Third World Centre for Water Management

Communications

AIIB: Myths, vested interests, reality

A formidable competitor to World Bank and ADB, the new bank will benefit developing Asian countries and also serve several objectives for China.

Cecilia Tortajada and Asit K. Biswas

 

China's Finance Minister Lou Jiwei signs a document, with the guests of the signing ceremony of the Asian Infrastructure Investment Bank at the Great Hall of the People in Beijing.  PHOTO: REUTERS

China’s Finance Minister Lou Jiwei signs a document, with the guests of the signing ceremony of the Asian Infrastructure Investment Bank at the Great Hall of the People in Beijing. PHOTO: REUTERS

The Business Times | October 31, 2014

On Oct 21, 21 Asian countries became founding members of the China-led Asian Infrastructure Investment Bank (AIIB). These were Bangladesh, Brunei, Cambodia, China, India, Kazakhstan, Kuwait, Laos, Malaysia, Mongolia, Myanmar, Nepal, Oman, Pakistan, Philippines, Qatar, Singapore, Sri Lanka, Thailand, Uzbekistan and Vietnam.

The founding members are expected to sign and ratify the articles of agreement in 2015, and the AIIB will start functioning formally in late 2015. The authorised capital will be US$100 billion, and the initial subscribed capital will be around US$50 million. The paid-in ratio will be 20 per cent. The headquarters of the bank will be in Beijing. Its head will be Jin Liqun, former vice-finance minister of China and ex-vice-president of the Asian Development Bank (ADB).

Voting rights and its modalities of operation will be decided after consultations between the founding members. The rights are likely to be decided on a combination of gross domestic product (GDP) and purchasing power parity. On that basis, China will be the largest shareholder of the bank, followed by India.

No sane individual will argue against the need for additional infrastructure funding in Asia. According to the ADB, investments required in the Asian developing countries during 2010-2020 for national infrastructure alone are US$8 trillion, or US$800 billion per year. The ADB lends only about 1.5 per cent of this amount. Thus additional funding from the new bank should be welcomed. Furthermore, as the middle class across Asia continues to grow significantly, this educated and affluent group will demand increasingly better standards of living and quality of life, all of which will require more and better infrastructure.

The new bank has seriously ruffled the feathers of the American and the Japanese governments and created turbulence in the cosy and smug world of the World Bank and ADB.

This should not be surprising. Exactly 70 years ago, in 1944, following World War II, two international financing institutions – the World Bank and International Monetary Fund (IMF) – were created following Bretton Woods’ discussions. Each member country received a quota, or financial contribution, depending on their share of global economy as measured by GDP. This quota represented the country’s voting power in the World Bank-IMF group.

SEA CHANGES
The world has undergone sea changes during the last 70 years. Consequently, the current global governance does not reflect the changing dynamics of economic and political power. China now has a bigger economy than France, Germany and Italy combined. Yet its voting power in the Bretton Woods institutions is only 5 per cent, even though it accounts for nearly 10 per cent of global GDP. The United States has nearly 17 per cent voting power, which allows it to block any reform for which an 85 per cent majority is needed.

Countries such as China, India, Brazil and Turkey feel that there has been a democratic deficit in the governance of these organisations, and the current situation does not reflect the fundamental changes that have been taken place in global economic and political power since their establishment.

Group of 20 finance ministers agreed on a reform to rectify this situation in 2010. This proposal was based on the size of the country’s economy at the end of 2008. This would have doubled the IMF’s capital to US$720 billion and transferred 6 per cent of voting power to the emerging powers. The US Congress has failed to ratify this revision, primarily because it feels this would reduce its influence in the Bretton Woods institutions. It is really moot that even if this revision was approved, the US would still have maintained its veto power. Also, the Chinese economy is now nearly twice the size of what it was at the end of 2008. The system was unfair in 2008, but it is even more so at present.

Unwilling to accept a continuing Western domination of the international financial situation, and in response to the critics, especially the US which has long argued that China should assume greater global responsibilities in areas such as climate change and arms proliferation because of its growing economic and political clout, Chinese President Xi Jingping surprised his Indonesian hosts during a state visit by announcing the formation of the AIIB.

