs embark from ports near the Gulf of Aden, including Port Djibouti, Salalah, Muscat, and Dar-Es-Salaam. A common port for disembarkation is Galle in southern Sri Lanka, an average 13 days passage from the Suez Canal and close to international shipping routes.[46] New support industries service armed teams there. Sri Lankan companies offer ‘battle hardened Sri Lankan Sea Marshals’ for hire, provide transport for teams boarding ships, and logistical support for the movement of weapons and ammunition.[47] The Sri Lankan government provides comprehensive support for PMSCs and the Sri Lankan Ministry of Defence licenses them to store equipment and weapons in bonded warehouses within naval bases.[48]

A majority of companies surveyed for this project procure their weapons in Western Europe and all reported complying with flag state regulations on the carriage of firearms. However, ‘flag of convenience’ states provide limited inspection regimes, and compliance with the International Traffic in Arms Regulations is complicated and expensive for maritime PMSCs. Governments require companies to register movement of weapons through their ports and often refuse permission to private companies.

Some PMSCs sidestep regulations by using their own floating armoury ships on the high seas.[49] This allows their contractors to embark on client ships in port, and pick up their weapons and equipment during a rendezvous outside of territorial waters. Some companies and contractors acquire weapons illegally and simply dispose of them overboard at the end of a transit. A contractor explains:

Given that you can get an AK-47 for about $200 in most big African towns … and it costs about $1,000 per weapon to do it legally, and then there’s all the forms, coastguard licences etc, a lot of people think it’s easier to buy weapons illegally and drop them down to Davy Jones’s locker when you get out of the danger area.[50]


Private patrol boats - seaborne vigilantes?

Whilst armed guards on ships are largely a passive and defensive counter-piracy measure, private armed patrol boats provide a more aggressive method of protecting shipping. At least 40 private armed patrol boats have been, are, or will soon be operating in the Indian Ocean.[51] They operate by establishing exclusion zones around the client ship and challenging suspicious boats that approach them. Some firms offer boarding teams on these escort vessels, with team members who are ‘well versed in waterborne operations and have experience in boarding/ counter boarding drills, waterborne interdiction and maritime/amphibious warfare’.[52] Private armed patrol boats are attractive to shipping companies because they do not require weapons-carriage on company ships and thus do not compromise their right to innocent passage through territorial waters.[53] Also, any consequences of firing weapons are outsourced to the captain of the private armed patrol boat.[54]

Such private navies are not new; they briefly operated in the Malacca Straits seven years ago and the notorious PMSC Blackwater unsuccessfully attempted a similar Indian Ocean venture in 2009.[55] Nor have they been particularly profitable in the past. But ambitious plans to raise new private fleets in the Indian Ocean are attracting corporate heavyweights and financing.[56] One venture raised US$40m in the past year. Another chaired by the CEO of global commodities trader Glencore is fitting out three boats in Singapore, which will carry 20 crew, 40 armed contractors, and utilise drones and helicopters to fight pirates.[57] The most common weapon employed on these boats is the 50-calibre heavy machine gun, able to fire at vessels more than a nautical mile away.

The status of private armed patrol boats under international law is unclear; they could themselves even be defined as pirates because they use aggressive force on the high seas without government authority.[58] Policy discussions on the boom in private counter-piracy have largely ducked the issue of private navies. As more vessels operate in the Indian Ocean, this will become a pressing issue. Some private armed patrol boat operators surveyed for this analysis have stated they would be willing to respond to non-client ships under attack. If unchecked, these fleets could be more akin to seaborne vigilantes than to private incarnations of naval counter-piracy forces.


Public privateers: national militaries for hire

For the past six months, two Italian marines have been held in a southern Indian jail awaiting trial for murder. Their arrest, for shooting two Indian fishermen they suspected of piracy whilst onboard the Italian ship Enrica Lexie, highlighted a concerning parallel development to the private security boom. Because of shipping company demands for armed teams and shrinking defence budgets, governments are now privately hiring out their soldiers to provide security onboard commercial ships. Such privately hired military teams are known as vessel protection detachments, or VPDs. Their role has been explained as ‘self defence, liaison with law enforcement agencies, training and security vetting of personnel, the use of weapons, communications with sovereign authorities, record-taking and evidence’.[59] Such teams have also been commonly offered by African nations to assist companies operating in their territorial waters.[60] The Russian Navy has employed them occasionally since 2009, and since 2010 European naval forces have sporadically offered VPDs to cruise liners and World Food Program ships in the piracy high-risk area.[61] However, the use of VPDs by European naval forces has soared in the past 18 months. By the end of next year almost 2000 naval personnel may be operating in the Indian Ocean under private hire to protect commercial interests.

The Netherlands, France, Spain, Belgium, and Italy all offer private shipping companies the opportunity to hire VPDs for use during transits of the Indian Ocean. Other countries are considering whether they should do the same. Indonesia, with over 76, 000 citizens employed as crew at sea, is seriously considering offering VPDs, partly in order to assuage concerns about the safety of its seafarers.[62] The services are available to ships registered in each nation, or to companies substantially controlled by each nation’s citizens. The shipping industry has voiced a strong preference for VPDs to conduct shipboard counter-piracy, rather than contractors from maritime PMSCs.[63] This is largely based on the logic that national militaries can move weapons and personnel through transit ports more easily, and that military personnel have better protection from prosecution, and more certain legal status, than private contractors.

The Dutch military commenced offering VPDs last year, asserting a constitutional imperative to protect their citizens operating at sea. Dutch shipping companies have been banned from using armed PMSCs onboard their ships due to Dutch government concerns that this would undermine the state’s monopoly on the use of force. An early VPD deployment placed 24 military personnel and medical staff onboard and the cost of the military team was borne largely by the private shipping company.[64] So far, the Dutch have deployed 26 VPD missions and plan on deploying 100 teams with ten personnel each this year, and 175 next year.[65] Total operating costs for Dutch teams are estimated at US$29m this year, of which shipping companies are expected to pay approximately half.[66] Transit points for Dutch VPDs include Singapore, Malta, Bahrain, Sharjah, Durban, and Mauritius.[67] In most locations, Dutch embassy staff supervise embarkation and disembarkation, and in February an agreement was signed to store weapons and equipment for commercial shipping transits on a Singapore Armed Forces airbase.[68]

There are a number of problems associated with the use of vessel protection detachments, not least of which is that they are often more expensive than private alternatives and often in short supply.[69] VPDs are an explicit alignment of national military power with private commercial interests. When national militaries patrol the piracy high-risk area in warships, they are patrolling for the common good and able to respond to any vessel under attack. When military personnel embark upon an individual ship as a VPD, they are only able to provide protection to that particular ship and do not contribute to the wider counter-piracy fight. Certainly, placing marines on a private ship is cheaper than escorting it with a warship. But it makes separating state and commercial interests difficult. The use of national militaries as guards on board shipping also creates substantial ambiguity about their identity, and raises a raft of political and legal problems. Port officials may be unclear as to whether military detachments are fulfilling other functions, such as intelligence collection, when they enter port on a civilian ship. States may choose to treat civilian vessels carrying VPDs as warships instead, with wider implications for legal and diplomatic status.

When militaries hire their personnel out as VPDs, they cede a degree of authority over them to the civilian ship captain and shipping company. In effect, VPDs have their movements dictated by shipping companies rather than governments, and are under the command of the civilian ship captain. This means the state may suffer the consequences of private decisions and opens up the possibility that a private ship might be perceived as an instrument of state policy. What happens to the ship will have direct implications for the national government. In the Enrica Lexie case, the actions of Italian marines onboard a private Italian ship created diplomatic furor. The Italian ambassador to India was recalled to Rome, and the incident has robbed Italy of any political capital it may have had in its wider relationship with India for the foreseeable future. It is becoming clear that many governments have not fully considered the consequences of hiring VPDs to shipping companies.


Concluding judgments and recommendations

The use of maritime PMSCs to guard against the piracy threat seems to have been effective, yet the practice is not without risks.  The boom in PMSCs responding to the piracy threat in the Indian Ocean raises serious questions about the quality of the contractors. The shipping industry has already acknowledged ‘significant competence and quality variations…across the spectrum of contractors’.[70] The legal status of armed PMSCs and, in particular, private armed patrol boats, is murky. The proliferation of PMSCs seems already to have contributed to breaches of international conventions on the movement of weapons.  It is extremely difficult to prosecute illegal behaviour by private contractors or the companies that support them because their legal status is unclear and there are so many overlapping jurisdictional issues associated with their use. In particular, the possibility of private armed patrol boats intercepting and perhaps boarding other civilian vessels raises significant legal questions, and there is significant potential for accidental confrontations at sea.

Disputes arising from contentious and potentially lethal confrontations between PMSCs and pirates are likely. Dispute resolution in the shipping industry is difficult enough because of its complexity and intersecting national interests.  As one commentator has noted ‘A ship [may be] built in Japan, owned by a brass-plate company in Malta, controlled by an Italian, managed by a company in Cyprus, chartered by the French, skippered by a Norwegian, crewed by Indians, registered in Panama, financed by a British bank, carrying a cargo owned by a multinational oil company’.[71] Contractors involved in shooting incidents, or detained by port states for illegal carriage of weapons, create consular and political difficulties for their home states.

The private hiring of national military personnel (VPDs) is potentially even more problematic, raising a range of legal and political questions. For example, by ceding some authority for military personnel to shipping companies, national militaries risk becoming embroiled in disputes beyond their control.  In these disputes the state that has hired out its military personnel might ultimately be held responsible for their actions.  At the very least, this has the potential to do serious damage to national reputations and to cause serious diplomatic incidents. An incident at sea, or in a port, involving a VPD could easily entangle several governments in serious legal and political disputes.

Most governments and shipping industry associations seem to assume that the use of PMSCs will be temporary. But it is far from clear that the current decline in pirate attacks in the Indian Ocean will be permanent.  And given the apparently positive impact of PMSCs in the Somali case their use is likely to become more common. Governments and the International Maritime Organization (IMO) need to accept that armed PMSCs have a legitimate and probably increasing, long-term role in the counter-piracy fight and act therefore to recapture leadership of the policy and regulatory agenda related to their use.

Greater regulation

As far as the regulatory agenda goes, the IMO and governments should build on a number of initiatives that already exist to regulate the private security industry. Originally devised to cover the use of private forces on land, the International Code of Conduct for Private Security Service Providers has been an excellent tool for bringing together private companies, international organisations, governments and NGOs.[72] The Code provides advice on the responsibilities of companies, as well as advice on dispute resolution and jurisdictional issues. It is developing protocols for accreditation of members through a regime of inspections and site visits. Though this will be difficult to implement at sea, the cooperative discussion on maritime PMSCs in this forum is productive and promising.[73] Regional organisations, such as the Indian Ocean Naval Symposium, should deepen discussions on maritime PMSCs and the need for greater government oversight.

Several industry associations are being formed to self-regulate PMSCs at sea, one of which is developing comprehensive guidance on contractor rules of engagement.[74] International standards are also in development for the maritime security industry.[75] Self-regulation could help to clearly define the risks of employing cheaper, poorly trained forces, and make sanctions from the insurance industry more readily available. That said, despite the promising progress of industry self-regulation, there will still be a role for national governments and the IMO in regulating maritime PMSCs. The main challenge for policy-makers will be wading through the ‘colossal’ legal complexities of private counter-piracy forces and the lack of a presumptive jurisdiction in which to resolve any disputes arising from their use.[76]

Countries whose nationals are heavily represented among maritime PMSCs need to invest greater effort in tracking their citizens employed in the private maritime security industry. Most contractors in the industry are former military personnel, and national governments have some responsibility for how the taxpayer-funded military skills of these personnel are used – even when they leave the military.  One way to begin addressing this risk is to require former military personnel to register their overseas employment in the security industry.[77]

There are also some aspects of the private counter-piracy effort that should be actively discouraged.  In particular, as already noted there are several troubling aspects about the use of private armed patrol boats. At the very least, governments need to closely monitor the development of these fleets.  Arguably, they should actively discourage their use where possible, and establish disincentives for national citizens and registered vessels that seek to procure private armed patrol boat services. The IMO should show greater leadership on the issue of private armed patrol boats.

