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U.S. President Barack Obama (L) attends a press conference with Vietnam's President Tran Dai Quang at the Presidential Palace Compound in Hanoi, Vietnam May 23, 2016. REUTERS/Carlos Barria - RTSFGX5

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By Greg Torode and Megha Rajagopalan

HONG KONG/BEIJING (Reuters) - At a stroke, the U.S. and Vietnam have complicated the strategic outlook for China over the disputed South China Sea.

As U.S. President Barack Obama marked one of his last trips to Asia by the historic lifting of Washington's arms embargo on Vietnam, he repeatedly insisted it was not directed at Beijing.

And yet regional military sources and security analysts say China will face short and longer term strategic headaches from the fully normalised relationship between former enemies in Hanoi and Washington.

Operationally, China faces the short-term prospect of Vietnam obtaining U.S.-sourced radars and sensors, surveillance planes and drones to better monitor and target Chinese forces, the analysts say.

In the longer term, the move makes Hanoi a key player in Obama's strategic pivot to East Asia. U.S. arms manufacturers will compete with Russia for big-ticket weapons sales to Vietnam. The U.S. Navy may get a long-held wish to use Cam Ranh Bay, the best natural harbour in the South China Sea, military sources say.

Then there is the prospect of political cooperation and greater intelligence sharing over China's assertiveness, according to diplomatic sources, even if Vietnam shuns any formal steps towards a military alliance.

Such moves dovetail with the goals of Vietnam's military strategists who have told Reuters they want to discreetly raise the costs on China's rapidly modernising forces from attacking Vietnam again.

Vietnam understands that a future conflict with their giant neighbour would be vastly more difficult than the bloody land battles on their northern border that rumbled through the 1980s, or the sea battle over the Spratlys in 1988.

RELYING ON DIPLOMACY

Chinese official reaction has so far been muted.

But Beijing is paying close attention to Vietnam's acquisition of modern weaponry and deployments in the South China Sea, said Ruan Zongze, a researcher at the China Institute of International Studies, a think tank linked to the Foreign Ministry.

"It's not impossible that this will then impact the territorial issue between China and Vietnam," said Ruan, a former Chinese diplomat.

Zhang Baohui, a mainland security expert at Hong Kong's Lingnan University, said he believed Vietnamese planners knew they could never prevail against the modern Chinese military, so they had to rely on diplomacy to keep stable relations with Beijing.

Zhang said he expected this to continue, despite the Obama visit, saying it was the "cheapest form of defence".

"Vietnam is working the U.S. into an enhanced deterrence strategy," he said. "To enhance its relations with China, they have to play the U.S. card," he said.

CAM RANH BAY

U.S. naval officials say they are keen to gradually increase ship visits, but are aware of Vietnamese concerns over pushing China too hard.

When in March Vietnamese officials announced the opening of a new international port in Cam Ranh to foreign navies, China was one of the first militaries to get a formal invite, according to reports in Vietnam's military press.

U.S. port calls are currently long-planned formal affairs. But U.S. military officials say a servicing agreement is one long term option to allow U.S. warships to make routine visits to Cam Ranh Bay.

Security analysts say even a small increase in ship visits, for example, would complicate China's operations in the South China Sea, now centred on dual-use facilities being built on seven artificial islands in the Spratlys archipelago.

China claims 80 percent of the South China Sea as its territory, while Taiwan, the Philippines, Malaysia, Vietnam and Brunei also have overlapping claims across one of the world's most important shipping lanes.

Lifting the embargo not only offers an opportunity for U.S. arms makers in Vietnam but elsewhere in rapidly developing Southeast as well, said a military advisor in Thailand.

"The U.S. sees opportunity and demand opening up in various other countries, such as Laos and Cambodia, which use weapons from Russia and China," said Panitan Wattanayagorn, an adviser to Thailand's Defence Minister and Deputy Prime Minister Prawit Wongsuwon.

"Their economies are expanding, but they still have old weapons so there is an opportunity."

(Reporting by Greg Torode and Megha Rajagopalan. Editing by Bill Tarrant.)

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