By Woo C. Lee, managing director, JL Thornton & Co.
From Caijing Online

The recent spate of Chinese investment in Australian mining companies is causing unease among many Down Under and has put the government of Prime Minister Kevin Rudd in a difficult spot. The country’s largest newspaper, for one, published a column entitled Say No to Chinalco, urging Canberra to reject the Chinese state-owned aluminum company’s bid to raise its stake in Rio Tinto, citing not only economic but also “geo-strategic” grounds.

Rudd will be forced to weigh the merits of maintaining good relations with his country’s biggest trading partner -- not to mention the real and urgent need for capital at many Australian mining companies -- against keeping valuable mineral assets firmly in Australian hands. Adding to the complexity of the case, at least two other sizeable Chinese investments in Australian resource companies have been under negotiation at the same time.

If the Australian government’s Foreign Investment Review Board (FIRB) gives a green light to Chinalco, Rudd will no doubt be pilloried by some countrymen for caving to Chinese pressure. If the investment is blocked, Beijing may feel forced to retaliate against Australian commercial interests, further setting back bilateral relations. It’s hard to see how any of the parties can score a clean win.

How did China and Australia get into such a situation?  What, if anything, could have been done to bring about a different outcome? And what lessons should China draw from the experience as it ramps up investment globally in the years to come?

Nearly four years after the CNOOC-Unocal controversy, few Chinese companies seem to have learned the core lessons of that unfortunate episode. The first lesson is that, whatever the commercial merits, a major investment by a large Chinese enterprise, especially an SOE, will inevitably be perceived abroad as a strategic move by “China Inc.” As such, how an investment is handled has a direct impact on China’s national image. All significant investment proposals should be evaluated with this in mind.

One irony of the recent flurry of Chinese activity is that Chinalco, Minmetals, and Hunan Valin Iron and Steel almost certainly did not consult with one another about their respective plans to invest in Australia. But the coincidence of the announcements has made many Australians fear that a coordinated Chinese push to lock up Australian assets is under way. Subplots such as the timing of Chinalco Chairman Xiao Yaqing’s move to the State Council did not help matters. Coming at the height of international press focus on the Rio Tinto bid, his promotion fueled the perception that Chinalco’s actions were being orchestrated by the Chinese government.

In fact, things may have gone more smoothly had senior Chinese officials indeed played a more active role. Chinese leaders could have spoken directly with their Australian counterparts beforehand to explain the rationale for the investment, and why China felt it was in the interests of each nation to proceed. If Australian leaders nonetheless opposed the idea, China could have quietly stood down for the sake of good relations between the two countries, which should always take precedence, no matter how large a transaction. This could have saved face for everyone.

On the other hand, if Australian leaders had signaled they were open to an investment, China could have asked what Beijing and Chinalco could do –how to structure the deal, for example – to make a transaction as attractive as possible to the Australian side.

Evidently, no such coordination took place. This seemed clear when Australian Treasurer Wayne Swan announced that the Australian government would amend regulations to make sure it retained the power to block the transaction, leaving the distinct impression that he felt the two companies had tried to pull one over on him by using convertible bonds to evade the 15 percent cap Australia placed last year on Chinalco ownership of Rio Tinto equity.

A more fundamental problem may lie in kinds of assets Chinalco is targeting. Rio Tinto has rights to some of the highest quality iron ore deposits in Australia. It is understandable that Australia would prefer that a domestic firm control those assets and sell them for the highest price the market can bear. While it is equally in China’s interests to secure a source of ore at the lowest price possible, Beijing should realize that this will always be a tough sell politically in Australia.

Setting its sights a little lower is one solution. There are vast deposits of harder to reach or lower grade ore that would not be profitable for an Australian firm to develop but that would make sense for China to exploit as a producer and consumer. It could be a win-win solution; this ore will never leave the ground unless the Chinese do the job.

Another approach China should consider is to focus even more on countries where politics are less sensitive. While developed nations such as the United States and Australia offer the benefit of political stability, Chinese expertise is needed and more welcome in many parts of the developing world. Mines in parts of Africa and Latin America, for instance, need roads, railways and power plants in addition to funding and operating skills. China has experienced companies that can meet these needs – infrastructure firms, mine operators, banks – to help a developing nation take advantage of resources that it cannot develop on its own, while securing valuable supply sources.

Finally, there is the question of reciprocity. While China has made great progress in opening its economy, many of its own core industries remain highly restricted, or even off-limits, to foreigners. China should keep in mind that this can be seen as a double standard in countries where it wants to invest in strategic sectors.

There has never been a time before when the world needed Chinese investment as much as it needs it now. One study found that in the mining sector alone there will be a capital shortfall of US$ 40 billion this year. Rio Tinto would have few good choices if Chinalco dropped out of the picture (which is one reason the Australian government may still approve the deal). By all rights, the world should be greeting Chinese capital with open arms. 

And yet the reaction to the first wave of Chinese outbound investment in 2009 has been decidedly mixed. It is in China’s interests to figure out why this is, make the necessary adjustments, and pursue a “going out” policy that serves China’s economic objectives and is unambiguously welcomed by the international community.

Woo C. Lee worked as an American diplomat for the US Department of State for 16 years, including assignments in China, Japan, Australia and Washington, DC.  From 2004-2006, he was Counselor for Political Affairs at the American Embassy in Canberra, Australia.  He is currently Managing Director or JL Thornton & Co., an advisory firm focused on China.