How the Asian Infrastructure Investment Bank Is Changing the Global Financial Landscape

By John Manning – john.manning@internationalbanker.com

During their visits to various Southeast Asian countries in October 2013, China’s president, Xi Jinping, and premier of the State Council, Li Keqiang, announced their first plans for the creation of the Asian Infrastructure Investment Bank (AIIB). The new lending institution would be a multilateral development bank (MDB) designed to foster economic integration within Asia in order to support the growing Asian need for investment in infrastructure, while it would also aim to work alongside existing global development banks. Within 12 months, 22 Asian countries had signed up as founding members to establish the new bank in Beijing.

Plugging an investment gap

The China-led AIIB intends to focus on providing capital for infrastructure projects in Asia, including within such industrial sectors as energy, telecommunications, transportation, agriculture and urban development. The requirement for substantially greater levels of investment in Asia’s rapidly developing economies has become a pressing issue. Given that the World Bank has a capital base of $223 billion and the Asian Development Bank (ADB) has just over $160 billion, an astounding gap in infrastructure needs has been growing, one which existing MDBs will be unable to plug. Indeed, the ADB estimated in 2010 that this gap will amount to approximately $8 trillion in total between 2010 and 2020, of which $2.5 trillion will be required for road and rail investment, $4.1 trillion for power plants and transmission, $1.1 trillion for telecommunications and $0.4 trillion for water and sanitation.

If managed professionally and in accordance with international standards of governance, the AIIB should help to correct this impending market failure. Despite the headlines that have been garnered in the last decade by regional powerhouses China, India and South Korea, Asia still experiences undesirably high levels of poverty. Although India is being increasingly viewed as the next hub of opportunity in the wake of China’s economic slowdown, the International Energy Agency (IEA) recently calculated that a quarter of the Indian population has no electricity. The IEA also estimated that 600 million Asians in total have no access to electricity, and 1.8 billion Asians have no access to clean cooking facilities.

Challenging US hegemony

With the advent of the AIIB, the hegemonic influence of the US in development finance is being severely challenged. Emerging as a credible rival to US-led development institutions, such as the World Bank and the IMF, the AIIB has managed to attract nations from all over the world for initial membership. 57 countries have been approved as founder members, with recent inductees including Australia, Sweden, Israel, South Africa, Azerbaijan, Iceland, Portugal and Poland. More importantly, the UK, France and several more of the US’s closest European allies have signed up to the AIIB, which has left the US fairly isolated as a non-member. Among its major economic partners, only Canada and Japan have remained outside to date.

At the IMF, more than 85 percent of total votes are needed to ratify any decision or proposal that is put forward. At present, the US holds a crucial 17.68 percent of voting power, which means that it has the power to unilaterally veto any proposal posited by the Fund. Furthermore, the US and its allies—Japan, Germany, the UK and France—make up the five most powerful members of the IMF, with a 40-percent shareholding in total. In contrast, China only commands 3.81 percent of the vote at the IMF and only 5.17 percent at the World Bank. Likewise at the ADB, Japan has traditionally been the dominant member and currently holds more than 12 percent of the total voting power, with the US closely following in second place with approximately the same share of power; China’s voting share, conversely, is less than 5.5 percent. In addition, the ADB’s president has always been of Japanese nationality.

The IMF voting quotas were readdressed in 2010, with the intention of making China the member with the third-largest voting rights and also putting emerging economies India, Brazil and Russia into the top 10 of the fund’s stockholders. The legislation to put the new voting rights into effect has been on the US Congress table now for five years. It appeared as though things would develop for China last year, but Congress again blocked any ratification of a new deal. China has openly criticised the US standstill on this issue in the past, with the central bank governor, Zhou Xiaochuan, describing the blockage as “irritating”.

In light of this frustration with the IMF and other MDBs, China decided to establish the AIIB, which begins life with a $100-billion capital base, of which 72 to 75 percent will be owned by Asian countries. China will also have de facto veto power over all decisions made by the AIIB, where it will hold more than 25 percent of the voting rights, while the next major shareholder, India, will have around 8 percent. This overwhelming dominance is proving to be of some concern to the US and Japan.

Furthermore, it is not only the emergence of the AIIB that is creating unease in America; China is also set to play a leading role in the new BRICS-led New Development Bank (NDB). While the initial contributory capital of the NDB will be an equal $10 billion from each of its five BRICS signatories, the additional $100 billion Contingency Reserve Arrangement—set up to provide liquidity protection to its members—is dominated by China’s contribution, which stands at an imposing $41 billion. Compared with the $18 billion being put in by each of India, China and Russia, and the $5 billion from South Africa, the lion’s share from China suggests that it is in the driving seat of the new MDB. Moreover, China also launched its major $40-billion Silk Road infrastructure fund, designed to provide investment and financing for projects along the maze of roads and ports connecting China’s old Silk Road land and sea routes between Asia, Europe and Africa. The combination of these Chinese-led initiatives, therefore, is expanding the strategic influence in the region of the world’s second largest economy, while simultaneously countering the US’s attempted Asia-Pacific pivot.

