Diplomatic ties might take a knock if Australia rejects China's $19.5 billion investment in miner Rio Tinto Ltd/Plc, but the biggest casualty could be a planned free trade deal and the economic growth it promises.

Australia's Foreign Investment Review Board (FIRB) is reviewing a raft of Chinese investments in Australia, including the Chinalco-Rio deal. Treasurer Wayne Swan will have the final say after weighing national interests.

Swan is under growing pressure from politicians and unions to oppose the deals due to concerns that China, a major customer for Australian resources, will be able to exert influence over prices and production of mineral exports from some mines.

Foreign policy analysts said they expected Swan would approve the deals, with some conditions, because an outright rejection would lead to a diplomatic backlash from China, Australia's top trading partner, and could stall negotiations for a free trade pact.

If the deal is turned down, there will be some negative impact to the bilateral relationship, said Australian National University Chinese investment analyst Chen Chunlai.

But the party worst hurt would be Australia, not China, Chen said, adding that Australia is increasingly relying upon exports to China to help avert a prolonged recession.

Two-way trade between Australia and China was worth A$68 billion ($46 billion) in 2008.

A joint China-Australia analysis said a free trade deal would boost Australia's gross domestic product (GDP) by A$18 billion over 10 years, and China's by A$64 billion over the same period.

It found a free trade deal would boost Australian sales to China of cereal grains, wool, minerals and metals, while China's manufacturing, textiles, clothing and toy industries would benefit from easier access to Australian markets.

Australia's Greens, a key independent Senator and a conservative politician have all spoken out against the China investment deals, warning that Australia must not sell prized national assets to companies controlled by a foreign government.

Conservative National Party Senator Barnaby Joyce has run television ads against them, saying China would never allow Australia to buy a mine in China, which might be difficult to dispute after China's rejection this week of a bid by Coca-Cola to buy juice maker Huiyuan Juice.

Swan will have to weigh up concerns about Chinese investment with the need to protect investment in mining projects and jobs in Australia, with unemployment set to rise as the economy slows, and with the government due to hold elections by late 2010.

The types of conditions Swan might impose could include insisting on a number of Australian directors on the board or other guarantees curbing Chinalco's influence on the company's decision making.


State-owned Chinalco, China's top aluminium maker, wants to pay $12.3 billion for stakes in Rio's key iron ore, copper and aluminium assets and $7.2 billion for convertible notes that would double its equity interest in Rio to 18 percent.

The FIRB is also examining two other Chinese investments in miners: Minmetals' $1.7 billion rescue bid for OZ Minerals Ltd and Hunan Valin Iron and Steel Group's $768 million plan to buy a 16.5 percent stake in iron ore miner Fortescue Metals Group.

If the Chinalco deal fails, Rio Tinto would need to speed up asset sales or find some other way to refinance $39 billion in debt, possibly with a steeply discounted rights issue.

Investors worried that the deal will not proceed have sent Rio's shares down 13 percent over the past two days.

Australia generally welcomes foreign investment, with FIRB decisions based mainly on business considerations. But growing investment from state-owned Chinese firms has added a new foreign policy dimension to the decisions.

Mark Thirwell, international economy director at the respected Lowy Institute foreign policy think-tank, said the rise of China as a major economic power raised new questions about Australia's trade and strategic outlook.

Previously, Australia's major trading partners -- Japan, the United States and Britain -- have also been Australia's key allies. Not only is China outside that club of traditional allies, it is also a a strategic competitor to both Japan and the United States.

This is not just an economic or business decision. It really is entangled with the importance of the bilateral relationship and how countries like Australia and others respond to China's rising economic power, Thirwell told Reuters.

A poll by the Lowy Institute in 2008 found 85 percent strongly supported more strict investment regulation on companies which are controlled by foreign governments.

Thirwell said world leaders could not talk about international cooperation to fight the global financial crisis, and at the same time shun investment from China.

China will become a more important player in the Australian economy, it will become a bigger investor. We need to get used to that. An outright 'no', and panic about that is not the way to go, Thirwell said. ($1=A$1.48) (Editing by John Chalmers and Sonya Hepinstall)

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