Governments and the International Maritime Organization also need to resolve the ambiguities surrounding the use of national militaries onboard commercial shipping (VPDs), and in the interim should be cautious about their use. Without an agreed international legal framework to resolve disputes involving VPDS, and with limited visibility of where and how such teams are operating, the potential for legal and political disputes between countries is substantial.

Develop practical coordination between naval and private counter-piracy forces

Beyond better regulations of PMSCs there is also a need for greater coordination.  Coordination between navies and privateers has generally been casual, but this should now be made more formal. Maritime PMSCs can help navies develop maritime situational awareness in the piracy high-risk area, and navies could share selected intelligence with PMSCs to help them assess the risks of certain transits. Navies could also facilitate access to military communications for vetted PMSCs.[78] Close information sharing will be necessary to monitor how pirates respond to the presence of armed security teams onboard shipping, and to prevent an arms race between such teams and pirates. Greater information sharing and coordination could also encourage PMSCs to more diligently report confrontations with pirates. Additionally, as the presence of maritime PMSCs becomes more common in the high-risk area, mistaken identification and friendly fire confrontations become a greater risk. Already, there have been occasions when warships attached to coalition military forces have mistaken private contractors for pirates.[79] Such episodes could have fatal consequences as well as major diplomatic repercussions. Tighter information-sharing is needed so that navies know when and where to expect the presence of private counter-piracy forces.

The United Kingdom is the natural locus for policy leadership on privateers

Because the IMO has been overly cautious thus far in approaching the issue of maritime PMSCs, the responsibility for policy leadership has largely fallen on the United Kingdom. The UK is a natural locus for both counter-piracy and maritime PMSC regulatory initiatives. Almost one-third of piracy ransoms paid last year flowed through the UK and the majority of maritime insurers and PMSCs are based in London. The UK government-initiated Security in Complex Environments Group, a special-interest group formed from PMSCs, is working with government to establish national accreditation schemes and provides a mechanism for dialogue on PMSC issues.[80] The UK is also well positioned to coordinate reporting and naval interactions with private armed teams:  two major counter-piracy flotillas are commanded form London, and the UK Maritime Trade Office already performs a coordination role in the high-risk area. The UK government has discussed maritime PMSCs at the highest levels, coordinated working groups with industry, released interim guidance and guidelines for its own flag ships, and the UK Secretary of State for Transport recently concluded that ‘ultimately we need an international accreditation scheme for PMSCS’.[81] The UK should lead the development of this accreditation scheme and develop a mechanism for standardising training and accrediting industry personnel. In consultation with the insurance and shipping industries, the UK government should develop a public register and reporting regime that includes a blacklist of substandard or illegal companies and sanctions for those who hire them.

The boom in private security in the Indian Ocean has caught governments by surprise. So far the use of private armed guards seems to have been effective, although not without risk. There is a legitimate and long-term role for private companies to provide security at sea. But their use requires more regulation and coordination than we have seen thus far.






[1] There is a considerable body of literature on definitions associated with the private use of force. This paper uses the term ‘private military security companies’ as it best represents that the key component of services offered by these companies is skills and training learned within militaries.

[2] Mike Pflanz, Piracy attacks drop to zero for first full month in five years, The Telegraph, 8 August 2012:

[3] Henry Bellingham, Tackling piracy. However, often the ships most likely to hire guards are those least likely to be attacked by pirates whereas vulnerable ships (those which are slow and have a low freeboard) are likely to fail to comply with even the most basic industry measures to counter piracy. Sam Bateman, Presentation to Perth counter piracy conference, 17th July 2012.

[4] 23 000 ships transit the Suez Canal annually, including at least 7 per cent of the world’s oil tankers and 26.5 per cent of all container traffic. Helen B. Bendall, Cost of piracy: a comparative voyage approach in Maritime economics and logistics 12 2011, pp178-195, 2011.

[5] Incidents such as ‘someone sneaking aboard a ship while it is in port and stealing rope or a tin of paint’ may be over-classified as a pirate attack. Conversely for actual piracy attacks ‘ship masters are often reluctant to make a report as it might involve a disruption to the voyage of a couple of days’ in Australia’s response to piracy: a legal perspective, edited by Andrew Forbes, Papers in Australian maritime affairs 31. Canberra, Navy Seapower Centre, 2011, p 19.

[6] Anja Shortland, Treasure mapped: using satellite imagery to track the developmental effects of Somali piracy, 2012:

[8] High risk area (HRA) is the area bounded by Suez and the Straits of Hormuz to the North, the African coastline to the West, 10°S to the South, and 78°E to the East. Definition from UK Department of Transport, Interim guidance to UK flagged ships on the use of armed guards to defend against the threat of piracy in exceptional circumstances, November 2011:, p 6.

[9] Peter Chalk, Piracy off the horn of Africa: scope, dimensions, causes and responses, Brown Journal of World Affairs 16 (2) 2010 provides a different analysis concluding that national interests still trump collaboration in counter-piracy.

[10] Shared Awareness and Deconfliction Group meetings, held in Bahrain since 2008, involve representatives from 27 countries and 14 international organisations: The liaison offices are MSCHOA, (part of EUNAVFOR based in UK), UK Maritime Trade Office (based in Dubai), and the US Navy Maritime Liaison Office (MARLO, based in Bahrain).

[11] See for an example of Chinese-led convoys through the IRTC.

[12] Peter Cook, Armed guards on ships – a controversy, presentation to International Union of Marine Insurance Paris conference, 18-21 October 2011:

[13] Charlotte Eagar, To catch a pirate: the British ex-servicemen battling to protect international shipping from the clutches of Somali pirates, The Daily Mail, 20 December 2011:

[14] Antonia Maria Costa, The war on piracy must start on land, The New York Times, 9 June 2010:

[15] The Royal Navy previously committed four frigates to Somali counter-piracy alone, now two frigates cover Somali piracy as well as other contingencies. See Navy forced to drop year round Somalia piracy patrols, The Telegraph, 13 May 2012:

[16] Henry Bellingham, Tackling piracy: UK government response, speech to the British Chamber of Shipping, 12 October 2011:

[17] CJ Chivers, Seized pirates in high seas legal limbo, with no formula for trials, The New York Times, 27 January 2012:

[18] Micah Zenko, Intervention please: the no-fly zone requests you don’t hear about, The Atlantic, 10 January 2012:

[19] European Naval Force, EU naval force delivers blow against Somali pirates on shoreline, press release EUNAVFOR public affairs office, 15 May 2012:

[20] Agence France-Presse, Volvo ocean race uses armed ship for pirates, The Australian, 29 Dec 2011:

[21] Ira Broudway, The arms race against the pirates, Bloomberg Businessweek, 21 April 2011:

[22] Peter Cook, Armed guards on ships, cites 160 firms. Also Christian Ménard et Jean-Claude Viollet, Rapport d’information par la commission de la defense nationale et des forces armees sur les sociétés militaires privées, Assemblee Nationale, 14 Feb 2012:

[23] Personal communication with MSCHOA, 28 February 2012. A survey of German ships found 27 per cent used armed teams – see Maritime private security: market responses to piracy, terrorism, and waterborne security risks in the 21st century, edited by Claude Berube and Patrick Cullen, Oxford, Routledge, 2012, p 6. Other sources report up to 50% of ships are using armed guards but provide scant evidence - see Oceans Beyond Piracy, The economic cost of Somali piracy 2011, 2012:

[24] Katherine Houreld, Piracy fighters using floating armouries, The Washington Post, 23 March 2012: and UN Monitoring Group on Somalia Report, 13 July 2012:

[25] Analysis based on MSCHOA data on shipping transits through high-risk area and ships reported to be using armed guards, minimum PMSC team of 4 contractors assumed.

[26] PVI Ltd claims it deployed over 300 contractors in 2010 and reported having 750 in 2011. See PVI Ltd website: and Charlotte Eagar, To catch a pirate.

[27] Control Risks Group, an established PMSC, reported a 50% increase in business last financial year largely due to an increase in piracy related work and the French maritime PMSC, Gallice, reported 2011 sales of US$26m. See Lucy Tobin, UK leads the world in private security industry, The Independent, 7 Jan 2012:

[28] Neil Maidment and Myles Neligan, UK security firms take up arms against pirates, Reuters, 22 November 2011:

[29] A venture backed by a UK insurer has raised US$30m for a fleet of armed escort ships for use in the high-risk area and aspires to escort up to 25% of transiting ships. Michelle Wiese Bockmann, Somali piracy spurs private navy to start within five months, Bloomberg Businessweek, 8 November 2011:

[30] Peter Swift, presentation to Intertanko Asia Panel Meeting Singapore, 3 November 2009: Also Lloyd's List, 15 September 2010, p 4.

[31] Major categories of marine insurance include hull and machinery, protection and indemnity, war risk, cargo loss of hire, and kidnap and ransom. See Ince and Co, Piracy issues arising from the use of armed guards, 2011:

[32] Navy chief wants ships to hit back at pirates, The Sydney Morning Herald, 9 September 2008:

[33] John W. Miller, Loaded: freighters ready to shoot across pirate bow, The Wall Street Journal, 6 January 2010:

[34] If PMSCs are employed a 50% reduction on war risk premiums is common, see Berube and Cullen, Maritime private security, p 34.

[35] The Independent Maritime Security Association cites the cost of an armed PMSC team as $50,000 per Gulf of Aden transit. Oceans Beyond Piracy, The economic cost of Somali piracy 2011.

[36] Robert Wright, Ships slow down to save fuel in pirate waters, Financial Times, 8 May 2012:

[37] The US 5th fleet commander recommended that armed PMSC teams operate in the high risk area, Admiral Mark Fitzgerald, Voice of America video: US Admiral says commercial ships need armed guards, 22 April 2010:

[38] The UK Prime Minister provided: ‘We’ve said that it’s right for merchant ships to have armed guards on them. That does seem to give them additional protection.’ David Cameron, Transcript of Interview with PM ahead of Somalia Conference, 23 February 2012:

[39] Encouraging ‘the responsible use of Privately Contracted Armed Security Personnel (PCASP) on merchant vessels transiting high-risk waters off the Horn of Africa’, Robert Young Pelton, US to promote use of armed guards on vessels in Somalia report, 4 November 2011:

[40] India, Liberia, Panama, Greece, Norway, Cyprus, Denmark, France, Egypt, Philippines have changed their laws. Japan, South Korea, Germany, and Indonesia are considering changes.

[41] Not all PMSC contractors are former naval personnel and it is common for maritime PMSCs to establish offices near the UK’s Special Boat Service to suggest an association.

[42] See Aspida Maritime Security website: and Sea Marshals Ltd website: for details on typical weapons. Some PMSCs have employed high-explosive weapons onboard ships although insurers discourage this: interview with private military security company December 2011. See also presentation to the America Club, Locked and loaded: what a shipowner needs to know when considering the use of armed security guards:

[43] Interview with private military security company, August 2012.

[45] See Flag Victor website:

[46] Interview with private military security company, January 2012.

