"China's public-private economic model enables it to convert economic debt into strategic influence and assets."

The unclassified document, dated 27 March 2018, emerged out of an earlier classified version written confidentially last year for United States Pacific Command (PACOM).

The policy analysis exercise by the Harvard graduate students was written under the supervision of Harvard's distinguished US-China researcher Graham Allison, a former US defence assistant secretary under president Bill Clinton.

It has not been publicly released and was prepared for the the US State Department policy planning staff, the document says.

Under President Xi Jinping's leadership, an emboldened China has spread its wings diplomatically, economically and militarily in the Asia Pacific in a bid to displace the US as the regional hegemony.

Amid doubts about President Donald Trump's commitment to the region, Beijing has massively expanded infrastructure funding to countries via its pledged $US1 trillion Belt and Road Initiative, including through the China Development Bank and Export-Import Bank of China.

The report says debtbook diplomacy is "likely to play an important role in China's multifaceted campaign to erode strategic advantages" of America and its allies and shift the balance of power in Asia.


Vanuatu is already "deeply in debt" to China and Beijing is "positioning itself to capitalise on the impending fiscal distress of Pacific Island Countries", the document says.

Employees at work on a hydroelectric dam being built by a Chinese firm in Laos. Taylor Weidman

Fairfax Media reported in April that China had held preliminary discussions with Vanuatu about building a military base for naval ships in the South Pacific less than 2000 kilometres from Australia.

China and Vanuatu both denied any plans were afoot, but the claim was taken seriously by Prime Minister Malcolm Turnbull, national security officials and Labor defence spokesman Richard Marles.

Mr Turnbull has warned China against establishing a military base in the South Pacific because it would jeopardise regional peace and last month he sought an assurance from Vanuatu's Prime Minister Charlot Salwai that it would never allow a Chinese-funded port in his country to be used as a military base.

American and some Australian national security professionals are worried China's economic leverage over Pacific nations could allow Chinese military access to strategic defence infrastructure such as ports and airstrips near international waterways patrolled by the US Navy and close to Australia.

Cambodian Prime Minister Hun Sen, left, shakes hands with Chinese President Xi Jinping during the welcome ceremony for the Belt and Road Forum last year. Cambodia, which has borrowed record amounts from China, has supported China's claims in the South China Sea. Kenzaburo Fukuhara

Andrew Shearer, a former national security adviser to prime ministers John Howard and Tony Abbott, said the vast majority of China's development assistance came in loans rather than grants like most Australian and Western aid.


"The risks are real" and had become more acute since he and a former think tank colleague, Fergus Hanson, first warned of the threat a decade ago, he said.

"Establishing a military base in any of the key islands proximate to our northern approaches would pose a major problem for Australia," said Mr Shearer, now a senior adviser on Asia Pacific security at the Center for Strategic and International Studies in Washington.

"Australia remains an influential country in the region and an important source of support but should step up its engagement, coordinating its efforts more closely with other partners such as New Zealand, Japan and the United States."

Hambantota port in Sri Lanka..Sri Lanka borrowed $US8 billion from Chinese-controlled firms for infrastructure projects, but could not afford to repay the ballooning debt and last year gave China a 99-year lease to the port, strategically located with access to the Indian Ocean.

If Pacific countries turn to China, it could undermine US strategic denial and basing rights, "eroding US advantage in any future US-China conflict," the report notes.

Australia is boosting development assistance to the Pacific with a large slice of the $1.3 billion allocated in last week's federal budget expected to be spent on undersea internet cables to the Solomon Islands and PNG, ostensibly to counter a rival bid by Chinese telco giant Huawei.

In January Chinese media dubbed Australia an "arrogant overlord" after International Development Minister Concetta Fierravanti-Wells accused China of trying to buy influence among Pacific island nations and for building useless roads to nowhere.

The Harvard researchers, Gabrielle Chefitz and Mr Parker, who was temporarily deployed to PACOM last year, highlight Sri Lanka borrowing $US8 billion from Chinese-controlled firms for infrastructure projects such an airport and upgrade to a port at the hometown of the-now-former-president Mahinda Rajapaksa.


The Sri Lankan government could not afford to repay the ballooning debt and last year gave China a 99-year lease to the Hambantota port, strategically located with access to the Indian Ocean.