From a Chinese viewpoint, such a bank makes eminent sense. A major feature of China’s miraculous economic progress has been its emphasis on infrastructure development. During the period of 1992-2011, the country spent nearly 8.5 per cent of its GDP on infrastructure. The corresponding figures for other Asian countries were between 2 and 4 per cent.

The AIIB will serve at least five objectives for China. First, the country could invest part of its foreign reserves of US$3.9 trillion on commercial terms rather than putting them in US Treasuries where the real value is shrinking. Secondly, it will contribute to the internationalisation of the yuan. Thirdly, it will help secure contracts for Chinese firms and thus boost employment opportunities at home.

Fourthly, as China has funded numerous infrastructure projects all over the world through China Development Bank and Exim Bank, some of which have created local resentment, there will likely be much less such animosity when the funds come from a regional multinational bank. And, fifthly, it will boost China’s influence internationally and significantly enhance its soft power.

The proposal has been badly received by the US, Japan and the ADB, three parties that are likely to lose some power because of the new bank. This is likely to be compounded when another new bank, the BRICS Bank, starts operating in Shanghai. Tokyo and Washington have worked in tandem to maintain their power structure in the 67-member ADB. China is now Asia’s largest economic power. Yet, the US and Japan hold 15.7 per cent of votes in the ADB, but China holds only 6.57 per cent.

The US has actively lobbied its close allies Australia and South Korea to not join the AIIB. It is basically a power play to curtail China’s growing soft power and economic influence in the region. US Secretary of State John Kerry lobbied Australian Prime Minister John Abbot to not join the AIIB when both met in Jakarta during the inauguration of President Joko Widodo. Similarly, a senior South Korean diplomatic source observed that Korea has “no reason not to join it”, and that it is now “in a deep dilemma on what sort of strategic choices it has to make as China challenges the US-led international order”.

Over the medium term, the three important holdouts – Australia, South Korea and Indonesia – simply cannot afford to antagonise Asia’s most important economic power and one of their largest trading partners. It would be surprising if they do not join within the next two to three years because it would be in their national interests.

GOVERNANCE PRACTICES
ADB and some unnamed senior Washington figures have questioned the likely governance practices of the AIIB, including upholding good social, environmental and labour conditions, transparency and sound economic principles. These in our view are red herrings, primarily to preserve the status quo.

The AIIB is a new southern alternative to traditional sources of international development funding. Properly structured, it could learn from and avoid the mistakes of the World Bank and ADB. It could reflect broader and more appropriate mandates, and adopt better governance practices. It would not be bound by tradition or historical precedents and may even develop new and more effective financing mechanisms.

In 2007, then-Chinese president Hu Jintao made environmental protection one of the seven pillars of foreign investment requirements. Anecdotal evidence indicates that environmental and social impacts of Chinese finance are now about average. They are more respectful and responsive to regulations of host governments, including oversights. No one can beat China’s record and experience in infrastructure, both within the country and abroad. According to Chinese Foreign Minister Lou Jiwei, China Development Bank’s commercial infrastructure loan is now far bigger than that of the World Bank and ADB combined. This has occurred only within the last 20 years.

Fred Hochberg, chairman of the US Export-Import Bank, has noted that his institution has extended some US$590 billion in loans and guarantees over its 80 years of history. In contrast, the Chinese institutions have provided some US$670 billion in only the last two years. Thus, the sceptics are underestimating and misrepresenting the Chinese knowledge and experience.

The AIIB will be a formidable competitor to the World Bank and ADB. It will shake up their current modus operandi, and force them to rethink some of their unnecessary lending restrictions and streamline their project approval, preparation and implementation processes. The impact on the ADB is likely to be significant. It does not have the same degree of expertise and intellectual prowess as the World Bank. Some of its thinking, for example in the water area, is at least 15 years behind time. Unless it can radically improve its performance, it would be increasingly marginalised by the AIIB and BRICS Bank.

Over the medium to long term, the AIIB is likely to have a positive impact. It will provide a new source of funding to Asian developing countries. For China, it will enhance its soft power and bring considerable economic benefits. The competition will force the ADB and World Bank to undertake serious reforms that have been long overdue.

Cecilia Tortajada is a senior research fellow and Asit K Biswas a distinguished visiting professor at the Lee Kuan Yew School of Public Policy, Singapore. They are co-founders of the Third World Centre for Water Management, Mexico.

Article published in The Business Times, October 31, 2014

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