[47] See Marine Transport Services (PVT) Ltd website:, Mercantile Shipping Group website:, and Wilhelmsen Ships Service website:

[48] Gotabaya Rajapaksa, Sri Lankan Secretary of Defence Galle dialogue maritime conference keynote address, November 2011: Also Tradewinds, 27 January 2012: However, there are recent suggestions that the Sri Lankan government is trying to force PMSCs to hire Sri Lankan provided weapons.

[49] The United Nations Report of the Monitoring Group on Somalia details illegal arrangements firms have made at Annex 6, July 2011:

[50] Charlotte Eagar, To catch a pirate.

[51] See PVI Ltd website for example of such vessels:

[52] See Mercator International website:

[53] Article 19 of the UN Convention on the Law of the Sea defines Innocent Passage and notes: ‘Passage of a foreign ship shall be considered prejudicial to the peace, good order or security of the coastal state if in the territorial sea it engages in any of the following activities: …..any exercise or practice with weapons of any kind.’

[54] The devolution of authority to fire in self-defence from the master of a ship to an armed PMSC team may breach Safety of Life at Sea regulations, see Ince & Co, Piracy – issues arising from the use of armed guards, and Christian Ménard et Jean-Claude Viollet, d’information par la commission de la defense nationale et des forces armees sur les sociétés militaires privées.

[55] A Singapore-based PMSC previously offered a 125m vessel with a helicopter and six fast boats for convoy escort missions in the South China Sea and Malacca Straits, and now operates in the Indian Ocean. See Background Asia Risk Solutions website,

[56] One PMSC plans to deploy seven former naval patrol boats with teams of eight people onboard, Michelle Wiese Bockmann, Somali piracy spurs private navy to start within five months.

[57] Neil Maidment and Myles Neligan, UK security firms take up arms against pirates, and Martin Plaut, Private patrol boats to tackle Somali pirates, BBC World Service Africa, 30 May 2012:

[58] Article 107 of the UN Convention on the Law of the Sea provides that the interception, destruction, or capture of pirates may only be undertaken by military warships or aircraft. See A Schwartz, Corsairs in the crosshairs: a strategic plan to eliminate modern day piracy, New York University Journal of Law and Liberty 5 (2) 2010.

[59] Sam Bateman, Riding shotgun: armed security guards onboard merchant ships, RSIS Commentaries, 28 2010.

[60] Andrew Forbes, Australia’s response to piracy: a legal perspective, p70.

[61] Sam Bateman, Riding shotgun.

[62] Interview with Indonesian navy, May 2012.

[63] Industry guidance in May 2011 announced a preference for VPDs, as did the the Malmo Declaration issued by the October 2011 International Conference on Piracy at Sea. See industry guidance:

[64] Justin Stares, The international community has ‘failed’ to tackle piracy, Public Service Europe, 28 February 2012: and Christian Ménard et Jean-Claude Viollet, Rapport d’information par la commission de la defense nationale et des forces armees sur les sociétés militaires privées.

[65] Interview with Dutch military representative, July 2012.

[66] The government has reduced team costs by 40 per cent to make them affordable for merchant shipping.

[69] Christian Ménard et Jean-Claude Viollet, Rapport d’information par la commission de la defense nationale et des forces armees sur les sociétés militaires privées.

[70] Industry May 2011 guidance:

[71] John S Burnett, Dangerous waters: modern piracy and terror on the high seas, New York, Dutton, 2002.

[72] Most of the maritime PMSCs identified in research for this paper are signatories to the ICOC: http://www.icoc‑

[73] Additional principles and standards relevant to the maritime environment are being developed by the ICOC

[74] Peter Cook, Armed guards on ships.

[76] Congressional Research Service, Piracy off the Horn of Africa, 27 April 2011, p 31.

[77] This can be made a condition of employment on initial enlistment in the military, with loss of military retiree benefits and/or legal sanctions if not adhered to once leaving the military. The New Zealand Defence Force has implemented a modified version of this scheme.

[78] Berube and Cullen, Maritime private security, p 42.

[79] Interview with Royal Australian Navy, December 2011.

[81] Justine Greening, Armed guards to tackle piracy, Speech to the International Maritime Organization, 16 July 2012:



Table: Policy Drift – changing policies on private counter-piracy forces



  • US National Defense Authorization Act recommends government embark armed security teams aboard US flagged vessels carrying US government cargo in high risk areas.

September 2010

  • EUNAVFOR commander supports private sector patrol boat fleet to protect merchant shipping, European Community Shipowners' Association calls for vessel protection detachments.

October 2010

  • Norwegian tanker company Odfjell seeks permission from Norwegian and Singaporean authorities to arm crew and carry armed guards.

February 2011

  • International Chamber of Shipping announces a change of stance on private armed guards, recognising that they are being used extensively off Somalia.

March 2011

  • Norwegian Shipowners’ Mutual War Risks Insurance Association issues guidance on the selection of maritime PMSCs to its members.

May 2011

  • Industry guidelines for the use of maritime PMSCs released, noting the increase in maritime PMSCs, expressing concern about the quality of some contractors, and ruling that the use of PMSCs is a matter for individual ship operators. The guidelines state a preference for the use of military vessel protection detachments as armed guards over contractors.
  • 89th session of the IMO Maritime Safety Committee releases Circulars 1405 and 1408 which incorporate the provisions of the May 2011 Industry Guidelines and normalise the use of private armed guards.

June 2011

  • Shipping company Dockwise warns the Netherlands it will sail its vessels under a different flag unless it is allowed to use private armed guards.
  • UK Minister of State, Foreign and Commonwealth Office announces a reconsideration of UK policy banning private armed guards on shipping.

July 2011

  • Swedish car shipper Wallenius Lines announces it is using private armed guards.

August 2011

  • Egyptian Ministry of Defence withdraws prohibition on the carriage of armed guards, weapons and ammunition on vessels transiting the Suez Canal and Egyptian territorial waters.

August 2011

  • German government announces it will consider changing its policy on private armed guards.
  • Indian Shipping Ministry releases Guidelines on deployment of armed security guards on merchant ships.

September 2011

  • IMO approves revised guidance for flag states, ship owners, ship operators, ship masters, and port and coastal states on the use of privately contracted armed security personnel on board ships in the high-risk area.
  • Spain announces that Spanish tuna vessels in the Indian Ocean will be fitted with heavy machine guns and trained in how to use them by the Spanish navy.

October 2011

  • UK government announces change in policy on the use of private armed guards on ships ‘because there is no doubt that private armed security provides significant protection’.
  • International Chamber of Shipping cautions, “Private armed guards do not represent a long term solution. Rather their use actually signifies a failure on the part of the international community – and those governments with significant military forces – to ensure the security of maritime trade…the reality is they have ceded control of the Indian Ocean to pirates.”

November 2011

  • US Department of State issues guidance encouraging “the responsible use of Privately Contracted Armed Security Personnel (PCASP) on merchant vessels transiting high-risk waters off the Horn of Africa.”
  • UK Department of Transport releases Interim guidance to UK flagged shipping on the use of armed guards to defend against the threat of piracy in exceptional circumstances.

January 2012

  • Philippines changes its policy to allow private armed guards on shipping.

February 2012

  • At the London Conference on Somalia the UK Prime Minister declares, “it’s right for merchant ships to have armed guards on them.”


Map: Private counter-piracy forces




Lowy Institute welcomes Treasurer’s announcement on new G20 Studies Centre

Today the Chairman of the Lowy Institute for International Policy, Mr Frank Lowy AC, welcomed the announcement of a $4M funding grant from the Treasury for the establishment of a G20 Studies Centre at the Lowy Institute. The announcement took place this morning at the Institute’s headquarters in Bligh Street, Sydney.

The new Centre will analyse the changing landscape for global economic governance and the G20's role in the international economy.  It will complement the existing International Economy program at the Lowy Institute.

On this page

Key Findings

  • China’s currency is on the rise, but obstacles loom: the path to reserve currency status necessitates a near complete retooling of China’s economic model.
  • The central bank may be pursuing ‘reform by Trojan horse’: by pinning strategic value to internationalisation, they have been able to achieve buy-in from top leaders in pushing their reform agenda.
  • Given rising domestic pushback, a cacophony of competing voices and the unpalatable economic consequences of further internationalisation, it appears that breathless commentary about the rise of the renminbi is misplaced.

Executive Summary

Anaemic ascent: why China's currency is far from going global

‘What is needed is a roadmap with a stronger and more flexible exchange rate, more effective liquidity and monetary management, with higher quality supervision and regulation, with a more well-developed financial market, with flexible deposit and lending rates, and finally with the opening up of the capital account… If all that happens, there is no reason why the renminbi will not reach the status of a reserve currency occupying a position on par with China’s economic status’.     

                       Christine Lagarde, IMF Managing Director, 18 March 2012, Beijing[1]

Change is afoot in the international monetary system. The Chinese renminbi has been set on a path of internationalisation, the eventual destination of which, it has been suggested, could be a place alongside – or, perhaps, even above – the US dollar as a primary reserve currency.

IMF Managing Director Christine Lagarde, for example, has noted that ‘there is no reason why the renminbi will not reach’[2] reserve currency status. No reason, that is, should China manage to complete a long list of reforms. Similarly, The Peterson Institute’s Arvind Subramanian has extolled the currency’s dominance as ‘conditionally imminent’, predicting the renminbi ‘could become the premier reserve currency by the end of the decade’.[3] ‘Conditional’, that is, on the same long list of reforms. Off the back of such analysis, the City of London has rushed to lay the foundations for an offshore trading hub, whilst Australia is pushing to make its dollar directly convertible with the renminbi.

Both the IMF and Peterson Institute analyses are correct. Should China manage to undertake this veritable laundry-list of necessary reforms, the country’s economic size and trade impact mean it stands a strong chance of eventually elevating its currency to primary reserve status. The problem, though, is that these reforms are not going to happen within the next decade. The challenges that China faces in this task are near insurmountable, ensuring that whilst some measure of internationalisation is indeed underway, movement towards a reserve currency status commensurate with China’s global economic status will be tortuously slow, relegating the prospect to irrelevance. 


Internationally reserved

Much of the confusion in the debate stems from distinguishing between two often-conflated terms: an internationalised currency and a reserve currency.[4] Internationalisation means the use of a currency in ‘denominating and settling cross-border trade and financial transactions’;[5] that is, the use of a currency as a global medium of exchange, and even as an investment and funding instrument. A reserve currency is one that is held as a store of value and by ‘central banks as protection against balance of payments crises’[6] – either a minor reserve currency such as the Japanese yen and Swiss franc, or a primary reserve currency such as the US dollar and the pound sterling of the eighteenth and nineteenth centuries.

The difference between the two is critical. Whilst internationalisation is a necessary condition for reserve currency status, it is by no means sufficient. Indeed, whilst China has accelerated the internationalisation of its currency, in all likelihood it will be unable or unwilling to fulfill the conditions necessary to achieve primary reserve currency status. The very best Beijing can hope for within the next couple of decades is a renminbi similar in position to that of the Japanese yen – an internationalised, but modestly used, reserve currency. Even that will prove a stretch.


The renminbi takes off…

The natural drivers for renminbi internationalisation have been obvious for some time. China has grown from the world’s eleventh largest economy in 1990 to the second largest (surpassing Japan in 2010), surging to become the world’s second largest trading country and holder of the world’s largest pool of foreign exchange reserves. Its outlook, relative to advanced economies, is optimistic. The extensive literature on the history of reserve currencies centres primarily around relative size. As Subramanian notes, ‘a country that is large in output, trade, and finance’ is a natural contender for reserve currency status. The Dutch guilder accompanied The Netherlands’ expansionary trade reaches, whilst the pound sterling rose alongside the British Empire, and the US dollar climbed with the United States’ global economic ascension.

