Every week, The Diplomat’s editorial team scours the web to find the best material on all things China. From Beijing’s relations with its neighbors and growing military might, to a rapidly evolving economy and amazing arts and culture, we present a diverse grouping of articles for your reading pleasure.

Here are our top picks for this week. What did we miss? Want to share an important article with other readers? Please submit your links in the comment box below!

The Kunming city government in Yunnan Province has posted a statement “strictly” forbidding any demonstrations during the China-South Asia Expo next week. According to the Global Times, the statement “vows to punish violators severely.” Kunming has been the scene of two protests this month over a proposal to build a chemical plant nearby. GT quotes a local resident as saying that a larger protest has been organized to coincide with the opening day of the expo.

GT also reports that several travel agencies along China's border with North Korea in Dandong, Liaoning Province have said that local authorities have lifted restrictions on allowing tourism into the DPRK. The agencies said they had initially received a notice to seize providing guided tours in North Korea on April 10^th.

China released a policy directive on Friday that seeks to reduce the role of the state in the economy. The directive followed a bold speech on the same topic that was delivered by Premier Li Keqiang. Many experts are praising the directive as being both significant and bold.

Chinese director Jia Zhangke won the best screenplay award at the Cannes Film Festival for A Touch of Sin, a Chinese-language film “based on true events” that follows four individuals in China whose life is touched by corruption. Despite the subject matte,r the film will be shown uncut in mainland China, according to Jia, and will be released in the U.S. later this year.

The Washington Post reports that a confidential internal Pentagon report written by the Defense Science Board found that around two dozen major U.S. defense systems had been hacked by people in China. Wapo’s World Views blog has a description of the major systems mentioned in the Pentagon report. The Pentagon has dismissed the seriousness of the hack, prompting some to speculate the U.S. is feeding cyber hackers disinformation.

Also in U.S.-China relations this week, National Security Adviser Tom Donilon was in China from Sunday to Tuesday preparing for the meeting between Xi Jinping and Barack Obama in California early next month. While there Donilon met with Vice Chairman of the Central Military Commission Gen. Fan Changlong, Vice Premier Wang Yang, and President Xi Jinping among others. Cybersecurity is expected to feature prominently in the Xi-Obama summit next month. Meanwhile, the New York Times reports that China and the U.S. are both struggling to define what a “new type of great power relationship” truly means.

Bonus: James Mann has a lengthy profile of Tom Donilon over at Foreign Policy.

Meanwhile, China is the latest factor dividing the European Union.

As had been speculated, Chinese President Xi Jinping recently met with North Korean envoy Choe Ryong-hae on the last day of his visit to China, and accepted a personal letter from Kim Jong-un. The meeting has four noteworthy details, which may help illuminate the increasingly subtle nature of China-DPRK relations and perhaps even suggest trends on the Korean Peninsula.

First, the arrangements for the visit. The visit seemed hasty, but Pyongyang must have communicated with China through the embassy and the International Liaison Department to determine which Chinese officials would receive Choe.

Xi left Beijing for local visits one day before Choe arrived, raising questions about whether he would even meet with the envoy. This might indicate that China wasn’t considering the meeting when arranging Choe’s visit, but delayed a final decision until it got the response it wanted from Pyongyang. China has expressed some dissatisfaction with North Korea for exacerbating regional tensions, although the pressure has been restrained. Before meeting with the Chinese president, Choe had met with officials at all levels and visited Beijing's high-tech development zone. Overall, China appeared to be accommodating to Choe while subtly expressing its own position.

Second, we have Choe’s sartorial choices. On day one, Choe met with Wang Jiarui, Director of the International Liaison Department directly responsible for Sino-DPRK exchange. The next day, he met with Liu Yunshan, standing member of the CPC Central Committee, ranked No. 5 in the party and in charge of interparty diplomacy. This was a working-level conference. On the third day, Choe met with Fan Changlong, CMC Vice Chairman and a long-time figure in the Shenyang Military Region. This was likewise a working-level discussion in the military sphere. Although Choe has both a political and a military role in North Korea, on these three days he stayed in uniform.

But in his meeting with the Chinese president, it was notable that Choe opted for mufti, even as other DPRK military officials remained in uniform. That might seem a minor point, but Choe appeared to be underscoring his role as special envoy for Kim Jong-un while conforming to diplomatic etiquette and perhaps trying to elevate the status of the meeting.

Then we have Xi’s own utterances. The Chinese president was quite solemn when meeting with Choe, even when accepting a personal letter from Kim Jong-un. What he said was worth noting.

First, the statement that the "China-DPRK friendship is in line with the common interests of peoples of the two countries” reassured Pyongyang that it still had China’s support. Second, the remark that "denuclearization of the Korean Peninsula and lasting peace and stability represent the popular sentiment and the general trend" sent a clear warning to North Korea on its nuclear aspirations. Third, in mentioning exchanges between the DPRK and South Korea, the United States and Japan to "solve the problem through dialogue and consultation", Xi indicated that China will oppose military provocations by any side. Fourth, the call to "restart the six-party talks process (to achieve the denuclearization of the Peninsula) and make unremitting efforts for the lasting peace and stability (of the Peninsula and Northeast Asia)," expressed Beijing’s requirement that the DPRK return to the six-party talks and for the parties to sign a peace treaty that can replace the armistice.

