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The Strategic Calculations Shaping Sino-British Relations

The British government learnt a valuable lesson when Premier Wen visited the UK four years ago. In the run up to that visit Chinese officials were so pre-occupied by protocol issues that it was hard to engage them on substance. Last week during the state visit of President Xi the British government visibly accommodated Chinese demands for pageantry with a carriage procession, an address to parliament and a state banquet, while carefully linking this to issues of substance, at least behind the scenes. In return Prime Minister Cameron and the British government was able to show off in a different sort of parade, with a succession of announcements of Chinese investment in the UK.

There is, however, real substance in the deals that have been done, particularly in two areas. The first is energy. Britain has embraced Chinese investment in the sensitive civil nuclear sector. Cameron and Xi announced that China General Nuclear Power Corporation will take a one-third stake in the £18bn Hinkley Point project which will now begin construction. The British government is confident that it can manage any security risks, so confident in fact that it is keen to go further and adopt Chinese technology in the next wave of nuclear projects.

The other area is finance. This week the People's Bank of China issued Rmb5bn in one-year bills in London, in what was the first debt issue by the PBOC outside of China. This came just a week after the Agricultural Bank of China and China Construction Bank both sold renminbi bonds in London. Moreover, the Chinese Finance Ministry has signalled its intent to issue longer-dated renminbi bonds in London soon. There is now both breadth and depth to financial cooperation between the two countries, underlined by President Xi this week telling the British parliament that London is the leading off-shore renminbi trading centre "after Hong Kong."

Much has been said about whether the British government is getting a good deal or simply falling over in response to a domineering power, not just in the British media, but elsewhere in Europe and in the US. The analysis has been one-sided and has largely failed to probe what China is getting out of the relationship and what sort of calculation President Xi may be making. That is an unfortunate omission, after a state visit which has been extraordinary by Chinese as well as British standards.

Significant strategic decisions by China are evident in at least two areas. The first is in China's outward investment strategy and specifically the approach China is taking to penetrate western markets. Until now China has been circumspect in its choice of investments in western countries, both because of a limited appetite for risk and because its involvement in sensitive sectors is still regarded with suspicion by many countries. The £6bn investment in Hinkley Point and the promise by both sides of more to come in civil nuclear is a re-writing of the rulebook on both counts.

Perhaps even more profoundly, the Chinese appear to have bought the argument made by the British that by being seen to be a responsible and reliable investor in the UK this will open doors for China elsewhere, first in Europe, but then potentially also the US. This is not a trivial step. In some ways it is the familiar Chinese approach of policymaking by experimentation. But in this case the experiment is exposed to an international audience. This requires a substantial amount of trust on both sides.

The second strategic decision is in finance. The steps taken by China to issue debt and the statements made by President Xi are a coup for the British government and financial industry as they seek to make London the international home of Chinese finance. Until now the Chinese have been careful not to back a single international financial centre too strongly. That is partly out of a desire to create healthy competition between the many centres in Europe and elsewhere that are looking for a slice of the fast-growing renminbi business. It also reflects a reluctance to become too reliant on a single location for fear that this may create a source of strategic vulnerability in future. However, economies of scale and scope in finance mean this is inevitable at some point. The Chinese government took a large step closer to that point this week.

This is now a productive if not yet a fully mature relationship. Despite talk of win-win outcomes (or even 'triple-wins' when dealing with other countries) the diplomatic negotiations leading up the summit were still bruising and on occasion resembled a zero-sum process. UK negotiators have learnt the hard way to play the same game as the Chinese. The UK's positioning on China is, however, now much more open and strikingly differentiated from the US and many other EU countries. Prime Minister Cameron is calculating this will help to build trust and create increasing opportunities over time. President Xi this week said both countries are "increasingly interdependent" and talked of a "community of shared interests" and a "global comprehensive strategic partnership". The deepening strategic interdependence in the civil nuclear and financial sectors is a very visible sign of that.

Gregor Irwin was the Chief Economist of the British Foreign Office from April 2008 until December 2013.

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