Endowed with these natural advantages, internationalisation began in earnest in late 2008, following the onset of the global financial crisis.[7] With trade financing markets frozen, China signed bilateral renminbi currency swap agreements with eight central banks totaling over 800 billion renminbi, in theory allowing central banks access to capital in times of shortage. Currency swap agreements provided a backstop for the June 2009 launch of a pilot scheme for cross-border trade settlement in renminbi. At first, this was restricted to a few mainland cities and Hong Kong, but was subsequently expanded to the whole of China and any trading partner. In February 2010, the Hong Kong Monetary Authority (HKMA) gave permission for non-financial mainland corporations to issue renminbi bonds in Hong Kong, following the Ministry of Finance’s raising of its first offshore bond.[8] In July 2010, restrictions were relaxed on the renminbi activities of banks in Hong Kong, allowing financial institutions to open renminbi accounts. In August 2010, the People’s Bank of China (PBoC) permitted central banks some access to China’s interbank market, subject to quota. Five months later, in January 2011, the PBoC launched a pilot scheme for the settlement of renminbi foreign direct investment (FDI).

Most symbolically, in August 2011, Vice-Premier Li Keqiang visited Hong Kong to announce 36 liberalisation measures. Li’s status as Premier-in-Waiting gave strong signaling of continued policy support at the central-government level into the next administration, which takes the reins in late 2012. His message of commitment was delivered at a forum on China’s 12th Five-Year Plan, indicating the role that Hong Kong and internationalisation play in Beijing’s long-term strategy.

Further measures continue to be announced; a 20 billion renminbi cross-border investment scheme (an expansion of the Qualified Foreign Institutional Investor mechanism), an easing of renminbi foreign direct investment regulations, announcements with London surrounding the City’s position as a potential offshore trading hub, and the Shanghai municipal government’s plan to establish Shanghai as ‘the global centre’ for renminbi trading by 2015, feeding into its plans for the city to become an ‘international finance centre’ by 2020. Qianhai in Shenzhen has been put forward to trial capital account convertibility, whilst Australia is pushing for its dollar to become the third currency to become directly convertible with the renminbi.

Accommodative policy has spurred a dramatic pick-up in renminbi activity in Hong Kong and elsewhere. Whilst only 0.04% of China’s total trade was settled in renminbi at the end of 2009, 9% was settled by year-end 2011. As of year-end 2009, renminbi deposits in Hong Kong were 60 billion renminbi. One year on, they totaled over 300 billion renminbi. As of December 2011, they totaled around 600 billion. Daily trading in the foreign exchange market rose similarly, up from nearly zero in mid-2010 to 250 million US dollars by year-end 2010.

This rapid pick-up in activity, it has to be noted, comes from a low base, and there is much distance to cover before the renminbi becomes a global currency with status commensurate to China’s economic weight. Even after this growth, the renminbi remains a minor player in global currency markets. According to the Bank for International Settlements, it accounts for less than 1% of average daily turnover, less than the Russian ruble and slightly more than the Turkish new lira. The US dollar, in contrast, accounts for 85% of turnover, and the euro nearly 40%. Swift, the international payments system, reports that the renminbi was used in 0.3% of global payments in 2011, compared to 43% for the euro.[9] In short, despite rapid progress, there is a long road ahead for the renminbi.

Of late, this long road has got longer. With tumultuous global investor sentiment over the past six months, internationalisation has slowed, and in some areas, actually reversed. The volume of renminbi-denominated trade settlement fell to 583 billion renminbi in the third quarter of 2011, down 2% from the second quarter, although a bounce in December saw the full-year figure rise to 2.1 trillion. The slowdown has been compounded by a slowing of transactions between mainland firms and their Hong Kong subsidiaries looking to arbitrage the difference in onshore and offshore renminbi markets. The steady climb in renminbi deposits in Hong Kong also looks to have peaked in November 2011, shrinking from 627 billion down through to 552 billion in April 2012.[10]


…but obstacles loom

The internationalisation that has thus far taken place, though, does not necessarily propel the currency towards reserve status – be it minor or primary reserve status. Indeed, almost insurmountable obstacles loom. The path to reserve status necessitates a near complete retooling of China’s economic model – a formidable political and economic challenge.

There are two basic prerequisites to achieving reserve currency status: an open capital account and well-developed financial markets. Without these, foreign central banks and investors will not hold onto the renminbi in any significant quantity. In their own way, however, both pose major policy challenges.

Authorities will need to make the renminbi fully convertible and remove restrictions on the capital account, allowing capital to flow freely in and out of the country. Whilst controls on the current account and some on the capital account (for foreign direct investment) were lifted in the early 1980s, tight restrictions remain on the cross-border flow of capital, particularly portfolio flows. This has enabled the government to insulate domestic financial markets from global markets, allowing authorities to operate a fixed currency whilst maintaining monetary policy independence. Whilst partial removal of controls will allow for partial internationalisation, as the currency is allowed to circulate more freely, a completely open capital account is necessary in order to convince central bankers to hold anything more than merely symbolic amounts of renminbi in their reserves.[11]

A major policy decision is then presented as capital controls are dismantled. Allowing the free flow of capital will force Beijing to either abandon its fixed exchange rate or forfeit its independent monetary policy (as, for example, Hong Kong does). Given it is unfeasible for China to sacrifice its monetary policy on account of its size and sui generis economic dynamics, Beijing would have to float the currency. Whilst moving to a floating currency would go some way to addressing global imbalances (and alleviate much US berating), a flexible currency and open financial system would bring with it vulnerability and volatility. Policymakers have drawn lessons  from the impact of both the rapid currency appreciation in Japan following the 1985 Plaza Accord and the unimpeded capital flows on the under-developed financial markets of Thailand as the Asian Financial Crisis struck in 1997. The central bank has also undoubtedly studied the experiences of both South Korea and Mexico, who witnessed financial crises following their rapid capital account liberalisations. Whilst conservatism can likely be overcome in time, policymakers are in no rush to place the economy at greater risk. Moving towards an open capital account and shifting the exchange rate regime constitutes a significant alteration in China’s economic model, and as such, is likely to be undertaken gradually, despite almost continuous PBoC commentary to the contrary. Indeed, it is important to remember that most PBoC commentary appears to be designed to shape the domestic debate, rather than outline realistic blueprints for future reform initiatives.

Controls will, therefore, be lifted cautiously, in turn slowing the pace of the renminbi’s long voyage towards reserve status. Some influential voices have argued, in fact, that it serves China’s interest to maintain the fixed exchange rate and strengthen capital controls whilst focusing efforts on developing domestic financial markets.[12] Only once domestic imbalances are resolved can measures be put in place to open capital controls and progress towards currency internationalisation. Indeed, a precise sequencing in policy liberalisation will need to be such that there is proven confidence in the domestic financial markets’ ability to cope with, then thrive from, increasing exposure to global capital flows.

At present, this confidence is desperately lacking and movements towards market maturity are likely to face considerable political and economic constraints. As such, prospects for fulfilling the second prerequisite for reserve currency status – safe, liquid financial markets – remain weak. The heart of China’s financial system, its banking sector, is woefully underdeveloped, yet it dominates at the expense of further development in capital markets.[13] The state banks have little incentive to allocate capital efficiently because of guaranteed ‘net interest margins’ – profit margins on, and an almost monopoly over, loans.[14] It is because of these margins that capital allocation is skewed towards state firms and heavy industry, starving smaller private sector firms of credit. Bonds function largely as bank loans, given that prices are influenced by the PBoC’s lending rates, not a market-driven yield curve, with most buyers not trading in the secondary markets but rather holding to maturity.

The primary impediment to maturing the financial markets is the government’s desire to maintain direct control over the economy. Suppressing interest rates and maintaining quantitative controls on the flow of credit – known as ‘financial repression’ – provides authorities the levers with which to effectively, but crudely, shape macroeconomic performance. Funneling credit through the banking sector to large firms reinforces investment-driven growth and allows banks to build up a strong capital buffer. The cost, however, is that ‘to maintain the effectiveness of these levers, they need to hold depositors in China hostage to the state financial system’.[15] [16] This has consequent effects on the property market, the proliferation of shadow banking, and more broadly, the imbalance between consumption and investment. As such, ‘so long as the financial system remains a tool of fiscal policy, and the price of capital is determined by the fiat of the party-state to satisfy its budgetary needs, China’s capital markets and financial system more generally will remain deformed, and will not be true markets’.[17] Until China has true capital markets, the renminbi does not stand a chance of achieving significant progress towards reserve currency status.

In short, then, the lifting of capital controls, parallel floating of the exchange rate, and liberalisation of the domestic financial markets, require a fundamental retooling of the economic growth model that has driven China for the bulk of the past 30 years. It requires facing down tough political opposition and powerful vested interests, a willingness to expose the economy to new and unknown stresses and external volatilities, and a recognition that China needs to implement one of the largest set of economic and financial reforms in recent history. Against a backdrop of a weak and uncertain outlook in the global economy, it would be unsurprising if leaders in China receded into policy conservatism.

More intangibly, much is dependent on the continuation of China’s economic rise, its capacity to create functioning institutions with checks and balances, and ability to instill confidence in reserve managers and investors that the currency is a good store of value. A stable macroeconomic climate and low debt levels are necessary in this regard, and neither is guaranteed, particularly following China’s economic performance over the past couple of years. It could also be argued that the most important long-term challenge is the establishment of rule of law, without which there surely cannot be genuine trust in macroeconomic stability. This probably calls into question the whole compatibility of the Communist Party. Indeed, as Subramanian notes, ‘when the chips are down, will investors feel that their money is safer in China than in the United States?’.[18] It is unlikely many would choose China, and this stymies progress towards dominant reserve status.


Pushing and pulling on the renminbi

The stark contrast between a rapid burst of internationalisation and a near insurmountable challenge in achieving reserve currency status raises the question as to why authorities are pushing in this direction. What is the motivation for renminbi internationalisation?