Finally, we have Choe's reactions. Of course, his statements were made on behalf of North Korean leader Kim Jong-un. Choe said that North Korea cherishes its friendship with China and that it is willing to strengthen high-level exchanges, deepen communication, and develop friendly relations with China. This suggests more high-level exchanges to come, and that a visit to China by Kim is on the agenda. The remarks indicate how keen Kim is to avoid dissent with Beijing.

Commenting on the situation on the Peninsula and the nuclear issue during the meeting with Liu Yunshan, Choe repeated the expectation for "economic development to improve people's livelihood in the DPRK".

But the most important statement made by Choe came when he said that the DPRK is willing to make joint efforts with the parties concerned, properly solve related problems through the six-party talks and other forms of dialogue and consultation, safeguard peace and stability on the Peninsula, and take positive action. This implies that the DPRK will not only return to the six-party talks, but that it will also reach out independently to its neighbors, as seen for instance in the recent visit to Pyongyang by a Japanese envoy.

Overall, Choe’s visit to China is significant for the DPRK and good news for the region. It shows that the DPRK is normalizing two years into Kim’s rule. It also underlines China’s irreplaceable role in maintaining the security situation on the Korean Peninsula.

Xi Jinping has taken over the helm of China’s state apparatus as well as the Party, but where the new leadership will take the country remains uncertain. Recent developments give us an indication. Recently, the Party presented a new plan to reduce inequality and has implemented an anti-corruption campaign. This has – amongst other things – hit luxury goods sellers and upmarket restaurants hard. Mr. Xi has also made the “Chinese Dream” into the leitmotif of his politics in order to “realize the great rejuvenation of the Chinese nation.”  Other than this, identifying a direction has revolved around looking at the backgrounds, characters and objectives of the new leaders, in particular Mr. Xi, and to a lesser extent, Li Keqiang, the Party secretary.

But focusing on the individuals tells us little about their real ability to affect outcomes. Nor does it tell us much about the constraints within which they make their decisions – institutional, ideological or otherwise. Chinese politicians are often described as “reformist,” a term used in a manner that implies that these individuals will bring China closer to “us” in the West. Not only is this conception naïve in its notion of convergence to the Western model, it is also analytically useless in the Chinese context. In Mandarin, “reform” refers to the amelioration of existing structures and policies. It became the core concept of Chinese politics in 1979, after the death of Mao. Deng Xiaoping, China’s reformist leader from 1978 to 1992, proclaimed that China had been victorious in the revolution and in class struggle, and now needed to reform and modernize, in order to achieve its ultimate objective – becoming a rich and strong nation able to withstand foreign pressure.

In fact, this objective precedes the Communist government, dating from the 19th century, a disastrous one for China, given the foreign invasions and internal fragmentation. In the 21st century, it remains the central objective of the current leadership. When Xi refers to the “great rejuvenation of the Chinese nation,” or the “Chinese dream,” that is what he means. Reform, then, consists of the necessary steps to attaining this goal. As such, every Chinese politician at the higher level of the CCP is a reformist.

It is also important to understand that China is a consummate technocracy. The Party justifies its policies on the basis that they are the scientifically correct means to achieve both the main objective of self-strengthening, and the subordinate goals identified by the Party: economic growth, technological development, social and political stability and environmental protection (to some extent). Morality or an explicit reflection of the public interest do not play a significant role, outside of the fact that, in the same way that neoclassical economics postulate that maximization of aggregate welfare is always good, the Party proclaims that realizing the Chinese dream will somehow engender prosperity at the individual level.

This is not to say that the Chinese government doesn’t worry about the exceedingly high levels of inequality. It does. Both the Hu and Xi leadership have made reducing inequality a key priority. This is not justified, however, on moral grounds, where inequality is a wrong that must be rectified through social justice, but on technocratic and scientific considerations. According to their accepted development theory, inequality may cause China’s development to derail because it endangers social cohesion.

As a consequence, we must understand China’s reform efforts as a bid to rationalize both its economic and social structures, within a framework of strongly ideology-laden national rejuvenation. But what does that tell us about concrete policymaking? China’s economic governance structure provides us with a useful map to navigate the different areas of policy and gauge the potential for reform. The best place to start is the Foreign Investment Catalogue. The Catalogue is a bellwether of economic policy change, as it clearly indicates the strategic direction of the leadership in economic reforms. A list of industrial sectors, revised every few years, it divides the economy into three categories:

-- The first is the ‘encouraged’ category. Sectors falling under this heading generally do not need administrative approval for investment and preferential policies may be in place.

-- Second, under the ‘restricted’ category, it is necessary to apply for government approval, covering sections where the government, for different reasons, may want to limit foreign or private presence.

-- Third, under the ‘prohibited’ category, one finds sectors that the leadership feels are too sensitive to allow for uncontrolled capital flows. This includes social research, most media activities, power, postal activities and certain manufacturing sectors.

