World Economy

South China Sea: Beijing considers next moves after Hague ruling

US diplomats try to cut South China Sea tensions

An international tribunal sent a pointed message to China on Tuesday — just because you say something is yours doesn't mean it is.

This week's binding decision from the Permanent Court of Arbitration at The Hague, Netherlands, dealt a serious blow to China's claim to most of the South China Sea, a 1.4 million-square-mile body of water that contains the world's busiest shipping lanes. The ruling was rejected immediately by the Chinese Foreign Ministry — as expected — but it has left Beijing in an exceedingly difficult position where it has to balance an angry, nationalistic population against an international community that expects it to back down.

"What's at stake here is the question of China's image and China's future — what kind of nation, what kind of country will China be? And how will it be regarded by its neighbors as well as by its people?" Assistant Secretary of State for East Asian and Pacific Affairs Daniel Russel told CNBC.

A fear of losing territory, which dates to China's bitter and bloody war with Japan in the 20th century, permeates both the leadership in Beijing and the general population in China. In the eyes of the Chinese, a majority of the South China Sea belongs to them — backed by what Beijing claims are historical documents that support its sovereignty there. The Hague ruling specifically invalidated those historical claims.

So now, the world is watching closely at what President Xi Jinping's course of action will be.

"The Chinese won't be happy," said James Keith, a former U.S. ambassador to Malaysia and former National Security Council director for China.

What the Chinese media will say

Experts say it's likely that in the short term, Chinese leadership will use bold and in some cases hostile commentary to demonstrate the country's power and alleviate anxiety among citizens who may start to question China's ability to maintain influence at a time when it's already dealing with a slowing domestic economy.

"China will respond at different levels to the ruling of the ... tribunal, ranging from crude propaganda to highly sophisticated," said Wim Muller of the International Law Programme at policy institute Chatham House in London.

Chinese state media over the past three weeks have tried to shape the conversation around the South China Sea dispute, running op-eds and cartoons that dismiss the Hague ruling as either meaningless or part of a conspiracy against China.

"It will be tempting for the official press to spin it into the old narrative in which a U.S.- and Western-dominated tribunal is rigged against China and therefore lacks any legitimacy," added Muller.

The military picture

Military confrontation in the South China Sea, in particular in the vicinity of man-made islands that China is building, continues to be an ongoing threat. The U.S. Navy and warships from China both patrol the region, and political strategists stress that the chances of an unintended conflict are rising.

As tensions have worsened, Washington has steadily expanded its presence in Asia-Pacific waters. Other countries with South China Sea claims, especially the Philippines, Vietnam and Indonesia, have taken an increasingly vigilant naval stance.

Assistant Secretary Russel stressed the importance of diplomatic engagement and respect for the rule of law.

"I do believe China is faced with some important questions regarding its future and its intentions. The United States, China's neighbors, the world, wants to see a responsible neighbor who abides by the rule of law, who honors its commitments under a treaty, and who will work with its neighbors — big and small — to promote regional stability and regional prosperity," he said.

"No good will come for anyone — let alone China particularly, as it struggles with a slowing economy — from any kind of military clash. I truly do not believe that China seeks that kind of military confrontation," Russel said.

How China's economy comes into play

Aside from the potential military threat, there is also growing speculation around whether China will lash out against international partners by depriving them of the economic benefits they get from doing business in China.

However, most experts who spoke to CNBC said the world's second-largest economy will not allow this particular geopolitical event to impede its economic goals.

"While it is embarrassing for President Xi's regime, domestic considerations such as the state of the economy are more important to ordinary Chinese," said Muller.

NSBO Bank, a think tank in Beijing, agrees: "If the Chinese use economic policy to protest this ruling, it would be very strange. I don't think they would do it because it wouldn't be productive," said Duncan Wrigley, who specializes in Chinese macro research at NSBO.

Ambassador Keith pointed out that there are two important international meetings coming up this fall that China does not want to jeopardize. The first is a scheduled G-20 meeting hosted by China in Hangzhou, where President Barack Obama is scheduled to attend. In October, the IMF is widely expected to formally add the Chinese yuan to its globally recognized basket of reserve currencies.

"The Chinese do not want to overreact, because it would undermine their economic goals," Keith said.

Shan Huang, a reporter who has worked extensively in China, told CNBC that the country hopes the G-20 meeting will be successful and wants to avoid exacerbating tensions while the global economic recovery faces strong headwinds such as uncertainty around the U.K.'s Brexit vote and a slump in commodities prices.

It's "important that all parties show prudence and take no action to raise tensions," Russel said.

China's dangerous reach