China’s push for renminbi internationalisation appears to be primarily grounded in a critique of an international monetary system weakened by US dollar dominance. Whilst this has long been a concern for Chinese academics, in the eyes of policymakers the global financial crisis ‘laid bare the defects of the existing international monetary system’.[19] Many came to the conclusion ‘that the world should look to diversify beyond the dollar system’,[20] in large part by internationalising the renminbi.[21] This view was perhaps most famously captured by Zhou Xiaochuan, Governor of the PBoC, who in March 2009 published proposals for reform of the international monetary system, arguing for reduced reliance on the US dollar as the global reserve currency, and for a greater role of the IMF basket of currencies called Special Drawing Rights (SDRs). Importantly, this analysis is not restricted to China. Among others, Joseph Stiglitz, an American Nobel Prize-winning economist, has noted that ‘the system in which the dollar is the reserve currency is a system that has long been recognized to be unsustainable in the long run’.[22]

Clearly, China has more narrow interests at work too. The crisis in 2008 ‘exposed the vulnerability of China’s financial position under the existing international monetary system’.[23] The crisis raised concerns over the global inflationary impact of a dollar glut,[24] as the US Federal Reserve pursued ‘quantitative easing’, aggressively injecting liquidity into financial markets. This vulnerability springs from the ‘externalities’ of US domestic policy – the mismatch between national policies and their international implications. There is concern about ‘the dependence… on a currency subject to national management’.[25] Indeed, as one government think-tanker put it, ‘we are afraid of the hegemony of the US dollar… we cannot control [US government] behaviour’.[26]

Undoubtedly, pursuit of an internationalised currency is about more than escape from a US dollar trap. There are immediate benefits to currency internationalisation. At the simplest level, it provides convenience to Chinese importers and exporters, allowing them to invoice and settle in renminbi. This helps to reduce exchange rate risk, decreasing the vulnerability of exporters to shifts in global exchange rates, and lowers transaction costs. An internationalised currency also results in lower borrowing costs for that country,[27] and in significant volumes, in seigniorage income.[28]

As important as economic drivers, there are non-economic factors at play. Many academics and policymakers feel it only right that China has a currency commensurate with its new-found economic weight.[29] As one government think-tanker asks: China’s economy is internationalised, so why isn’t its currency?[30] Another complains about the ‘privilege enjoyed by holding reserve currency position’.[31] For some, it is even ‘as important [a symbol] as New China’s becoming a nuclear power’.[32]

Most interestingly, though, and perhaps most convincingly, it has been argued that internationalisation is ‘reform by Trojan Horse’.[33] As committed reformers, internationalisation is a mechanism for the PBoC (and other progressive actors) to push liberalisation whilst minimising the political debate surrounding the sensitive issues of capital controls and currency, much in the same way that Premier Zhu Rongji used entry into the World Trade Organization as a pretext for implementing necessary but politically difficult reform of the state-owned enterprises (SOEs).[34] In this argument, the PBoC does not want internationalisation per se, but the liberalisation that moving towards internationalisation brings. One think-tanker stressed the importance of ‘improving financial competitiveness’ as a goal of internationalisation,[35] whilst another noted that, in fact, ‘we never had the ambition to over-take the hegemon US dollar’.[36] In this light, the acceleration in internationalisation since 2009 could have been driven by the PBoC as a tool to push on with its reform agenda, as senior leadership had decided to revert to the US dollar peg (2008-2010) in the face of global financial turbulence. By attaching symbolic and strategic value to internationalisation, the PBoC was able to bypass much debate on the controversial but necessary steps to take. It allows authorities to push for measures that lead to a floating currency, for example, without appearing to have caved to US political pressure in doing so. Further, by starting internationalisation at arm’s length in Hong Kong, authorities established facts on the ground, acclimatising policymakers to developments, before taking on the tough reforms necessary domestically. Indeed, it is in this context that it makes sense to analyse the recent proposal floated by a PBoC researcher for accelerated capital account liberalisation. Far from being a government-approved plan, this is likely an aggressive reminder from a reform-focused organisation that the reform process needs to be advanced.


Unintended consequences cause pushback…

As some actors push forward, though, others are pushing back. Leading the charge, Yu Yongding of the Chinese Academy of Social Sciences has warned that internationalisation whilst the renminbi remains undervalued creates a dangerous asymmetry. Because exporters to China have been more willing to receive renminbi than have importers, given appreciation expectations, trade settlement has been completely skewed. In 2010, the import/export ratio of trade settlement reached 1:6. As appreciation expectations have calmed, though, more balanced flows have emerged, with the ratio softening to 1:2 in 2011. Total volumes have seen less growth accordingly.

The implication, therefore, is that much of the progress made in internationalisation has been driven by currency speculation, not by a true desire to settle transactions in renminbi. With renminbi growth substantially driven by appreciation expectations, ‘internationalisation can be easily reversed and will cause more problems for China’s monetary authority to solve in the future’.[37] Indeed, renminbi deposits in Hong Kong peaked in November last year, and continue to decline on account of scaled-back appreciation expectations. Moreover, offshore renminbi bond issuance – through so-called ‘dim sum’ bonds – has weakened, peaking out at 22 billion renminbi in September 2011, and since April 2012, has receded into single digits.[38] Part of the reason for this is that yields have had to climb to compensate investors for lack of appreciation (up from around 3% at the beginning of 2011 to over 5.5% in May 2012) ,[39] and issuers are therefore reevaluating whether it makes sense to issue in the offshore market, given higher costs[40] and the fact that approval is still required to repatriate bond proceeds onto the mainland (where the renminbi can actually be put to use). Many are turning back to more traditional US dollar funding markets.

It is not only appreciation expectations that lie behind market asymmetries, but also different market structures onshore and offshore. For instance, although the renminbi has now risen to become the third most popular currency for letters of credit (following the US dollar and euro), the market appears to be dominated by intra-firm trade flows, with large companies arbitraging differences in onshore and offshore interest rates.[41]

This asymmetry also has implications for China’s foreign exchange reserves. If a Chinese importer pays in renminbi rather than requesting US dollars from authorities, dollar reserves are not drawn down, so remain higher than they otherwise would be. In this respect, the pursuit of internationalisation via an offshore market in Hong Kong has the potential to tighten China’s dependence on the US dollar, not loosen it, as reserves continue to build. This could very well lessen appetite for further development of the offshore market in Hong Kong, thus hindering internationalisation. He Fan of the Chinese Academy of Social Sciences has warned extensively about this, noting the potential for added sterilisation costs on the PBoC.[42]

Asymmetry aside, internationalisation has had uncomfortable implications for domestic monetary policy. In early October 2011, for example, as global risk sentiment rose in the face of renewed recession fears, the offshore renminbi exchange rate dropped, as investors fled to safe-haven currencies. This drove the PBoC to further appreciate the onshore rate to demonstrate commitment to continued internationalisation. Indeed, the IMF highlights the risk of feedback loops between offshore and onshore markets, noting that ‘the stability of the onshore market could be negatively impacted by market dislocation offshore’ and that ‘as the offshore market develops, feedback channels are likely to strengthen’.[43] Further, by providing another avenue for mainland firms to raise capital, the authorities appear to be undercutting the effectiveness of domestic monetary policy, given firms’ reduced reliance on the domestic banking sector, the government’s main level of macroeconomic control. By extension, this also has the potential to jeopardise the profitability of state-owned banks, given their dependence on deposit taking and credit issuance for revenue.[44] Lastly, the ability of actors to remit offshore renminbi onshore, all other things equal, expands the money supply and supports inflationary pressures, or alternatively increases sterilisation costs for the central bank.


Despite the pushback and unexpected policy kinks, it is important to note that internationalisation is very much ‘still in trial stage’.[45] Indeed, it is largely for this reason that the experiment was started in relative safety outside China’s capital controls in Hong Kong. Authorities allowed rapid progress in 2010, and now appear to be in the process of assessing what has worked and what has not. In this respect, it could be argued that policymakers are moving pragmatically in a similar vein to the creation of Special Economic Zones that marked China’s early transition away from central planning in the 1980s.


…and competing voices vie for influence

Continued policy support for internationalisation should not be taken for granted,[46] despite Premier-in-Waiting Li Keqiang’s visit to Hong Kong and its place in the 12th Five-Year Plan. Policy formulation in China is increasingly defined by the battle between muscular competing interests.[47] The evolving ability of actors to influence the direction of policy rests on the shifting nature of power within domestic politics and the fast-changing external environment. Three main actors here are the PBoC, the National Development and Reform Commission (NDRC), and the Ministry of Commerce – additional ‘quantitative easing’ from the US Federal Reserve, for example, supports the case advanced by the PBoC; growing global commercial opportunities may help the National Development and Reform Commission (NDRC) argue its position; whilst a worsening export climate allows the Ministry of Commerce to push their agenda. Indeed, rather than leading, the Politburo Standing Committee – China’s supreme ruling body – is often seen as building consensus between competing voices.[48] The top echelons of political China are occupied by Party apparatchiks, not technocrats, and thus grander geo-strategic considerations tend to feature more heavily. A reflexive fear of the ‘US dollar trap’ and assumed geopolitical power gained from currency internationalisation provide momentum for proactive policy.

The PBoC is arguably the most important actor in this story. They are broadly seen as committed reformers within China, and, as noted above, it has been argued that their push for internationalisation is ‘reform by Trojan horse’. They (and others) wish to see the corollary liberalisation that internationalisation entails, and see political efficacy in attaching a symbolic value to the process, in part to help bypass politically sensitive discussions. However, even within the reform-minded PBoC there are voices pushing back. Close contacts of senior PBoC officials note that the PBoC was hesitant in acquiescing to provincial requests for renminbi-denominated FDI into China, perhaps out of fear over the reaction to loosening capital controls. Since the Asian Financial Crisis in 1997-1998, where rapid capital movements saw speculative attacks on Southeast Asian currencies, Party leaders have been extremely suspicious of calls to liberalise the capital account. Given the State Administration for Foreign Exchange are charged with the management of foreign exchange reserves, it is unsurprising they are also concerned about so-called ‘hot money’ – flows of speculative capital into and out of China.

The blogosphere is also an important actor here, with increasingly nationalist sentiment often arguing that China should not align with Western economic orthodoxy in liberalisation, pointing to the global financial crisis as proof that the Anglo-Saxon model of capitalism is bankrupt. Nationalistic tendencies can run the other way too, with commentators lamenting the fact that China provides the United States with cheap funding through its Treasury holdings, whilst failing to provide sufficient funding for hospitals and schools.

The NDRC, China’s old state planning body, has a keen interest in the impact continued internationalisation will have on the SOEs, given their treasured place in China’s political economy. The State-owned Assets Supervision and Administration Commission (SASAC), the SOE watchdog, would likely hold similar views, despite their perceived impotence. Further opening, for example, would expose state corporates and ‘infant industries’ to international competition, and liberalising domestic financial markets would undercut the monopoly that state banks use to generate revenue. The NDRC would perhaps also worry about the increasing reliance on, or exposure to, global markets that follows from internationalisation, whilst the Ministry of Finance would be concerned about the corollary weakening of financial control that comes with internationalisation. But on the other hand, allowing SOEs to settle trade in renminbi when operating abroad has its advantages, and as SOEs are net importers, they have a vested interest in the currency appreciation that is likely to accompany liberalisation in the long term. The Ministry of Commerce, which locates its powerbase in the export sector, may see similar benefits for smaller exporters to trade in renminbi, but nevertheless fiercely guards the status quo of a stable and structurally undervalued exchange rate.[49] It is regularly at odds with the PBoC over the pace of renminbi appreciation. Long-term moves towards internationalisation require a floating currency, which – over the medium term – will likely mean appreciation, squeezing the thin margins of many exporters. The NDRC, though, recognises the need to shift Chinese manufacturing up the value-chain, and may see renminbi appreciation as a critical part of that transition.

Provincial governments also have a strong influence over national policy direction, despite central government efforts to curtail their power. Shanghai is pushing aggressively for internationalisation, given it stands to gain through additional financial sector activity. The same is true for Hong Kong. Although both benefit from internationalisation, they are, in some respects, competitors, as they vie to become the long-term home to renminbi-denominated international finance. Once again, poorer provinces with less international exposure have a different set of interests regarding internationalisation, and may feel central government attention on the issue risks ceding policy focus on more pressing domestic challenges.


A muted internationalisation

Whilst the economic and political obstacles to the renminbi’s attaining reserve currency status remain severe, they do not preclude further internationalisation taking place. Despite the recent slowdown in the accumulation of renminbi deposits in Hong Kong, China’s continued growth in absolute size and as a trade power ensure that the renminbi has a role to play in trade settlement. In this respect, parallels can be drawn with the internationalisation of the Japanese yen through the 1970s and 1980s.[50] Internationalisation proceeded to the extent that close to half of Japanese exports were denominated in yen, yen-denominated ‘samurai bonds’ were issued internationally and the yen became actively traded on foreign exchange markets. The global proportion of yen reserve holdings peaked at only 9% in 1991, though, before retreating to around 3% – primarily because of Japanese unwillingness to completely open financial markets to foreign participants and failure to get serious about financial market product development.[51] Given sensitivities domestically, this appears a likely path for China.