The same categorization could also apply in the field of policy reform under the new generation of leaders.

-- Under the ‘encouraged’ heading, we would find the objectives that the leadership is directly pursuing. At present, they seem to relate to urbanization, “informatization,” continuing agricultural modernization and the development of new technologies. They also include subsidiary policies, such as the reform of the hukou system, the registration system that make it impossible for migrant laborers to enjoy social services in the cities where they work.

-- The “restricted” category consists of policy initiatives that the leadership may want to take, but remain politically sensitive. Hence, here we often see small trial measures or the low-key implementation of new rules. One example of this is the recent education changes through the labor system. This is a much-maligned detention system for culprits of petty crimes. Announced a little while ago, reform measures are so far limited to the southern provinces of Guangdong and Yunnan.

-- Under the ‘prohibited’ category are matters the Party deems so central to its mission that no change is tolerated. Any discussion over their merits is prohibited. They include the “six no’s”: no ideological pluralization, no multiparty governance, no separation of power, no bicameral legislature, no federalism and no privatization. They also include matters pertaining to territorial integrity: Tibet, Taiwan and Xinjiang, along with the Diaoyu Islands spat with Japan.

Where does this leave us? Obviously, even in authoritarian China, the leadership doesn’t have a free hand. Beijing’s ability to get things done at the local level is notoriously weak, and power relations within the post-18th Party still have to crystallize. This is especially true at the top. Crises will naturally pop up – and indeed, already have – requiring Mr. Xi to govern through improvisation. Furthermore, there is no single political spectrum: a free-marketeer may turn out to be highly xenophobic and believe strongly in coercive measures to maintain stability.

Nonetheless, the central leaders exhibit a relatively strong consensus on most political preferences. If they did not, they wouldn’t have made it to the Standing Committee. Not even Mr. Xi, who is often described as a more open, affable person than the wooden Hu Jintao, is different in this regard. Hence, to find out where China is going, it is necessary to look past the surface of personal character and try to identify the core drivers of Chinese policymaking.

Dr. Rogier Creemers is a Rubicon Scholar, researching Chinese media law and policy at the Programme for Comparative Media Law and Policy at the University of Oxford. He is also co-editor of OxOn China, collaborative project between Politics in Spires and the Oxford China Centre, where this piece initially appeared.

The recent dispute between Taiwan and the Philippines over the killed fisherman has been useful in shedding light on Asian nationalism, particularly that of Greater China. Specifically, it has shown some of the ways in which nationalism cuts across the Strait, from Taiwan to the People’s Republic of China (PRC), as much as it faces out to the rest of the region.

After all, whether you are from Beijing or Taipei the great father of modern Chinese nationalism is Sun Yat-sen. In the “Three Principles of the People” Sun delivered the canonical message of China’s destiny, which he defined as seeking nationalism, democracy and livelihood. Perhaps more than any other modern figure, he articulated the key elements of Chinese national identity. That he is respected and revered in both the Republic of Taiwan and the PRC shows a profound common linkage, despite the very real political differences that exist between the two.

That the Philippines’ handling of the crisis has been criticized in Taiwan for laxness, a lack of sensitivity and diplomatic discourtesy is understandable. Disagreements about tragic, contentious issues like this most recent one are all too frequent between states, and a diplomatic machinery has rightly developed to handle these tough issues precisely so they don’t threaten to get out of hand. Even so, the strength of public and media responses in Taiwan shows that, democracy or not, the Taipei’s nationalism can be every bit as unsettling as mainland China’s nationalism over issues with Japan.

Still, most Westerners and U.S. allied nations assume the worst every time there are angry protests in the PRC over some perceived Japanese transgression, taking these events as signs of a new “muscular nationalism.” Despite Taiwanese nationalism becoming so emotional and fervent during the most recent Philippines incident, it has been often perceived by these same observers as much more benign.

This underscores how Westerners and much of the region views Mainland China’s nationalism as way more pernicious than nationalism anywhere else in the region, including Taiwan, despite the fact that they clearly have common roots.

Why is this?

Some of the Taiwanese media and the public commentary has been every bit as threatening and deafening towards the Philippines as that emanating from across the Strait. And the ways in which some nationalists on both sides of the Strait have used similar language has also been revealing. Indeed, Xi Jinping’s advisors in Beijing must be wondering how they can do more to recruit countries like the Philippines to push Taiwan and the PRC closer together! The fisherman’s death has created a common cause where previously too much difference prevailed.

Of course, our assumption is that democracies can and should handle these moments of strong unified public emotion, and that they are better equipped to prevent public sentiment from getting out of control than the PRC, where all too often public anger and resentment bubbles over and ultimately gets dealt with by state violence and autocratic edict. Even so, events over the last few months have shown fascinating new dynamics in the relationships between countries in the region, and have been a useful antidote to this facile idea of a prevailing commitment to Asian values that in the end trumps everything else. What we really see is not so much Asian values as nationalistic ones – and ones that are likely to prove extremely volatile in the years ahead as nations simultaneously become more competitive economically, more powerful, and more interlinked. 

