The South China Sea has become Asia’s biggest potential military flashpoint as Beijing’s sovereignty claim over the huge area has set it against Vietnam and the Philippines, as the three countries race to tap possibly huge oil reserves believed to lie under the seabed.

Attendees hold hands while posing for a photo before the 19th ASEAN Regional Forum (ARF) Foreign Ministers Retreat at the office of the Council of Ministers in Phnom Penh July 12, 2012.

REUTERS/Samrang Pring Political leaders and officials say the row may not directly affect plans by the Association of Southeast Asian Nations (ASEAN) for the economic integration of countries ranging from wealthy Singapore to impoverished Myanmar.

Six clubs from six different countries of the Association of Southeast Asian Nations competed in the league’s 2009 inaugural season.

MANILA/BEIJING, July 15 (Reuters) – A Chinese frigategrounded in disputed waters close to the Philippines wasrefloated on Sunday and headed back home, averting a possiblestandoff with the Philippines navy amid rising tensions in thestrategically key South China Sea.

The South China Sea, which stretches from China to Indonesia and from Vietnam to the Philippines, lies atop what are believed to be rich reserves of oil and gas.

"It’s not going to hold progress (on integration) hostage," ASEAN Secretary General Surin Pitsuwan told diplomats in Jakarta, referring to a recent meeting in Cambodia, where rifts over the South China Sea prevented the group’s foreign ministers from issuing a communiqué for the first time in its history.

" Southeast Asia is a hot destination for investors seeking returns that are drying up in Europe, still to recover in the United States and slowing in the rest of Asia.

Estimated net flows into offshore ASEAN funds stood at $1.4 billion in 2012 through June, according to data reported until July 10.

By comparison, China and India offshore funds saw net outflows worth $1.6 billion and $185 million respectively.

Investors have high hopes for plans by the 10 member ASEAN for a single market and production base for a combined economy of $2 trillion, with free movement of goods, services, investment and skilled labour among 600 million people.

While there is consensus in ASEAN for economic union, the group struggles with political differences ranging from a land border dispute between Thailand and Cambodia to a cultural spat between Malaysia and Indonesia.

The most destructive is the inability to deal with claims by four of its members, and China and Taiwan, in the South China Sea.

Since only some elements of the economic plan will be in place by 2015, such as zero tariffs, more developed members may have to push on with integration in a two tier model, just as the European Union did, leaving the others at risk of missing out on regional investment.

When the AFTA agreement was originally signed, ASEAN had six members, namely, Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand.

The two tier model could leave fringe members further exposed to influence from China — and the United States — as they seek influence through investment and diplomacy in a "Great Game" played out in the tropics.

If ASEAN were a single entity, it would rank as the ninth largest economy in the world, behind the United States, China, Japan, Germany, France, Brazil, the United Kingdom, and Italy.

China is already the top investor in Cambodia and Myanmar and is catching up with investment by Europe, Japan and the United States in the region overall.

"The difference is that China is giving something that Cambodia needs, while ASEAN is promising something that is abstract," said Aleksius Jemadu, dean of the school of political and social sciences at Pelita Harapan University in Jakarta.

When this community is built we can’t expect them to be in unison, just like what happened to the South China Sea.

" ACRIMONY At the Phnom Penh meeting of foreign ministers, some diplomats said Cambodia blocked the South China Sea dispute being put on the agenda at China’s behest.

Cambodian diplomats in turn accused the Philippines and Vietnam of trying to hijack the meeting.

The Philippines has said it deplored ASEAN’s failure to address the row and criticised Cambodia for its handling of the issue.

Cambodia had GDP per capita of $900 in 2011 and foreign direct investment (FDI) of $800 million in 2010, according to World Bank figures.

Even without the economic and political differences, a lack of capacity among some of ASEAN’s members is making it hard to implement economic agreements.

Its aims include accelerating economic growth, social progress, cultural development among its members, protection of regional peace and stability, and opportunities for member countries to discuss differences peacefully.

Completion of measures towards a single market in its 2010 2011 phase was only 49 percent overall, according to ASEAN’s latest scorecard, with reform lagging in food and agriculture.

The process of transposing regional commitments into national laws is the biggest (challenge)," said Subash Pillai, ASEAN’s director of market integration.

The Philippines struggles to send officials to meetings sometimes and can be slow making decisions, insiders say, and may even risk falling into the weaker group of Cambodia, Laos, Vietnam and Myanmar.

A recent Reuters visit to Myanmar’s central bank found just a few idle computers, a stark contrast to the soaring towers that control banks and policy in Singapore and Indonesia.

ASEAN MINUS X The bloc’s ASEAN Minus X mechanism allows "flexible" implementation of commitments, by enabling members to opt out of economic schemes if they are not ready.

Singapore and Laos are the only members pushing ahead with an agreement on education services.

Six countries including Vietnam signed an agreement to link their stock markets by the end of 2011, to spur electronic cross border trading, but only Singapore and Malaysia are implementing it.

The ones lagging behind will suffer," said another senior ASEAN official, who declined to be identified.

The South China Sea spat also shows the problems ASEAN has resolving major disputes.

Unlike the European Union, an inspiration if not a model, ASEAN lacks elected members of a central parliament, a powerful executive body or a regional court to make law and enforce its will.

"Without a strong central mechanism it is very difficult to coordinate and survey all the issues that could become big issues," said Surin.

The bloc will face further challenges as it tries to standardise customs procedures and open up protected industries such as financial services to competition from within.

It has implemented free transfer of profits and dividends but needs to remove further barriers to intra regional investment flows.

They are not going to see much action on services," said Hal Hill, professor of Southeast Asian economies at the Australian National University.

"The Phnom Penh meetings in July were significant not just because China sought to divide ASEAN by leaning on Cambodia, but because China was happy to do so, so brazenly," said Bryony Lau, a researcher on the South China Sea for the International Crisis Group think tank in Jakarta.

(Additional reporting by Olivia Rondonuwu and Martin Petty; Editing by Raju Gopalakrishnan).

Sean Brierley is a business journalist based in Hobart, Australia. Sean has a passion for financial markets and breaking news stories and loves writing about business news, stock market, and economic opinions that matters most to its audience. Sean spends a lot of time discovering and researching latest financial markets and industry news stories in order to make sure the latest and greatest stories are brought to you first on BigBoardNews.com.