The South China Sea OR Why a rusty ship matters to Australian businesses

The Philippine ship Sierra Madre in the Second Thomas Shoal in the Spratly Islands in the South China Sea is a rusty wreck. It was grounded in the shoal in 1999 in order to underline Philippine territorial claims in the region. Since then, it has been maintained as a small Philippine military outpost that requires regular resupplies and repairs in order to prevent it from falling apart.

These resupplies and repairs are increasingly becoming an issue. Over the last couple of weeks, Philippine ships attempting to deliver resupply and repair materials to the Sierra Madre were harassed by Chinese coast guard vessels that also turned water cannons on Philippine ships, injuring Philippine navy personnel. What appears to happen here is that China is attempting to prevent the Philippines from maintaining the Sierra Madre as a physical support to their territorial claims. If the Sierra Madre falls apart (which, without repairs, is only a question of a rather short period of time), Philippine territorial claims in the South China Sea take a severe hit and theoretically, China is free to move into the shoal themselves to occupy it.

One might now be tempted to think that rusty ex-World War II vessels in a shoal in the South China Sea (aka the Sierra Madre) shouldn’t be a concern to Australian businesses. However, the geopolitical context speaks a different language. Increasingly, said rusty vessel is becoming an issue of geopolitical concern. At the beginning of this week, according to official sources, US president Biden stressed towards Chinese President Xi Jinping that the mutual defence treaty between the US and the Philippines applies to Philippine sailors and ships and thereby also to the Sierra Madre. Bringing in the US on a conflict that only superficially deals with a rusty ship and under the surface extends to far-reaching territorial conflicts, significantly raises the stakes for all parties involved.

For Australian businesses, this matters in two ways. In terms of location, not only the Sierra Madre but all the territorial conflicts in the South and also the East China Sea raise serious supply chain questions. As Australian businesses prepare to re-engage with China (also see below), most of their products will be shipped through the region where these conflicts are playing out. It therefore pays off of keep a close eye on what is happening in the South and East China Sea to hedge against potential supply chain disruptions.

Additionally, on a slightly different note, there have been official declarations within the last week that the US, the UK and Australia are planning on cooperating with Japan under pillar II of the AUKUS agreement. This involves the development of advanced military capabilities (the nuclear submarine deal isn’t part of this, that’s pillar I of AUKUS). Furthermore, Australia engaged with Japan, the Philippines and the US in the Maritime Cooperative Activity. In the words of Australian Defense Minister Richard Marles “The Maritime Cooperative Activity with the Philippines, Japan and the United States demonstrates our firm commitment to work together to maintain a peaceful, stable and prosperous region.”

For businesses, that might initially sound like a positive and promising initiative. And if everything goes well, that’s exactly what it is. However, having seen the Chinese government’s willingness to weaponise trade and place import bans on Australian products in the past, it’s again a space that businesses should closely watch. China is not happy about American involvement in the territorial conflicts and it’s not happy about the potential expansion of AUKUS to include Japan. Like with the supply chain risks, businesses are well advised to watch the space and develop dedicated political risk management strategies to avoid become caught out if things don’t develop as hoped for.

 

On the positive side: Relaxing bilateral trade relations

In terms of positive news, the South China Morning yesterday had two encouraging pieces of news for those in Australia, who are hoping for a further improvement of relations with China. The Hong Kong-based newspaper indicated that Chinese prime minister Li Qiang will visit Australia in June. Official confirmation is still to follow, but according to sources with knowledge of the issue, the newspaper states that the visit is planned for the third week of June.

In addition to the visit, the same sources are also quoted as indicating that the export ban on live lobsters from Australia to China might be lifted. The South China Morning Post quotes one of them as saying that “it is also expected that the unofficial ban on Australian live lobsters will be lifted as a signal of resuming a normal and friendly trade relationship for both sides”. After the ban on wine exports was lifted last month, exporters of rock lobsters were hopeful that the ban on their products might be lifted soon, too.

These, albeit so far inofficial, announcements bear hope for Australian businesses that overall trade relations might further improve. There is the general desire to re-engage with China economically and get back into the Chinese market. In light of difficult relations over the last couple of years and increasing geo-political tensions that is a good sign. The Chinese market is too big and important to be ignored and there are ample business opportunities for Australian businesses, particularly healthcare and life science businesses as the Chinese population ages and China seeks to develops its “silver economy” (also see my blog contribution here: https://www.sinovise.com.au/blog-decliningpopulation).

However, at the same time, businesses are also well advised to keep on top of potential political risks they might encounter in their re-engagement with China. The last three and a half years as well as the heightened tensions in the South China Sea show that political challenges are the new normal of business relations with China. Having a dedicated management plan for political risks is advisable for businesses to avoid be caught in the rain as they prepare to re-engage with China.