At the very least, should the renminbi’s rise be restricted to the Japanese experience, there is clearly more potential for renminbi trade settlement. Fortescue Metals Group, for example, made headlines in July 2011 when its Chief Executive announced that the firm had ‘started transacting in renminbi’, whilst Rio Tinto have openly mulled adopting the renminbi in trade settlement. These moves could prove to be the start of a more modest internationalisation trajectory.

Even muted progress in achieving reserve currency status is possible. Malaysia announced in late 2010 that they bought renminbi-denominated bonds for reserves. Thailand followed suit in November 2011, although adding that renminbi still only accounts for under 1% of total reserves. Likewise with Nigeria, that has ‘made a strategic decision to consider adding the renminbi to the basket of reserves’, aiming for 5-10%. Importantly, though, this demand appears almost wholly politically motivated, rather than driven by a desire to actually hold renminbi as a store of value and as a guard against balance of payments crises. Most likely, it is merely a symbolic show of support for growing trade relations with China.


An anaemic ascent

The first steps in the untethering of China’s currency have coincided with a shift in economic power that emerged through the global financial crisis, provoking breathless commentary about China as an ‘inevitable superpower’[52] and the renminbi’s imminent ‘dominance’.[53] Even the IMF Managing Director has talked up the prospects for the renminbi to rise to reserve currency status, whilst national governments are rushing to position themselves to benefit from the transition. For sure, China’s size and relatively optimistic long-term economic trajectory (in comparison to advanced economies) ensure that the renminbi has potential to play a more active role in international trade settlement. However, severe economic challenges and political obstacles look sure to resign the currency to a fate short of major reserve currency status. A status equivalent to that of the Japanese yen appears to be the best-case scenario over the next couple of decades. The renminbi has risen quickly the past couple of years, but its future ascent looks distinctly anaemic.







[1] China to reform, grow economy, IMF eyes freer yuan, Reuters, 18 March 2012.

[2] Ibid.

[3] Subramanian, Arvind, Renminbi rules: the conditional imminence of the reserve currency transition, Peterson Institute for International Economics, Working Paper 11-14, September 2011.

[4] Kroeber, Arthur, The Chinese yuan grows up – slowly, New America Foundation, March 2011.

[5] Prasad and Ye, The renminbi’s role in the global monetary system, Brookings Institution, February 2012.

[6] Ibid.

[7] Cheung, Ma, McCauley, Why does China attempt to internationalise the renminbi?, in Jane Golley and Ligang Song (eds), Rising China: global challenges and opportunities, ANU E Press, 2011; Kroeber, Arthur, The Chinese yuan grows up – slowly.

[8] Kroeber, Arthur, The Chinese yuan grows up – slowly.

[9] Banks institute renminbi safeguards, Financial Times, 14 February 2012.

[10] Admittedly, it could be argued that the reversal of CNH deposit growth is a healthy market development, should it reflect continued trade settlement and a more balanced CNH usage.

[11] As detailed later, current reserve holdings of renminbi appear to be entirely politically motivated.

[12] Xiao Geng, Exchange rate policy and macroeconomic adjustment, in Garnaut, Golley and Song (eds), China: the next twenty years of reform and development, ANU E Press, 2010.

[13] Walter and Howie, Red capitalism: the fragile financial foundation of China’s extraordinary rise, John Wiley and Sons, Singapore, 2011.

[14] The 25 basis point interest rate cut on 7 June 2012 was accompanied by a tweak to the way banks are allowed to set rates. Banks are now allowed the float deposit rates up to 10% over the benchmark rate, and float lending rates under the benchmark rates by 20%. Given the current scramble for deposits, most banks took advantage of this float to maintain deposit rates at 3.5%, resulting in a squeeze of bank spreads at shorter tenors. Whilst this is a step towards liberalisation, it is relatively minor, and more likely sprang from the desire to conduct an asymmetric cut, aimed at revitalising growth and stemming the outflow of deposits witnessed through Spring 2012.

[15] Shih, Victor, Goldilocks liberalisation: the uneven path towards interest rate reform in China, Journal of East Asian Studies, Vol. 11 2011, pp 435-464.

[16] To a small extent, the emergence of higher-yielding ‘wealth management products’ has enabled some depositors to escape the worst of financial repression. However, this is concentrated within wealthier households and has significant regulatory implications, meaning that the market faces barriers to expansion.

[17] Walter and Howie, Capital market reform. Market, what market?, China Economic Quarterly, June 2010.

[18] Subramanian, Arvind, Renminbi rules: the conditional imminence of the reserve currency transition.

[19] Chin and Wang, China debates: the dollar system and beyond, Chatham House, 2009.

[20] Ibid.

[21] Author interview, Beijing, November 2011.

[22] Subramanian, Arvind, Renminbi rules: the conditional imminence of the reserve currency transition, p 3.

[23] Gao and Yu, Internationalisation of the renminbi, Bank for International Settlements, 2009.

[24] Cheung, Ma, McCauley, Why does China attempt to internationalise the renminbi?.

[25] Ibid.

[26] Author interview, Beijing, November 2011.

[27] Taylor, Alan, The future of international liquidity and the role of China, Council on Foreign Relations, November 2011, p 12.

[28] Defined by the Bank of Canada as ‘the revenue earned from the issue of new money’ – the difference between the interest earned on government securities and the cost of issuing, distributing and replacing those notes. 

[29] Author interview, Beijing, November 2011.

[30] Author interview, Beijing, November 2011.

[31] Author interview, Beijing, November 2011 .

[32] Jiang Yong of CICIR, quoted in Godemont, François, The renminbi: “Our currency, your problem”, China Analysis, European Council on Foreign Relations, 2011.

[33] Author interviews, Beijing, November 2011.

[34] Author interview, Beijing, November 2011.

[35] Author interview, Beijing, November 2011 .

[36] Author interview, Shanghai, June 2012.

[37] Yu Yongding , The renminbi’s journey to the world, Caijing Magazine, 31 May 2011.

[38] BOCI Debt Capital Markets Weekly Update, BOC International, 8 June 2012.

[39] Dim sum bonds: out of favour, FT BeyondBrics, 29 May 2012.

[40] Fundings costs in offshore renminbi have now surpassed that of more traditional US dollar funding markets; Dim sum bonds: out of favour, FT BeyondBrics, 29 May 2012.

[41] Renminbi’s mysterious rise: trade finance or interest rate arbitrage?, FT BeyondBrics, 29 May 2012.

[42] Most recently in comments at the FX China 2012 conference, 7 June 2012, Shanghai.

[43] Maziad and Kang, RMB internationalisation: onshore/offshore links, IMF Working Paper, May 2012.

[44] Although, admittedly, whilst banks stand to lose out significantly via net interest margins, there is upside in potential fee income from foreign exchange services.

[45] Author interview, Beijing, November 2011.

[46] Author interviews, Beijing, November 2011.

[47] With regards to foreign policy, see: Jakobson and Knox, New foreign policy actors in China, SIPRI, September 2010.

[48] One think-tanker described it as ‘中庸之道’, seeking the middle way in confrontation. Author interview, Beijing, November 2011.

[49] Whilst recent depreciation pressure and more balanced capital flows highlight that the renminbi is nearing equilibrium through the short term, given China’s productivity gains, growth and interest rate differentials, the currency should have more to gain against the US dollar through the medium term.

[50] Kroeber, Arthur, The renminbi: the political economy of a currency, Foreign Policy, 7 September 2011.

[51] Author interview, Shanghai, June 2012.

[52] Subramanian, Arvind, The inevitable superpower, Foreign Affairs, September/October 2011.

[53] Subramanian, Arvind, Renminbi rules: The conditional imminence of the reserve currency transition.


Key Findings

  • Australia should pursue an annual strategic and economic dialogue with China at the Cabinet Minister level.
  • When elaborating on Australia's political and security challenges, political leaders should speak candidly about the uncertainties associated with China's rise.
  • Ideological differences should not deter Australian officials at all levels from trying to gain a comprehensive understanding of Beijing's intentions and the thinking of Chinese officials on contentious issues. Understanding is not synonymous with endorsement.

Australia-China ties: in search of political trust 

What is the problem?

Australia's political relationship with China is far less developed than its economic relationship. Senior Australian and Chinese political leaders do not meet regularly to discuss either regional issues or bilateral problems. This is detrimental to Australia's interests because China is both an economic power and a crucial political and security actor in the region. Underdeveloped political and strategic relations between Canberra and Beijing weaken Australia's ability to exert influence regionally. Australia risks being viewed by China's leaders merely as a provider of resources and – since the decision to base US Marines in Darwin for parts of the year – a junior partner of the United States. Moreover, there is a danger that problems in the bilateral relationship could escalate into a crisis due to the lack of familiarity and political trust between key Australian and Chinese decision-makers.

What should be done?

Australia's Prime Minister needs to clearly state Canberra's desire to build substantial political ties with Beijing with the goal of increasing political trust. Australia should pursue an annual strategic and economic dialogue with China at the Cabinet Minister level, with three strands: political, defence and economic. A fixed and regular forum with substantive working groups in each strand would over time increase clarity about each side’s intentions and allow officials to improve communication.



How Canberra should manage its relations with Beijing, given the importance of China economically, politically and militarily, is a question which divides Australians. There is general agreement that the rise of China will have a profound effect on the well-being and security of Australia. The consensus ends there.

Some maintain that a nearly exclusive focus on the economic dimensions of the relationship has detrimental consequences. These include the risk of Australia falling short of achieving the regional influence it aspires to and Australia being perceived as unable or unwilling to pursue an independent foreign policy. Furthermore, if political and strategic relations remain underdeveloped, it is conceivable that Canberra and Beijing will be unable to resolve problems within the economic relationship which inevitably emerge from time to time.

Others maintain that because Australia and China do not share values it is not in Australia's interest to forge close political and military ties with a one-party authoritarian state. China is above all an economic partner of Australia and should remain just that. There are also Australians who see no reason for Canberra to desire a meaningful political and strategic relationship with an emerging strategic competitor of the United States, Australia’s close ally.

No serious observer of Australia-China relations questions the importance to Australia of its strong commitment to the US alliance. Rather, opinions vary regarding the degree to which Australia should simultaneously commit to a non-economic partnership with China and how it should go about doing it. Put more bluntly, considering the uncertainties and even anxieties that China's growing power evokes, is it possible to hedge against the potential negative consequences of China's rise while at the same time striving for genuine trust with China? At present, Australia pays lip service to the notion of building trust with China by public assurances that Canberra wants to have both an ally in Washington and a friend in Beijing.[2] Senior political leaders in Canberra repeat Washington's mantra that President Barack Obama's decision to ‘rebalance’ toward the Asia-Pacific does not target China, when in Beijing it is perceived as doing precisely that.[3] Why emphasise the rotation of US marines when everyone – Chinese officials included – know that the marines are based in Darwin during the months when the climate is most suitable for them to train there? Why insist that Australia's and the United States' decision to strengthen defence cooperation is not about China?

