One of the benefits of becoming a major economic power is the ability to project soft power, essentially buying good will through investment and building your nation’s image through cultural, diplomatic and economic exchanges.

Over the past three decades, China has become extremely adept at projecting soft power across the globe, investing about $688 billion in projects ranging from resource mining and transportation infrastructure to electric grid development and agricultural since 2005. It has spent about $60 billion in 2013 alone and its investment touches on every continent buy Antarctica.

But soft power has its limits, particularly when it comes to enforcing maritime claims or territorial ambitions and protecting regional interests.

Until the mid-1980s, despite long simmering border disputes with India and other neighbors, China’s military was focused primarily on defensive capability. The country’s famed million-man army has been trained to prosecute offensive war if necessary—the Korean Conflict of the 1950s serves as a salient example. However, historically it has been largely geared towards maintaining civil order and protecting China’s territorial integrity, due to the lack of resources necessary for achieving more global ambitions.

But as China’s economic power has grown, so has its military might.

While China’s defense spending comes in at less than 2 percent of gross domestic product (GDP), in real terms it amounts to about $120 billion this year alone, a 10.7 percent increase over last year. Beijing’s defense budget is second only to Washington’s and has been growing in the double-digits for more than two decades.

With all of that spending comes the growing ability to project hard power both on a regional and global basis.

Over the past year, the Chinese navy has commissioned its first aircraft carrier and a frigate with stealth capabilities and continued developing its own aerial drone program. It has also expanded its ambitions to include outer space, completing its first manned space docking and launching its own version of a global positioning system. China has also, reportedly, bolstered its abilities to conduct cyber warfare operations.

A growing confidence goes hand-in-hand with increased military capability and, as a result, tensions have been rising of late, particularly in the oceans off China’s coast.

China and the Philippines are in the midst of a territorial dispute over an area of water known as the Second Thomas Shoal. The Philippines have claimed control of the area since the late 1990s but China has become increasingly interested in it as a gateway to the Reed Bank which is believed to hold oil and natural gas.

There is also the ongoing dispute between China and Japan over the Diaoyu/Senkaku Islands which, in addition to rich fishing grounds, is also believed to sit atop energy resources.

With increasing tensions a regional arms race of sorts has been sparked, with Japan, Vietnam and the Philippines all increasing their defense spending to bolster their capabilities. But China’s spending doesn’t appear set to slow any time soon.

With China increasingly focusing its spending on technological capability, there are two interesting Hong Kong-listed companies which provide exposure to the government’s spending spree.

China Aerospace International Holdings (Hong Kong: 31) is a subsidiary of China Aerospace Science and Technology Corporation. The company is involved in the development and manufacture of spacecraft, launch vehicles and satellites such as those used in China’s GPS system.

The company’s revenues have shot up from just HKD1.3 billion in 2009 to HKD2.6 billion last year, though earnings have been declining largely thanks to the higher expenses associated with its research and development efforts.

Despite falling earnings, shares have been rallying as China’s military capability comes into increasing focus.

Another interesting play is AviChina Industry & Technology Co. (Hong Kong: 2357). The company is involved in the manufacture, sales and upgrade of helicopters, regional jets, trainers and general-purpose aircraft. The company made headlines back in 2011 when it launched a public test flight of its J-20 stealth fighter and is a leading supplier to the Chinese military.

Investing in Asia’s defense establishment is a bit more challenging than in Western defense operations, because contracts are spread out among many different companies through diffuse corporate structures. But this is an idea I plan on developing in coming issues of both Passport to Profits and Global Investment Strategist.

Portfolio Updates

Please see yesterday’s issue of Global Investment Strategist.