Kerry Brown is Executive Director of the China Studies Centre at the University of Sydney, and Professor of Chinese Politics. He was previously Head of the Asia Programme at Chatham House. He leads the Europe China Research and Advice Network (ECRAN) funded by the European Union (www.euecran.eu).

An official announcement on May 21 revealed that Chinese President Xi Jinping will be visiting the United States in June, where he will meet with U.S. President Barack Obama at a Californian retreat. The visit is a fitting end to the first round of diplomatic outreach by the new Chinese leadership.

Qin Gang, a spokesperson for the Chinese Ministry of Foreign Affairs, announced the itinerary for Xi’s second overseas trip since taking office. Qin said that the president would be visiting three countries – Trinidad and Tobago, Costa Rica, Mexico – from May 31 to June 6, and would then meet with Obama at the Annenberg Retreat in Rancho Mirage, California on June 7-8.

The highlight of the trip is undoubtedly the Sino-U.S. summit. According to Qin, the two leaders will “have an extensive and in-depth exchange of views on bilateral relations as well as international and regional issues of common interest. It is believed that this meeting is important to the long-term, sound and steady development of China-US relations as well as regional and international peace, stability and prosperity.” Qin also noted that National Security Advisor Tom Donilon will visit China from May 26 to 28, to prepare for the summit.

This news has been quite sudden, but it allows us to identify some characteristics of current Sino-US relations.

First, it was interesting to note how little coverage of the visit there was prior to the official announcement, even in the usually well-informed international media. In fact, the summit is to be held somewhat earlier than expected. That suggests both sides were careful in their preparations and attention.

Second, the fact that planning for the visit involves the U.S. National Security Advisor and his counterparts in China indicates that security is an important objective of this visit, rather than the usual focus on general political, economic and cultural issues that might be associated with a state visit.

Third, Xi visited the U.S. in February 2012 when he was vice president. The upcoming visit is coming only just over a year later and only two months after taking office. That’s quite unprecedented in the context of bilateral relations. Former President Hu Jintao took office in March 2003, but didn’t visit the U.S. until three years later in April 2006. Jiang Zemin became president in March 1993, and made his first U.S. visit four years later, in October 1997.

Finally, this is not a state visit. Xi and Obama will meet at the Annenberg Retreat in Rancho Mirage, California. The arrangement suggests a degree of maturity in the Sino-U.S. relations, and a chance to take the relationship to a new level.

Xi Jinping’s visit is the climax of a wave of diplomacy that has taken place in the 100 days since the new Chinese leadership took office.

Over the past three months, top Chinese officials including President Xi Jinping, Premier Li Keqiang, Vice President Li Yuanchao, State Councilor for Foreign Affairs Yang Jiechi, and Foreign Minister Wang Yi have all taken trips abroad. Destinations have encompassed Africa and Latin America; Russia, Germany and other major powers, Tanzania and a number of smaller countries; both India and Pakistan as well as other Chinese neighbors; and traditional friends such as Venezuela.

Xi opened his travels with Russia, and so the U.S. trip is a fitting bookend. These visits underscore the importance Beijing places on relations with both Moscow and Washington, and its interest in keeping those ties steady. It also offers evidence of China's commitment to multi-faceted – or “all-directional” – great power diplomacy. 

Over the last couple months, China has had record-breaking problems with pollution.  This past January, Beijing’s air pollution (PM 2.5) readings reached 886µg/m3, far surpassing the Environmental Protection Agency and the World Health Organization’s standards for acceptable air quality. In fact, pollution has become so bad that some Chinese experts have said it is worse than SARS.

But for all the attention air pollution has received, it’s quite likely that water scarcity will prove to be China’s more vexing problem. Fortunately, the government is taking proactive steps to help prevent a water crisis.

China faces a pressing shortage of usable water. The China Daily reports that over 400 cities have a deficiency of water while 110 of them face serious shortages of water. The problem is exacerbated by water pollution, which further reduces the availability of usable water. As Elizabeth Economy has noted, “Up to 40 percent of China’s rivers were seriously polluted and 20 percent were so polluted their water quality was rated too toxic even to come into contact with.”

China’s water shortage has the potential to disrupt its development and worsen existing social tensions. It also constrains Beijing’s ability to exploit certain opportunities like shale gas.

But the Chinese government is cognizant of the challenge and is actively seeking to address it. In its most recent  Five Year Plan (2011-2015), for example, the government pledges to “reverse the trend of ecological degradation from the grassroots by implementing major ecological restoration and bolstering natural forest conservation and reforestation.” It also promises to address “desertification and soil petrification” while preserving grasslands and wetlands. The plan says the government will “accelerate the establishment of ecological compensation mechanisms and the protection of major ecologically functional areas” and will “reinforce water and soil conservation by promoting sand consolidation.”

This isn’t merely hollow rhetoric. Forest Trends, a global non-profit, published a recent report focusing on investments in watershed projects around the world that found that China accounted for 61 of 205 active watershed investment programs in 2011, second only to the U.S.’ 67 active projects. In terms of dollars amount China is likely ahead of the U.S. As the report explains: “China represents the lion’s share of reported payments [worldwide] as the country’s leadership has increased funding for ‘eco-compensation’ mechanisms and placed eco-compensation in a key role in the most recent national Five-Year Plan.”  