Australia and China in the Indo-Pacific century

If Australia seeks to be perceived as a constructive and innovative regional power, it is in Australia's interest that its political leaders pave the way both at home and abroad for a more candid discussion of Australia's political and security challenges as a result of China's rise. This demands reinforcement by Australia's political leadership that Australia pursues a foreign policy which takes into account Australia's own needs. This also requires avoiding phrases which lack genuine substance. A more constructive starting point is the acknowledgement that China's growing political and military power gives rise to anxieties because no one knows with certainty how China will use its power. And because China's policy-making processes are not transparent there is a lack of trust among Australians, as highlighted by the 2012 Lowy Institute poll, that China's intentions are entirely benign. [4]

A fundamental transition of economic, political and military power is underway in the Indo-Pacific region. At the same time, interdependence among countries has grown exponentially. Both trends will transform the region's bilateral relationships and multilateral governance architecture, as well as the way people across the Indo-Pacific region live and think. Of course, India's and Indonesia's growing economic, political and military power will also affect Australia's future, but not to the same degree as will China. China is more likely to determine Australia's prosperity in the 21st century than any other country.[5] Additionally, the degree of transparency in India and Indonesia is higher than in China, dispelling to a greater extent concerns among Australians about the intentions of those two regional powers.

Beijing's leaders are aware of the anxieties which China's rise causes. In private conversations in Beijing, Chinese officials from section heads all the way up to the minister level acknowledge that they too are uncertain about what kind of a power China will evolve into during the next few decades – despite official assurances of Beijing's pursuit of a harmonious world and peaceful development. This Policy Brief recommends that Australian political leaders, when elaborating in public on Australia's security needs, speak about these uncertainties, even anxieties, with regard to how China will use its power.

Admittedly, this is a tall order for any political leader because of the extremely fine line which must be drawn between speaking of uncertainty, anxiety and fear, on the one hand, and demonising China, on the other hand. Realpolitik requires well-informed, agile, thoughtful and far-sighted political leaders. Every country in the region is struggling with a similar China challenge. Australia can be a trail-blazer in the way in which it conducts both public diplomacy and traditional quiet diplomacy in this demanding and increasingly volatile strategic environment.

Australia's China rhetoric

Over the past 15 years no Australian political leader has defined the building of political trust as the foremost goal of Australia’s engagement with China. John Howard advocated that the countries focus on their convergent interests, namely economic interaction.[6] But as Prime Minister, Howard lived in a different era. China was not yet the major political and military power it is today, nor did China contribute to Australia's prosperity to the same extent it does today. When Howard took office in 1996, Australia's exports to China constituted less than five per cent of Australia's total exports.[7] Today, over a quarter of all exports are to China. Howard's successor, Kevin Rudd, attempted to leap straight into a relationship with China which is reminiscent of one between the best of friends, overlooking that close friendship is based on many years of mutual achievements and shared experiences. Rudd's emphasis on human rights in his maiden public speech in China prior to initiating mechanisms for establishing political trust simply alienated Beijing. The Gillard government, in turn, has repeatedly fallen back on the platitudes that Australia seeks robust economic ties with China and a relationship which contributes to a peaceful and stable region.[8] Th[9]e government's confidential high-level China strategy which Rudd approved before leaving office has not, in the two years since, led to a more meaningful political and strategic relationship with Beijing.

A central goal in the government’s forthcoming White Paper on Australia in the Asian Century should be to answer the question, ‘What does Australia want from China?’[10]  Canberra needs to build its relationship with Beijing on the basis of its own national interests. At present, Beijing perceives Australian strategic objectives as being defined nearly exclusively through the prism of the US alliance. Australia should seek meaningful political and strategic ties with China which would enable Canberra and Beijing to candidly discuss and find mutually acceptable ways to manage diverging stances between the two countries on several complex but vital bilateral and regional issues.

One such bilateral issue concerns the legal status in China of Australians and their right to be treated in Chinese courts as Australian citizens, regardless of whether or not they were born in China. When Foreign Affairs Minister Bob Carr in May 2012 raised the cases of three Australian citizens, all sentenced to long prison terms in China, Carr said that he was told by his counterpart Yang Jiechi that China does not recognise dual nationality. These cases highlight concerns that Australians are treated differently if they are naturalised Australian citizens of ethnic Chinese descent.[11] It is imperative that these concerns be discussed with Chinese officials at the most senior level.

An equally sensitive and important regional issue is China's desire to be more directly involved in sea-lane protection in the Western Pacific, which stems from China's resource insecurity. Australia’s approach could be to first pursue talks on this issue bilaterally, both with China and other countries in the region, including the United States, to establish a comprehensive understanding of each country's specific goals, capabilities and constraints, and only then pursue the issue at a multilateral forum. This should initially take place at semi-official meetings which enable mid-level officials and non-governmental experts to explore novel but possibly contentious approaches.

Canberra is in an advantageous position to engage with Beijing on key regional questions because Australia is a peripheral actor in China's 'near waters' – even though Australia would be affected if sovereignty disputes between China and its neighbours in the South and East China Seas resulted in military conflict and the consequent disruption of sea lines of communication. Australia could genuinely advance regional stability as an honest broker because it does not have emotionally driven territorial disputes with China, unlike Japan, South Korea, Vietnam, the Philippines, and India, for example. But this requires Australia being perceived by China as an honest broker with an independent foreign policy.

Neither of these two issues, described here merely as examples, can be resolved without political familiarity and trust at the most senior levels of government. This will require years of effort and a strong foundation.

Regular summit meetings

This Policy Brief further recommends that Australia strive to build meaningful political and strategic ties with China based on the premise that it is in Australia's interest for officials at all levels to have a comprehensive understanding of Beijing's intentions, its policies and the thinking of Chinese officials on contentious issues. Understanding is not synonymous with endorsement. To quote Richard Woolcott: ‘Just as alliance does not equate to compliance, understanding does not equate to agreement.’[12]

High-level meetings which are fixed and occur at regular intervals provide a platform for senior leaders to meet regardless of their differences and regardless of the ups and downs which are inevitable in bilateral ties. They offer leaders a chance to shape their counterparts' perceptions and possibly even decisions. They also compel lower and mid-level officials to do their utmost to work through divergent views. When problems in the bilateral relationship occur, leaders who know each other can engage more frankly with their counterparts than those who are not well-acquainted.

A case in point is the success American and Chinese officials had earlier this year in handling two extremely sensitive cases of Chinese citizens turning up on the doorstep of American diplomats in China, seeking the protection of American authorities. The request for political asylum by former Chongqing police chief Wang Lijun just before the visit to Washington by China's President-in-waiting Xi Jinping and the plea by blind legal activist Chen Guangcheng to receive help in relocating to the United States amidst the Sino-US Strategic and Economic Dialogue (SED) could have caused a serious diplomatic rift had not Assistant Secretary of State Kurt Campbell and his Chinese counterpart Cui Tiankai had such a long history of talking to one another – about tough issues. That both cases were resolved without major damage to Sino-US ties attests to the maturity of the relationship. This can only be achieved through a commitment by both countries' most senior leaders to maintain constructive relations, constant engagement, and a willingness by both sides to communicate on any and all contentious issues.

Another case in point is the adverse effect the Stern Hu case in 2009 had on Australia-China relations. Several Australians and Chinese who were involved in handling the case following the arrest of the Rio Tinto manager by the Chinese authorities have said in off-the-record conversations that relations would not have spiraled downhill so rapidly had there been better communication between the two sides, and ‘if a senior leader would have known his counterpart well enough to pick up the phone and discuss the problem’.

China and the United States do not share common values when it comes to human rights and the need for accountability and transparency in governance, but this has not deterred each side from trying to gain an understanding of its counterpart's position nor from explaining their respective stances. There are over 60 regular dialogues in place between China and the United States in addition to the SED.[13] If ideological differences do not deter the American government from regularly discussing a wide range of issues at the highest level with the Chinese government, Canberra should not be deterred either.

A further impetus for Australia to seek a structured, multifaceted dialogue with China at the highest possible level stems from the complexity of China's decision-making apparatus. China no longer speaks with one voice. Each of the 204 members of the Central Committee of China's Communist Party (and many of the 167 alternate members) has some political clout. To engage effectively with China on any given issue requires an understanding of the sometimes conflicting stances of numerous actors who have an input in the decision-making processes.[14] These include actors within the official establishment (senior officials within the Communist Party of China and the government of the People's Republic of China as well as high-ranking officers of the People's Liberation Army) and actors on the margins (executives of state-owned enterprises, senior officials of local governments, as well as media commentators and influential foreign and security policy specialists with ties to Central Committee members). In their attempt to have sway over top decision-makers, many actors try to influence each other and public opinion. Australians need to take into consideration that there are omnidirectional influences at play.

Australians have invested time and resources to understand and successfully work with the complexities of the American political system. Now is the time to invest in China knowhow.

A latecomer knocking on China’s door

Given China's increasing political and strategic influence, as well as Australia's desire to contribute as a middle power to maintain a stable regional and international order, it is inexplicable that Canberra engages in a bilateral strategic dialogue with Beijing at the modest level of vice-minister on the Chinese side and DFAT Secretary on the Australian side. This is symptomatic of the predominantly economic lens through which Canberra sees the present relationship. China continues to be viewed as a country that purchases Australian natural resources more than any other country,[15] whose students contribute to financing Australian higher education more than any other group of foreign students,[16] and whose tourists spend more money than any other country's citizens when they visit Australia.[17]

China has already indicated its desire for something more than a purely economic relationship.  When visiting Australia in 2010, Vice-President Xi Jinping announced five, admittedly vaguely articulated, steps which could boost relations.[18] More importantly, in a joint Australia-China report published in 2012, Cui Liru, an official of ministerial rank who has a direct communication channel to China's top leadership, wrote: ‘The strategic relationship between our two countries is clearly lagging behind the changes in the overall strategic situation in Asia and the Pacific. It is for this reason that it is a matter of pressing urgency as to how our two countries develop new forms of collaboration in the strategically complex environment of Asia and the Pacific so that the shift of global gravity will be more assured...’[19] Obama's speech in Canberra in November 2011 and the Darwin announcement put Australia on the radar screen of Chinese strategic thinkers. While previously Australia was perceived in Beijing as a rather innocuous player in regional security, in the past six months Chinese security and defence analysts have shown an interest to more clearly understand Australia's strategic intent.[20] Recurring high-level meetings between the countries' senior leaders would give Australians an opportunity to convey Canberra's thinking on the Australia-US alliance.

Energetic defence cooperation

Interestingly, on the defence side, Australia and China have developed cooperation more energetically than in the political sphere (see Table 1 in Appendix). Since 2004, Australian Defence Forces (ADF) and the People's Liberation Army (PLA) have participated in six joint exercises (although most were naval exercises limited in scope). The Chief (or Deputy Chief) of Staffs have held annual talks since 1997. PLA officers receive training in Australia. The Royal Australian Navy (RAN) has paid ten ship visits to mainland China.[21] The long list of interaction between ADF / RAN and the PLA / PLAN looks impressive, but in research interviews for this Policy Brief, Australian defence officials conceded that on substantive issues defence cooperation has hitherto merely scratched the surface. The present level of engagement between ADF and the Indonesian defence forces (TNI) should be a goal. However, though the Australian-Chinese defence relationship has the potential to expand, it cannot progress much further without the foundation for political trust being laid.

Unfortunately, Canberra will now discover that it is a latecomer knocking at Beijing's door. China will not readily consent to a strategic dialogue at the level of Cabinet minister. Numerous countries, including Canada, are making similar requests, and Beijing is increasingly reluctant to commit senior leaders' time. Among G-20 nations, Cabinet ministers of the European Union, Germany, India, Indonesia, Russia, Saudi Arabia, the United Kingdom and the United States already have regular strategic dialogues with their Chinese counterparts.[22]

There are presently ten agreed-upon regular dialogues or consultations between Australian and Chinese officials on issues including climate change, defence, higher education, human rights, resource exploration, strategic issues, tourism and trade (see Table 2 in Appendix). There are also scores of ad hoc meetings between officials and academics from both countries on an even wider range of issues. But this is simply not enough.

