Xi Jinping's state visit to the UK

More than a decade has passed since a Chinese head of state last visited Britain; these two countries are very far from being peers. Yet President Xi Jinping’s trip to London this week illustrates how the relationship between them has grown stronger, just as Beijing’s dealings with Washington have become strained.

Britain has long been courting Chinese capital to finance everything from railways and residential property to nuclear power stations. As recently as a decade ago, Chinese backing for such projects was unheard of. But in 2011, tired of watching export earnings pile up idly in huge mountains of foreign exchange, Beijing started investing its wealth overseas via more direct investment.

Aiming to earn a return and perhaps drum up some demand for idle steel mills back home, the country put $18bn to work in EU investments last year. The UK has become the top recipient, accounting for about a third of the annual flow.

Its status as a major US ally is an obvious attraction, as is its position as a commercial conduit to the EU. And British politicians have been solicitous. When George Osborne visited China earlier this year, the chancellor of the exchequer earned his hosts’ goodwill by travelling to the troubled western province of Xinjiang (and discussing the construction business, rather than human rights, once he was there).

But the biggest draw is undoubtedly the City of London, which occupies a central place in the global financial system in which China would like its currency to play a bigger role.

Both governments want London to become the premier western financial centre for renminbi trading, clearing and settlement facilities. Hence a flurry of recent announcements. Some are technical, such as an extended currency swap facility. Others, such as a study to investigate how the Shanghai and London stock exchanges could be more closely linked, may not get very far. But some will make a difference. A batch of renminbi-denominated sovereign bonds will henceforth be issued in London — the first time this has happened outside China.

These initiatives are part of a broader plan to use commerce to spread economic and political influence across central Asia to the Middle East and Europe. The creation last year of an Asian Infrastructure Investment Bank has so far been the most significant step; Britain was the first advanced nation to sign up. But, if that institution is to be anything more than a clone of Bretton Woods institutions such as the World Bank, the renminbi will have to outmuscle the US dollar.

On the surface, then, all is set fair for a celebration of mutual friendship. But awkward political issues lurk beneath.

From China’s standpoint, the main problem is Britain’s existential navel-gazing over its membership of the EU. A vote to leave would put the continued arrival of Chinese capital — if not tourists and students — at risk. It would damage London’s capacity as a financial centre by triggering regulatory changes that would draw much euro-denominated business away from the City. And it would expose the UK economy to significant risks, which would make China and other investors leery.

Since 2005, China’s economy has almost quadrupled and its share of world output has almost doubled, to 17 per cent. From the UK’s standpoint, cosying up to China makes commercial sense. Hundreds of British companies already do business in China, and David Cameron’s government wants to see the country become Britain’s second-biggest trade partner by the 2020s.

But Beijing remains an opaque political partner that makes no secret of its disdain for “western values”. Mr Xi will have no truck with a Chinese glasnost as he tries to cleanse the Communist party of corruption and strengthen its grip at a time of great economic uncertainty.

Between July and September the Chinese economy is said to have grown at an annualised rate of 6.9 per cent. But current data on investment, production and services suggest weaker underlying growth and more deflation than expected. The vaunted “rebalancing” that was supposed to turn an investment-driven manufacturing powerhouse into a consumption-driven services economy is proving very slow to get going.

The anti-corruption drive is stifling reform and generating inertia. But if Mr Xi changes course — either backing off his campaign or intensifying it — he risks creating more upheaval. It would be indelicate for the British government to probe. But it should recognise the risks that closer commerce could bring.

The writer is an associate at Oxford university’s China Centre, and senior economic adviser at UBS

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