In fact, China’s growing investment in watershed projects has helped keep global levels of investment steady despite declines in other areas of the world. As Forest Trends notes, China’s aggregate investment in ecological infrastructure has “more than offset falling investments in ecological infrastructure in North and Latin America, traditionally global leaders in funding watershed protection.”

China’s eco-compensation strategy reaches into all echelons of Chinese society, with the report noting that the government has focused on “compensation and cooperation between government bodies and households, communities, and other arms of government” to address problems stemming from ecological degradation. That being said, much of China’s water scarcity policies aim in part to offset rising social disparities that economic development has created, while also fostering more sustainable development.

A good example is the construction of three additional reservoirs on the Yellow River. The reservoirs – Guxian, Qikou, and Heishanxia – will be built over the next two decades and, once completed, will help improve “water and silt control, flood prevention, water and soil erosion prevention, water resource allocation and utilization, water resource and water ecology protection, and the drainage areas’ comprehensive management.” The director of the Yellow River Conservancy Commission of the Ministry Water Resources, Chen Xiaojing, has noted optimistically that, “The development, protection and management of the Yellow River will have strategic significance for the promotion of China’s sustainable development and environmental protection efforts.”

Another project currently underway in Zhuhai City, Guangdong province requires that polluters pay compensation directly to the victims of their activities. According to the Forest Trends report, this program was implemented to help those living in the area to more easily benefit from Guangdong’s “economic reforms, industrialization, and the results of modernization.”  In 2009, the city reserved US$106 million for the Zhuhai City Drinking Water Source Protection Area Support and Incentive Instrument program, which provides “health insurance for 108,000 rural residents in the drinking water source areas as non-cash compensation for foregone livelihood benefits.”

Thus, there are important socioeconomic benefits to these ecological investments, in addition to protecting important water resources. Forest Trends, for instance, “tracked 54 programs that report explicit social objectives, exhibiting a variety of social goals” and found that “nearly half of these are in China, where eco-compensation can be considered in part a rural welfare support program to more evenly distribute benefits of economic growth to poorer regions of the country.”

The report also mentions that such investments can help contribute to community development, by improving incomes and food security while reducing income inequality. As this underscores, addressing water security can translate into greater social stability in rural China. After all, along with local land grabs many rural protests stem from water scarcity and pollution issues.

Thus, addressing water security can boost government legitimacy while also helping advance key objectives of the Chinese government, including accelerating the pace of urbanization. As China Daily notes, “It may be costly to include water conservation, the protection of drinking water sources, the effective treatment of sewage and efficient use of treated water as well as the collection of rainwater in urban planning, but it will be even more costly when we realize a decade later that the lack of water threatens our existence and we have to make up for what we failed to do 10 years earlier.” 

Elleka Watts is an editorial assistant at The Diplomat.

Every week, The Diplomat’s editorial team scours the web to find the best material on all things China. From Beijing’s relations with its neighbors and growing military might, to a rapidly evolving economy and amazing arts and culture, we present a diverse grouping of articles for your reading pleasure.

Here are our top picks for this week. What did we miss? Want to share an important article with other readers? Please submit your links in the comment box below!

During his trip to India Premier Li Keqiang published an op-ed in The Hindu calling for a “Handshake Across the Himalayas,” as the headline put it. While in India Li pledged to narrow the trade deficit between the two countries and said his time in the country helped expand “strategic trust.” As always, how these powers get along in the weeks and months after a high-level visit will be more telling than what was said at the visit. For what it’s worth, the vast majority of Indians (83 percent) view China as a security threat while 63 percent of Indians want to expand ties with Beijing, according to a new poll by the Lowy Institute. Li is off to Pakistan followed by stops in Europe. For more on his trip, check out these posts from earlier this week.

Chinese artist and political activist Ai Weiwei has a wide-ranging interview with Playboy (link is to interviewer’s personal web page) and a new music video about his 2011 detention, officially cementing his rock star status in the Western world. Meanwhile, human rights activist and blind lawyer Chen Guangcheng called out British Prime Minister David Cameron this week for what Chen said was his reluctance to offend Chinese leaders. Chen was in London accepting an award from the British parliament. Kerry Brown discussed the current tensions in the UK-Chinese relationship earlier this month.

Chinese students studying at University of Pennsylvania are demanding an apology from U.S. Vice President Joe Biden over a comment he made during his commencement address at the university. Biden reportedly said that China cannot “think different” or “breathe free” during that address. One student told South China Morning Post that “It was a humiliating experience,” and asked “And how can a graduation speech be this political?”

Goldman Sachs sold the last of its shares in the Industrial and Commercial Bank of China (ICBC), another sign of growing concern over the health of China’s banks. For more on that subject, check out Eve Carey’s article earlier this week on China Power. Meanwhile, China Finance 40 Forum called for opening up the financial system when it met on May 19. As a side note, some of China’s biggest tech companies like WeChat and China Mobile are registering strong growth. That’s a good thing, as Chinese leaders continue to express reluctance on the possibility of a stimulus package. Ross Garnaut sees hope for one still, however.