The US reaction

Officially, the US has stated in various capacities that the AIIB may not live up to international standards concerning procurement, labour and environmental matters. The AIIB has specified that it will operate in a “lean, clean and green” manner: “lean” through its small and efficient management team and support staff, “clean” through its zero tolerance for corruption, and “green” through its respect for the environment. The language of the official US stance on the AIIB has remained consistently diplomatic, as expected. The White House’s National Security Council, for example, has stated that the US believes “any new multilateral institution should incorporate the high standards of the World Bank and the regional development banks”. Whether the AIIB will consistently meet those standards remains debatable, although the Obama Administration has reminded the international community that they have “a stake in seeing the AIIB complement the existing architecture, and to work effectively alongside the World Bank and Asian Development Bank”.

Behind the scenes, however, it has become clear that the US perceives the rise of the AIIB, as well as the recent launch of the aforementioned NDB, as a way for China to expand its global influence in Asia and beyond, at the expense of America and Japan, the region’s long-established economic powers. Among the most crucial factors at stake is the US dollar’s use as the world’s leading reserve currency. China has previously been insistent over its desire for the renminbi to be included in the IMF’s composite currency, the “Special Drawing Rights”, which currently consists of the dollar, yen, pound and euro. It would appear that China is keen to turn the renminbi into a major regional reserve currency on the same level as the dollar and the yen. As unlikely as this seems at present, the more deals conducted in yuan through the AIIB and NDB, the more influence the renminbi will exert on the international stage, and as a consequence, the more the dollar’s dominance will be gradually eroded.

The US reaction to China’s recent activity has been criticised by many prominent figures as being too sluggish. Former Federal Reserve Chairman Ben Bernanke believes that US Congress should shoulder much of the blame for the AIIB’s strong emergence. “The US Congress has not approved it. They should, they haven’t…so I understand why other countries say, ‘Well, let’s take our marbles and go home’”, Mr Bernanke stated, emphasising the increasingly common view that Beijing was forced into creating the AIIB as a result of Congress’s refusal to give China greater clout in existing MDBs, particularly the IMF.

The government has tried to persuade its allies to resist China’s lure, at the very least until the role that China plays within the AIIB is more clearly ascertained. The US has almost completely failed in this mission, however, and has been left increasingly isolated since its close ally the UK, in addition to other advanced economies, signed up. Indeed in March, the US was moved to comment on the UK’s decision to join the AIIB, emphasising its hopes that it uses its influence to ensure that the AIIB adheres to international standards of governance. Speaking to the Financial Times, however, an unnamed US official expressed further consternation at the wholesale rush towards the AIIB, admitting that the US is wary over the “trend toward constant accommodation of China, which is not the best way to engage a rising power”.

To compound matters for the US, Obama recently failed to win support within Congress for his Asia-Pacific trade pact, which would have created a free trade zone between the US and 11 Pacific Rim nations. This has not been perceived well by many of the US’s closest Asian ties. K. Shanmugam, Singapore’s foreign minister, stated in early June that if the trade agreement gets completely blocked, “How will people view America as reliable? How will people see America as a country that can still get things done?”

Meanwhile, Japan has countered the AIIB by announcing a $110-billion investment plan in May for “high-quality infrastructure” projects within Asia over the next five years. The amount trumps the $100-billion founding capital of the AIIB. Japanese state-affiliated agencies will provide roughly half of the capital, while the ADB will provide the rest.

Slowly warming to the AIIB

Given the failures on the part of the US to contain the AIIB’s emergence, Obama’s position on the bank appears to have relaxed since the second quarter of the year, stating more recently that he is “all for it”, provided that international lending regulations are followed. Indeed, it may be beneficial to the US to appease China and the AIIB at this stage, or perhaps even to join as a new member of the bank. Given the large number of countries that have signed up, it could be in the best interests of the US to influence the AIIB’s decision-making process as a recognised partner, especially regarding environmental matters. The commonalities that exist between US and Chinese interests include the desire to ensure Asian economic growth stays strong and that their respective climate-change policies are adhered to, as evidenced by the joint announcement last November by Presidents Obama and Jinping of their shared environmental initiatives. By joining the AIIB, the US might be able to sway China into financing more infrastructure projects that lower CO2 emissions than if it remains outside.

There are also those who believe that the AIIB’s ostensible impact on the global financial system is being overstated. Michael Pettis, finance professor at Peking University and a senior associate at the Carnegie Endowment for International Peace, stated in April that in order for the AIIB to be considered a world-beater, China’s economy would have to be similar in relative size to that of the US in the 1940s and 1950s, when America experienced a significant gain in economic and political influence, and that the renminbi would have to be the world’s premier reserve currency. According to Pettis, the chances of either occurring are slim, especially as China’s central bank would have to take on “trillions of dollars of risk of sub-investment grade countries or…run large current account deficits”, both of which are highly unlikely.

From China’s perspective, it also makes little sense to not cooperate with the likes of the ADB and World Bank. The knowledge, experience and expertise that will be on hand at these institutions, and from which China will be able to tap, will provide the AIIB with an extremely efficient way to build capacity and ensure the smooth running of projects, in accordance with the high standards of governance that the world is now expecting.

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