"The port had become a debt trap," the report says. "Once Sri Lanka made the initial commitment, the sunk cost and need to generate profit to pay off the original loans drove it to take out additional loans, a cycle that repeated itself until it was finally cornered into giving up the port in a debt-for-equity swap."

China has poured money into a port in Pakistan.

The report raises concern that China may use economic leverage in Cambodia, Laos, and the Philippines to give China a "proxy veto" in the Association of Southeast Asian Nations, including in its contested claims on artificial islands in the South China Sea, a vital international trade route.

A crane operates at a construction site for a monument in Phnom Penh, Cambodia, on Tuesday, Oct. 24, 2017. China's ambassador to Cambodia recently hailed the "strong momentum" in relations between the two countries, saying his nation's companies have built a third of Cambodia's highways and more than a dozen major bridges and hydropower stations. Brent Lewin

Laos and Cambodia, which have borrowed record amounts from China, have supported China's claims in the South China Sea, despite Beijing in 2016 ignoring an international tribunal ruling that it lost.

China has invested $US6.7 billion in 760 projects in Laos, more than half of the country's GDP.

Beijing invested heavily in recent years in projects for Malaysia's then-Prime Minister Najib Razak, who separately was under international investigation for corruption before a shock election loss last week.


Malaysia went largely silent on China's claims to most of Malaysia's South China Sea economic zone.

Professor Allison, who supervised the paper and is the author of Destined for War: Can America and China Escape Thucydides's Trap?, said China has a portfolio of "economic warfare", including "cheque book" diplomacy, bribery and trade leverage.

"The Chinese have been smart about this for a long time," he said.

"Economic balance of power will become more powerful than the military balance of power."

In February, the Chinese Ministry of Education and Chinese Embassy in Canberra warned students to be vigilant about their personal safety in Australia, a move that was interpreted as a tacit warning to Canberra after the Turnbull government's outspoken efforts to stamp out perceived Chinese interference in Australia's democratic political institutions.

South Korea's exports dived last year when China announced it would block market access for entertainment, consumer goods and tourism, in response to Seoul announcing it would deploy a US anti-missile defence system. South Korean-owned retailer Lotte Mart was financially crippled and forced to exit the Chinese market.

Claiming fruit infestation, China banned and destroyed thousands of tonnes of the Philippines No.1 export, bananas, around the same time the small Asian country challenged China's claimed sovereignty over the Scarborough Shoals in the South China Sea.

When Filipino President Rodrigo Duterte backed down on the South China Sea, China resumed buying large quantities of tropical fruit from the Philippines.


The US document notes "no strings" Chinese investment is appealing to economically weaker countries to boost their economic growth, enhance the political legitimacy of leaders and, in some cases, enlarge their personal bank accounts via corruption.

The competitive challenge facing Western institutions such as the International Monetary Fund, World Bank, Asian Development Bank, governments and corporations is that they typically abide by stricter protocols on contract transparency, economic viability, labour rules, safety and environmental standards.

Chinese state-owned enterprises have an implicit underwriting by the government and can sometimes invest beyond pure economic reasons to gain strategic advantage for China, in contrast to firms from liberal democracies which face market-discipline and operate independent of government.

Still, China's strategic approach comes with risks due to non-performing loans and its high debt burden.

David Lampton, director of China Studies at the Johns Hopkins School of Advanced International Studies, said China was funding a mix of "good and bad" infrastructure projects through Belt and Road.

"In fact, many Chinese are worried about China dumping money into hopeless projects," he said.

China's debt has ballooned to more than 250 per cent of GDP, from 141 per cent in 2008.

"I think China is taking a 30-year view," Mr Lampton said.


"The Chinese are probably going to write off a lot, but at a strategic level have a view that once this infrastructure is laid down, it will reorient its production chains as the cost of labour goes up and increase the flow of economic goods towards China."

The report recommends the mooted the Quadrilateral Dialogue between Australia, India, Japan and the US should be revitalised to bolster India's role as a regional leader and to promote a rules-based order in the Indo Pacific.

It also suggests the US support the Asian Infrastructure Investment Bank as a bargaining chip to entice China to become a more responsible creditor.

Unlike the US, Australia joined the China-inspired multilateral Asian Infrastructure Investment Bank, and successfully pushed for strict governance rules to ensure loans were made prudently.

Most of China's more controversial funding to developing countries has been conducted outside the AIIB.

The report has parallels to the Trump administration's national security strategy which warned in December China is leveraging "predatory economics" to achieve regional and global goals.