A new report out this week, U.S.-China 2022: Economic Relations in the Next 10 Years, looks at the bilateral economic relationship through the next decade. The report was sponsored by the China-United States Exchange Foundation. Among its conclusions is that China’s middle class will triple over the next 10 years. This should give Presidents Xi and Obama something to talk about when they meet in California next month in what China’s media is emphasizing is an “unofficial” trip that Xi is taking on his way back from stops in Latin America. At an Asia Society event for the report’s release, however, Henry Kissinger hailed the upcoming leaders’ summit as potentially a “seminal event.”

Kim Jong-Un has dispatched a high-level envoy to China soon after North Korea released a Chinese fishing boat and its crew it had held for two weeks. Meanwhile, South Korean President Park Geun-hye will visit China in late June, with the dates June 26-28 being floated by South Korean news sources.

China is a better friend to Pacific Island countries than the United States, says Samoan Prime Minister Tuilaepa. Certainly, the emerging giant’s growing presence in the region has captured the public imagination. But politicians and officials in Australia and the United States are not quite as enthusiastic about that as the Samoan prime minister appears to be.

Indeed, in 2011, then Secretary of State Hillary Clinton described the United States as being in competition with China in the Pacific Islands, and led a resurgence of US commitments to the region. Clinton adopted more conciliatory language when she attended the Pacific Islands Forum Leaders’ meeting in the Cook Islands in 2012, but she also reminded Island states of the history, values and goals the United States shared with them. The Australian government has long called for more transparency around Chinese aid to the Pacific Islands and sought unsuccessfully to persuade China to join the Cairns Compact for Strengthening Development Cooperation in the region. The Australian Defence White Paper 2013 described the growing reach and influence of “Asian nations” (read China) in the Pacific Islands as a challenge and cautioned that Australia’s contributions may be balanced by support and assistance given by “others” (again, read China) in the future.

Although its presence in the Pacific Islands is not new, it is China’s interests in the region in the last five years that have provoked most unease in the capitals of the region’s established international partners. It is tempting for these partners to adopt the popular threat narrative so frequently invoked in debate about China’s role in the wider Asia-Pacific to interpret its rise in the Pacific Islands but this would be wrong.

To understand China’s ambitions in the Pacific Islands we should look not at what American, Australian, Japanese and Pacific Island officials and analysts think are China’s hidden intentions, but at what China is actually doing.

The actual extent of the three main elements of China’s engagement with the region - trade and investment, aid, and diplomatic and military ties – is not consistent with the argument that China presents a geo-strategic threat to Western influence in the Pacific Islands.

China’s trade with the Pacific Islands has increased sevenfold over a decade. Its total bilateral trade with the region of $2 billion is, however, still only one third that of the region’s largest bilateral trading partner, Australia. Chinese companies are particularly visible because they are usually involved in major construction projects in the region. But they are competing with, not dominating, an increasingly crowded business environment that includes investors from Asian as well as Western nations. Chinese investment does not nearly approach the 16.2 billion Australian dollars ($15.8 billion) Canberra invests in Papua New Guinea and it is US company Exxon Mobil that boasts the biggest single investment in the region – the $19 billion LNG project in Papua New Guinea.

China’s aid to the Pacific Islands has been lauded by Pacific Island leaders as more flexible than that provided by traditional donors. It may be popular but a comparison of China’s aid of $850 million over the period 2006 to 2011 (a five-year aggregate is the most accurate measure of China’s non-traditional aid) with the contributions of the region’s other major donors shows China is only the region’s fifth largest aid donor, behind Australia, the United States, New Zealand, and Japan. China, which devotes a tiny 4 per cent of its global aid program to Pacific Island countries, is unlikely to challenge the region’s leading donor, Australia, which spent $4.8 billion over 5 years. Even if a reported new $1 billion soft loan assistance package from China is made available to Pacific Island countries, this will likely be spent over a number of years.

There is little evidence to suggest that China’s diplomats are any more successful in persuading Pacific Island countries to align with China’s international positions than those from other countries who leverage aid commitments in efforts to obtain support for votes in the United Nations and elsewhere. China’s military assistance to the region is limited to the provision of uniforms, non-lethal equipment and refurbishment of barracks for the region’s three defence forces in Fiji, Papua New Guinea and Tonga. This pales into insignificance compared with the AU$183 million Australia spends on defence cooperation with the region and on securing Australia’s neighbourhood.

It is Chinese business interests that are really driving China’s rising influence in the Pacific Islands and they present a massive opportunity for Island countries, once remote from the global center of economic gravity. But the Island states need to manage the risks of a rapid rise of economic interest from China, which include a lack of capacity to repay loans and potential resentment towards investors who do not provide sufficient jobs or benefits to rural communities. Less suspicion and more cooperation from the region’s traditional partners would help.

