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BEIJING/YANGON (Reuters) - The surprise decision by Myanmar's new civilian government to suspend a controversial, Chinese-backed dam is straining relations between the erstwhile allies, but neither is likely to risk lasting damage.
China is pressing for an "appropriate solution" to the shelving of the $3.6 billion Myitsone dam, a moved hailed by its opponents who had warned of the scheme's environmental damage and forced relocation of residents.
For Myanmar, under wide-reaching sanctions by Western countries for human rights issues, China is its most important diplomatic and economic ally.
And for China, the country formerly known as Burma provides access for its landlocked southwestern provinces to the Indian Ocean. China is building gas and oil pipelines across Myanmar to avoid the Malacca Strait choke point.
"Overall the relationship will be there, as the two countries have a very close relationship economically," said Zheng Yongnian, director of East Asian Institute at the National University of Singapore.
"Myanmar relies on the Chinese side. Other countries, like India or the United States, are becoming actors. But China has geopolitical and economic advantages."
The ruling Communist Party's official newspaper, the People's Daily, noted that Myanmar's government had said it would talk to China about the dam project "to avoid damaging bilateral ties and friendship".
China is unlikely to give in easily over the project, which is part of a broader scheme to build seven dams, the majority of whose power will feed its booming economy.
The military junta proposed the dam in 2006, and in 2009 contracted Myanmar's military-backed Asia World Company and China Power Investment Corp to build it.
The Chinese-state owned firm has expressed shock at the Myanmar government's decision to suspend the project and warned of legal consequences.
"Given everything that China Power Investment has put into this project, it would be unlikely for them to walk away without first sitting down and pledging to do more environmental impact studies and so on," said Grace Mang, China Global Programme Coordinator at International Rivers.
"It's still too early to tell, but I don't think it's just as simple as Myitsone is cancelled."
China will likely now worry about another huge investment project it has in Myanmar, an oil pipeline being built into southwestern China by China National Petroleum Corp, which says work is continuing.
"The Chinese government is wise enough to handle this issue amicably with great care after taking into considerations other strategic interests like their seeking access to the Indian Ocean through us," a retired senior Myanmar diplomat said, referring to the pipeline and other rail and road projects.
"In fact, it was a big blunder of them to have made secret deals with such an illegitimate government for such strategic mega projects," added the retired diplomat, who asked not to be identified citing the sensitive nature of the subject.
Despite their reputation for being close, the two have deep mutual suspicions.
China's growing economic role in Myanmar has caused considerable popular resentment. Myanmar historically has feared being dominated by its much larger neighbour, while China worries about instability along its vast borders.
Beijing frets that Myanmar's civilian government may try and cosy up to the United States, adding to Chinese concerns about being "encircled" by hostile forces, such as the U.S. military bases in Japan and South Korea.
"I know historically there's been some issues of distrust with China but in general terms, I guess relations have warmed a lot and Myanmar still needs quite a bit in terms of trade in terms of gas and oil pipelines in 2013," said Christopher Roberts, a Myanmar expert at Australian National University, calling the move a gesture to show it was being accountable.
"But from Myanmar's perspective, I suspect something like the suspension of a dam is not a relationship-breaker like say the suspension of a gas plant or an oil pipeline. So I think strategically this is something that wouldn't put a significant dent in the relationship with China."
Economic relations are booming. Bilateral trade rose by more than half last year to $4.4 billion, and China's investment in Myanmar reached $12.3 billion, Chinese figures show. There is a strong focus on natural resources and energy projects.
"China and Hong Kong reached the top of the list of foreign investors just because of a few giant hydro power, oil and gas pipeline and mining projects. In fact, China has not invested much in the labour intensive manufacturing sectors," a senior official from Myanmar's Federation of Chambers of Commerce said.
"Since the Chinese bring thousands of workers, including manual labourers, their projects do not benefit local people much," he added, also asking not to be identified.
Ethnic minorities in Myanmar see the construction of Chinese-built dams as expanding military presence into their territory. Some analysts say Kachin rebels may be trying to hold the dams hostage in return for a share of the revenue from the projects.
The dam decision was a rare rebuke of China by Myanmar, especially as Beijing has gone out of its way to cultivate the new leadership.
Thein Sein's first major foreign visitor since taking office in February under Myanmar's "road map" back to democracy and civilian rule was the Chinese Communist Party's fourth ranked leader, Jia Qinglin.
During a visit to Beijing in May, Thein Sein praised the Chinese as a trustworthy, selfless ally, and received a line of credit worth 540 million euros.
Ultimately, observers expect Myanmar to compensate China somehow for the dam, but Beijing would become warier about future projects.
"The moral of the story is I think the Chinese side should now think, whatever the investments or the projects they'd like to do with Burma, they should look long-term," said Zaw Oo, director of the Chiang Mai, Thailand-based Vahu Development Institute.
"They should not consider or conceive any projects just for the sake of short-term benefits. (The Myitsone project) for the long-run is not going to be very positive for the development of Myanmar."
(Editing by Jonathan Thatcher)