Recommended first steps by the Australian government include:

  • A statement by Australia's Prime Minister that Canberra seeks meaningful political and strategic ties with Beijing in order to build political trust between the two governments.

  • Initiation of an annual, structured high-level strategic and economic dialogue with China. The dialogue should be held at a minimum at the Cabinet Minister level and include three strands: political, defence and economic.[23]

  • Avoidance by political leaders of meaningless rhetoric when speaking about the uncertainties of how China will use its power.

  • Establishment of an annual, comprehensive exchange program for the next generation of Australian and Chinese leaders, which provides small group lectures and discussions on political and security issues (not trade). The exchange program should target younger Australian state officials, members of parliament and party officials, on the one hand, and vice governors and deputy party secretaries in China's provinces and mayors of major Chinese cities, on the other hand. These are the people who in the next ten years will rise to paramount positions of power in China. It would be in Australia's interests that at least one of China's top leaders in 2022 has an intimate knowledge of Australia and long-standing personal relationships within Australian elite circles.

  • Inclusion of China in proposed multi-national disaster relief and humanitarian assistance exercises involving Australia, Indonesia and the United States.[24] After two or three rounds of multi-national exercises Canberra should extend an invitation to China for PLA forces to ‘be rotated in and out’ of Darwin to jointly continue disaster relief and humanitarian assistance training with the ADF.[25]

  • Commitment of resources to substantially strengthen Australia's diplomatic presence in China.

  • Establishment of an annual 'strategic security dialogue' on contentious bilateral and regional issues in the political and strategic spheres among senior staff of leading Chinese and Australian security and defence 'think tanks' as well as mid-level security and defence officials of both countries. (The United States and China held a similar 'strategic security dialogue' for the second time in conjunction with the Strategic Economic Dialogue in May 2012.[26])

  • Commission an in-depth study of the strategic and defence community in China. Several Australian officials stress the need to obtain a clearer picture of the multilayered structure of the strategic and defence community in Beijing. This would also facilitate a more nuanced interpretation of statements and articles by Chinese strategic analysts and military officers.

  • Commitment of resources and incentives for Australian diplomats and military officers to acquire necessary language proficiency. Far more Chinese officers come to Australia than Australian officers go to China for military education, due to a lack of Mandarin skills.

  • Commitment of resources to support Australians to pursue undergraduate and postgraduate studies in Chinese politics and strategic thought at Chinese institutions of higher learning.







[1] This Policy Brief focuses on steps which the Australian government should take to improve political and strategic relations between Australia and China, while acknowledging that much could also be done to deepen trade, investment, societal and cultural ties between the two countries as well as strengthen Australia's other key relations in the region.

[2] Gillard seeks to reassure China on US presence, Sydney Morning Herald, 19 November 2011.

[3] Smith, Stephen, Interview with Barrie Cassidy, ABC, 3 June 2012:

[4] Hanson, Fergus, The Lowy Institute poll 2012: Australia and New Zealand in the world – public opinion and foreign policy, 5 June 2012, pp 3, 12. Compared to Australia’s relatively warm view of the United States and Japan (71 and 70 respectively), Australians rated China at 59 (below both Malaysia and South Korea). The poll also highlights Australian views towards Chinese investment, stating 37% of respondents thought Australia was allowing too much Chinese investment in Australia because ‘it is hard to trust China’.

[5] Dupont, Alan, Living with the dragon: why Australia needs a China strategy, Lowy Institute Policy Brief, June 2011, p 3.

[6] The Howard government introduced the concept of 'strategic economic partnership' with China in its 2003 foreign affairs white paper. See Uren, David, The Kingdom and the quarry: China, Australia, fear and greed, Black Inc., 2012, pp 114-116.

[7] When Howard left office in 2007, Australia's exports to China made up 13.6 per cent of total exports. Australian Bureau of Statistics, Yearbook Australia, 1997 and 2008 – International accounts and trade.

[8] ABC Radio Australia, ANZUS military ties and China, Jim Middleton interview with Prime Minister Gillard, 22 November 2011:

[9] China imports about 55 % of its oil. See e.g. Kennedy, Andrew B, China’s new energy security debate, Survival, 52(3) June-July 2010.

[10] Dupont, Alan, Living with the dragon, p 10.

[11] Wen, Philip, Jailed executives are Chinese, Carr told, The Age, 15 May 2011.

[12] Woolcott, Richard, How a US ally can be friends with China, Sydney Morning Herald, 12 March 2012.

[13] An excellent overview of the United States’ engagement with China is: Lawrence, Susan V and Lum, Thomas, US-China relations: policy issues, Congressional Research Service Report R41108, 11 March 2011, tables A-2 and A-3, pp 32-33.

[14] Jakobson, Linda and Knox, Dean, New foreign policy actors in China, SIPRI Policy Paper 26/2010.

[15] Australian Bureau of Statistics, Yearbook Australia 2012 – International accounts and trade.

[16] Australian Bureau of Statistics, Australian social trends, December 2011. Chinese international students receive approximately 20% of all student visas granted in Australia, the largest by volume, leading India (12%) and South Korea (5%). In terms of total international student enrollments in Australia, China accounts for more than one quarter (27%).

[17] Tourism Research Australia, International visitors in Australia – March 2012 quarterly results of the international visitor survey, 6 June 2012. China is the third largest source of tourists in Australia (behind New Zealand and the United Kingdom). However, Chinese tourists have the largest total inbound economic value (TIEV), spending on average $3.5 billion in Australia annually (around $900 million more than visitors from the United Kingdom).

[18] Xi Jinping’s five steps included increasing mutual trust, expanding cooperation, enhancing people-to-people and cultural exchange, and properly handling sensitive issues. See Embassy of the People’s Republic of China in Australia, Xi Jinping, Kevin Rudd call for boosting China-Australia ties, 21 June 2010:

[19] Australian Centre on China in the World and China Institutes for Contemporary International Relations, Australia and China: a joint report on the bilateral relationship, February 2012. The report is co-authored by writing groups at the Australian Centre on China in the World, ANU and the China Institutes of Contemporary International Relations, CICIR, Beijing. Cui Liru is the President of CICIR, one of China's most influential security policy research institutions under the Ministry of State Security. Cui's position is unique among Chinese research institute heads because he has direct access to President Hu Jintao. See Jakobson, Linda and Knox, Dean, New foreign policy actors in China.

[20] Since moving from Beijing to Sydney in April 2011, the author has met with Chinese security policy officials in Beijing on four visits (May, October 2011; March, May 2012).

[21] Compiled from data on websites of the Ministry of Foreign Affairs and Ministry of Defence of the People’s Republic of China as well as information provided by the Royal Australian Navy.

[22] Information retrieved from relevant foreign ministry, embassy and news service websites. All countries listed have regular bilateral strategic dialogues with China at the Cabinet Minister level or above, except Saudi Arabia. Saudi Arabia’s Foreign Minister is part of the regular strategic dialogue between China and the six-member Gulf Cooperation Council.

[23] Geoff Raby, Australia's Ambassador to China 2007-2011, elaborates on the structure of a high-level dialogue mechanism in his submission to the Asia Century White Paper. He also advocates that the Business Roundtable could be timed to coincide with the Strategic and Economic Dialogue. Raby's submission is available at:

[24] Smith, Stephen, Speech in the plenary session on deterrence and regional security, Shangri-La Dialogue, 2 June 2012: A major outcome of the first Australia-Indonesia Foreign and Defence Ministers (‘2+2’) Dialogue in Canberra in March 2012 was the idea  of conducting  a trilateral Australia-Indonesia-United States humanitarian assistance and disaster relief exercise off Darwin within the East Asia Summit’s humanitarian assistance and disaster relief framework.

[25] It is possible that China will initially refuse an invitation to join the ADF in joint exercises, and even in the event that it accepts, it will probably first send observers. China has in the past refused an invitation to join the biennial multilateral Kakadu maritime exercise. See Medcalf, Rory, Unselfish giants: understanding China and India as security providers, Australian Journal of International Affairs, 65(4) 2011, pp 1-13.

[26] The strategic security dialogue is jointly chaired by a US Deputy Secretary of State and Chinese Vice-Foreign Minister. See Xinhua News, China, US hold second strategic security dialogue:


Table 1: Formalised dialogues between Australia and China

Table 2: Military exchange and joint exercises between Australia and China*




Australian Principal(s)

Chinese Principal(s)

First held

Most recent

Human Rights Dialogue

Deputy Secretary of DFAT

Vice Foreign Minister



Defence Strategic Dialogue

Secretary of Defence, Chief or Vice Chief of Defence Force

Chief or Deputy Chief of PLA General Staff



University Leaders Forum (formerly High Education Forum)

University leaders; ministerial involvement not yet determined

University leaders; ministerial involvement yet to be determined



Bilateral Resources and Energy Dialogue

Senior bureaucrats from Department of Resources, Energy and Tourism

Senior bureaucrats from National Development and Reform Commission (NDRC)



Consultation on Issues Related to Pacific Island Countries

Deputy Secretary of DFAT

Vice Foreign Minister



Strategic Dialogue

Secretary of DFAT

Vice Foreign Minister



Ministerial Dialogue on Climate Change

Minister for Climate Change and Energy Efficiency

Vice Chairman of NDRC, Minister responsible for climate change



High Level Economic Cooperation Dialogue (HLECD)

Minister for Trade

NDRC Chairman



Bilateral Health Policy Dialogue

Minister of Health; supported by AusAID

Minister of Health; supported by Chinese Ministry of Health



Bilateral Tourism Dialogue

Representatives from Tourism Australia and Australian Department of Tourism.

Representatives from Chinese National Tourism Administration
















Type of exchange




Ship visit

Three Royal Australian Navy (RAN) ships visit Qingdao



Ship visit

Three Peoples Liberation Army Navy (PLAN) ships visit Sydney



Ship visit

A group of RAN ships visit Shanghai



Ship visit

A RAN ship visits Shanghai



Ship visit

RAN ship HMAS Success visits Shanghai



Ship visit

A group of PLAN ships visits Sydney



Ship visit

RAN ship HMAS Sydney visits Qingdao




RAN ship HMAS Anzac visits Qingdao. Search-and-rescue drill. First joint exercise between RAN and PLAN


Shanghai & Zhanjiang

Ship visits

RAN guided missile frigate HMAS Canberra joins a brief exercise with a PLAN ship




Regional Counter Terrorist Subject Matter Expert Exchange. Participants: Australian Special Forces, Cambodia, China, India, Indonesia, Japan, Malaysia, New Zealand, Papua New Guinea, Philippines, Singapore, Thailand, US, Vietnam



Ship visit

RAN ships HMAS Parramatta and HMAS Perth visit Shanghai




Drill on communications, fleet formation, vessel supply, and search-and-rescue involving one RAN ship, one New Zealand RNZN ship and two PLAN ships



Ship visit

RAN ships HMAS Success and HMAS Pirie visit Qingdao


Qingdao & Zhanjiang

Exercise & ship visit

RAN ship HMAS Warramunga visits Qingdao. Joint live-fire exercise, joint helicopter operations, search and rescue drills and personnel exchange between ADF and PLAN


Tasman Sea


Joint manoeuvre exercise involving two PLAN ships and one RAN ship


Waters off the coast of Darwin


China-Australia joint maritime exercise and training involving two PLAN ships and one RAN ship




Disaster Relief Exercise involving ADF and PLA



Ship visit

RAN ship HMAS Ballarat visit marks 40th anniversary of diplomatic relations

* Only includes ship visits to mainland China (excluding Hong Kong).


















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