Jenny Hayward-Jones is the Myer Foundation Melanesia Program Director at the Lowy Institute for International Policy and author of a new Lowy Institute Analysis, Big Enough for All of Us: Geo-Strategic Competition in the Pacific Islands.

China’s banking system is reaching high highs, but has the potential to see very low lows. On a high note, last month, China’s Industrial and Commercial Bank of China (ICBC) took the top spot on the Forbes Global 2000 list, which weights sales, profits, assets, and market value to determine the world’s biggest public companies.  In 2012, ICBC had US$37.8 billion in profits and $2.8 trillion in assets. Additionally, in the first quarter of 2013, China’s banks made excellent profits: ICBC’s profits were just over US$11 billion, up 12 percent from 2012’s first quarter, but slower than that period’s 14 percent increase.  Agricultural Bank of China had a net profit for the first quarter that was $7.58 billion, up 8.2%, but down from 2012’s 28% first quarter rise.

However, as Xinhua reported this month, there are dangers lurking: non-performing loans reached nearly $85 billion in the first quarter of 2013, creating an NPL ratio of 0.96 percent, slightly up from the previous quarter, and the sixth straight quarter of increases since the end of 2011.  Bad debt rose in all lender categories, such as regional and state-owned banks. Additionally, overdue loans, a precursor to non-performing loans, are also increasing; by mid-2012, the top 10 lenders had 489 billion yuan (nearly $80 billion) in outstanding overdue loans, up from 112.9 billion yuan ($18.4 billion) in the beginning of 2012. In April, the China Banking Regulatory Commission said that non-performing loans and “increased risk in some areas and industries” means that the banking industry “still faces severe risks.”

One of the most salient features of the Chinese banking system moving forward is the prevalence of shadow banking.  Shadow banking plays an important role in the future health of China’s banking system, and falls loosely into two categories: non-banks offering financial services, such as trust entities, and banks that offer off-balance sheet products (to avoid regulation and underwriting requirements), such as wealth management products (WMPs). A new report by Moody’s notes that the volume of shadow banking has increased 67 percent over the past two years, reaching US$4.7 trillion by the end of 2012, a staggering 55 percent of China’s gross domestic product. Shadow banking has blossomed in a period of restricted credit and artificially low interest rates as an option for those that cannot get loans through regular channels and for those that want a higher return on investments, thus becoming a very useful tool for the Chinese economy by giving small, new and non-state owned entities access to credit.  Loans from shadow banking sources have kept the economy going by allowing projects to continue and helping entities service existing debt. In the case of WMPs, Reuters notes that the central government has allowed them to continue growing because it provides a channel for investors to get higher returns, sparking consumption, and is a “backdoor way to liberalize interest rates.” 

However, shadow banking can also inflate the asset bubble and exacerbate unbalanced investment in overheated sectors such as the real estate market. WMPs are one such tool that has exploded on the scene:  in 2012, the top 10 commercial banks issued US$1.24 trillion in wealth management products, a rise of 68 percent from the year before. WMPs are sometimes backed by high-risk projects that can go belly-up or projects with a long maturity, creating a mismatch with short maturity WMPs and making it difficult for banks to pay investors.

According to Bloomberg, shadow banking played a role in Moody’s recent decision to lower China’s credit rating to stable from positive. As for the impact of shadow banking on the banking system as a whole, the Moody’s report noted, “Given the substantial scale and growth of shadow banking activities in China, we are doubtful of the banks’ ability to isolate themselves from a significant increase in defaults in the shadow banking domain.”  However, the company notes that while shadow banking creates “excessive financial leverage,” the real impact on banks will “depend on the amount and timing of losses and how they are allocated,” information that is difficult to know because of “the lack of transparency and fast-evolving nature of shadow banking in China.”

Banks are vulnerable because of their own shadow banking products and by the products they back that are issued by other entities.  In December, several WMPs failed to make payments to investors, sparking small protests and bringing the faults of WMPs into the spotlight.  WMPs can be akin to Ponzi schemes, in that sales of new products allow the banks to pay returns on existing products. Many WMPs also involve fund pooling, which helps banks hide risks and provide the promised payouts for WMPs, but carries significant risks in that it is backed by bonds that may not be mature or may have declined in value, creating a liquidity risk.

The government has taken some steps to address the issue of shadow banking and the stability of the banking system as a whole.  Last October, Xiao Gang, then-Chairman of the Board of Directors, Bank of China and now (significantly) head of the China Securities Regulatory Commission, discussed shadow banking in a China Daily editorial. He said, “In order to prevent China's financial systemic or regional risks from happening, it is imperative to pay more attention to shadow banking and to enhance supervision over shadow banking activities.... It must be tackled with care and sufficient flexibility, but it must be tackled nonetheless.”

There is subtlety in the government’s handling of shadow banking, representing an understanding of the delicate balancing act needed to allow shadow banking to fulfill its necessary role in the economy while minimizing its risks. Potential and imminent reforms include: required disclosures about off-balance sheet investment products, required registration of wealth management products, and a potential hard cap on the quantity of investment products.

At the April Boao Forum, George Soros noted: "The rapid growth of shadow banking has some disturbing similarities with the subprime-mortgage market in the US that caused the financial crisis of 2007-2008," and cautioned “if the American experience is any guide, the authorities have a couple of years to bring shadow banking under control.....it's of utmost importance that the authorities should succeed. Not only for China, but also for the world."

As for other problem areas in banking, the China Banking Regulatory Commission (CBRC) said that they would move to reduce the volume of non-performing loans and deal with outstanding bad loans by debt restructuring.  In May, the China Foreign Exchange Trade System (CFETS) closed a loophole in banks’ use of fund pooling for wealth management products, requiring more stringent checks on underlying assets.  As a result of a CBRC directive to cap wealth management investment and slower growth, Moody’s expects that the growth rate of assets in shadow banking will fall to 20 percent from last year’s 30 percent.

As for the overall future health of the banking system, Forbes has noted: "Most analysts don't expect a banking crisis in China, but rising defaults and shrinking loan profitability are serious threats to the country's banking system.” 

The latent risks in the Chinese banking system (including growing liabilities) and the emergence of “black market” solutions for economic issues suggests the need for banking reform. Indeed, it is an oft-discussed oft-argued topic among China watchers and Chinese officials alike. On a very general note, a recent report by the Chinese Academy of Social Sciences (CASS) had a number of suggestions for reforming the banking system, including liberalizing the interest rate regime and creating a unified bond market to provide more investment opportunities.

Chinese Premier Li Keqiang has started his first overseas trip since the change in government in March. Li will cover four countries through May 27 with visits that will focus heavily on economic issues.

His first stop is India, where he is meeting with Indian President Pranab Mukherjee and Prime Minister Manmohan Singh, while also attending a China-India Business Cooperation Summit where he will deliver a keynote speech.

Although some believe that the premier’s time in India will be overshadowed by the recent border incident, the charm offensive China launched ahead of the trip has sought to minimize the chances of that happening. It just may work.

Although the border issue will be discussed, both sides have a strong interest in ensuring the trip goes off smoothly, which is why there has been such intense diplomacy after China’s forces withdrew from their position on the border.

Both sides will be seeking to play up the economic aspect of the trip. Bilateral trade between India and China has skyrocketed to US$66 billion last year, but remains highly imbalanced with India running a US$29 billion deficit with China. India has called on China to address this issue, which Beijing has pledged to do. On Thursday, Vice Commerce Minister Jiang Yaoping said this effort would continue on this trip, with Li expected to bring an investment promotion mission and one of the biggest ever business delegations with him.

The investment mission and business delegation will follow Li to his next stop in Pakistan, where he is scheduled to meet both the outgoing and incoming Presidents of Pakistan, Asif Ali Zardari and Muhammad Nawaz Sharif, respectively. The trip is mostly symbolic for how soon after the election a senior level Chinese delegation will be in Islamabad, but China has said that three intergovernmental agreements on economic and trade cooperation will also be signed during the trip.

After leaving Pakistan, Li will head to Europe for stops in Switzerland and Germany. In many ways Chinese-EU ties have been robust under President Xi Jinping and Premier Li, with China signing its first free trade agreement with a European state, hosting two European heads of states and the EU foreign policy chief, and gaining permanent observer status at the Arctic Council, all of which may help expand Chinese-EU trade considerably in the future.

Yet there have also been a number of irritants in China’s relationships with individual European nations and increasingly the EU as a whole. In the former category is the ongoing spate between China and the United Kingdom (still part of Europe, for now anyway) over Prime Minister David Cameron’s meeting with the Dalai Lama. More problematic from China’s perspective is the increasing scrutiny its trade practices are being given by the EU, with Brussels threatening trade sanctions against China’s solar and telecommunication companies as part of anti-dumping and anti-subsidy legislation.

These issues may well find themselves on the backburner while Li is in Switzerland and Germany. In the former country, Premier Li will meet with President Ueli Maurer and other officials in what China’s Foreign Ministry has said will be an effort to establish bilateral ties that are “a model of friendly exchanges between countries with different social systems.” Bureaucratic jargon aside, discussions will likely focus on concluding a free trade agreement that both sides said was close to being signed following the ninth round of negotiations held last week.

In Germany, the Chinese premier expects to meet with President Joachim Gauck and Chancellor Angela Merkel, as well as give a speech to a business luncheon as part of Li’s effort to increase ties with non-governmental groups inside Germany. After the meeting with Merkel the two leaders plan to announce the “year of languages” between the two countries, a new initiative aimed at boosting the study of each other’s languages.

Vice Foreign Minister Song Tao placed a high premium on ties with Germany during a press conference on Li’s trip that was held on Thursday.

"China-Germany relations are at the forefront of China-Europe relations, featuring the most frequent high-level contacts and the most effective dialogue mechanisms," Song said, according to Chinese media reports.

According to China’s Vice Commerce Minister, Jiang Yaoping, China’s trade with Germany last year accounted for nearly 30 percent of its trade with the entire EU. The two countries’ economies are increasingly complementary as the export-reliant German economy seeks to open up markets outside of Europe and Chinese leaders seek to transition to a consumption economy.