AIIB’s Importance in the New Financial Order

The China-led Asian Infrastructure Investment Bank (AIIB) is set to give Asia a boost in development funding and a voice to developing nations who have often been side-lined in international finance. However, this new institution has received a mixed welcome from the West, and especially from major institutions that are heavily influenced by the United States (US). In this article, Chris Russell from CKGSB Knowledge explains how the AIIB can influence development finance and investment not only in Asia, but throughout the world.

For decades, China has steadfastly operated in accordance with Deng Xiaoping’s dictum “hide your strength, bide your time”. However, if there has been a defining feature of President Xi Jinping’s time as president, it is that this rule no longer applies.

From overseas investments by leading companies to new, bilateral free-trade agreements, China is now going out into the world with a new vigour. Nowhere is this better demonstrated than with the AIIB. Asia faces a potentially massive shortfall in infrastructure investment, with the Asian Development Bank (ADB) estimating in 2009 that the region would require United States dollar (USD) 8 trillion in infrastructure funding between 2010 and 2020. Having opened for business in January 2016, the AIIB, with 84 members, 25 approved projects and USD 4.39 billion in loans, has confirmed that China is stepping into the spotlight of international economic decision-making.

In-group/out-group

The AIIB was born into a system of decades old development banks that played a defining role in the post-World War II international order. From an Asian perspective, the most important of these financial institutions are the World Bank and the ADB. The former was initially known as the International Bank for Reconstruction and Development and came into being during the 1944 Bretton Woods Conference, which laid out the new global financial order after World War II. Today, the World Bank continues to work on eradicating poverty. In contrast, the ADB, as its name implies, was established to focus on facilitating growth in Asia. However, its focus changed to poverty reduction in 1999.

Despite being headquartered in Manila, the ADB has, and continues to be, a Japan and US-dominated institution. That has led to frustration on the part of the world’s developing economies, such as China and India, whose increased economic clout has gone unrecognised. Although the AIIB’s articles specifically state that its intent is to complement existing institutions, it is nonetheless meant to redress this imbalance.

“The creation of the AIIB is intended to contribute to a more multipolar organisation of the international financial system that in Beijing’s view should no longer be exclusively shaped by US-dominated institutions,” says Sandra Heep, head of the Economic Policy and Financial System Program at the Mercator Institute for China Studies in Berlin.

Even though the AIIB is seen to play a crucial role in giving a greater voice to developing countries, the organisation is still only one part of China’s attempts at changing the post-war international order. In addition to the Belt and Road Initiative, China is also a member of the New Development Bank (NDB), an organisation created by a group of countries collectively known as the BRICS (Brazil, Russia, India, and China). The NDB differs not only on its wider geographical focus, but also on its contingency reserve arrangement, which will provide liquidity to countries hit by a future financial crisis. While decision-making power is distributed equally between countries in the NDB, the AIIB is squarely aimed at bolstering China’s international influence.

Means to an end

The AIIB’s stated aim is to promote “sustainable economic development”, and as its name indicates, this will primarily be done through infrastructure investment. There is a clear need for that in Asia, but the project nonetheless represents something of a throwback, as other development banks now shy away from such projects due to the controversy they can generate. “By defining an institutional mission squarely around infrastructure investment, the AIIB’s architects are clearly responding to the priorities of developing countries and are returning to the roots of all of the MDBs (multilateral development banks), which were much more focused on infrastructure at the time of their founding,” says Scott Morris, senior associate at the Center for Global Development.

The bank has also sought to differentiate itself from other development institutions by aiming to be a faster, leaner organisation with less bureaucracy, reflected in its use of a non-resident, unpaid board of directors. “The AIIB may well be able to facilitate infrastructure funding more effectively than the ADB,” says Leslie Young, professor of Economics at the Cheung Kong Graduate School of Business, “some countries are reluctant to borrow from the ADB due to its bureaucratic processes”.

Beyond the AIIB’s immediate aims, there is of course a wider strategic context for China creating this bank. For all its outward focus, it is at least partially aimed at addressing domestic issues, as Ms Heep clarifies, “China wants to lend support to its domestic economy and provide the construction sector that is suffering from overcapacity with new markets and investment opportunities.”

Bidding for projects isn’t limited only to members, and countries like the United Kingdom, Germany and South Korea will all have an eye on their own industries as they work with the AIIB. Infrastructure projects, in particular, will represent a real opportunity for China’s cement, steel and high-speed rail sectors, although it is questionable whether the sums involved are truly large enough to soak up the current excess capacity.

Explaining why China benefits comparatively more than most, Mr Young goes on to say, “Economics ensures China the most benefits from the AIIB…the return on infrastructure investment depends on the value added by the trade that it enables; the highest returns on such investment in Asia will involve its dominant economy — China. Both in construction and operation, Asian infrastructure opens avenues for China’s expansion through thinly-populated areas where its workers, manufacturers and industrial skills have few competitors.”

Bridge to nowhere?

The success of the AIIB will depend at least in part, on its ability to act responsibly and to placate countries when it comes to setting standards and safeguards, which could potentially create tension with the bank’s desire for efficiency. This is unfamiliar terrain for China’s leaders, who have not led such a high-profile multilateral institution before. “Given the fact that the AIIB’s creation is at least partially aimed at establishing China as a responsible global stakeholder, Beijing will be careful to avoid the impression that it is trying to overrule the supporters of its development initiative,” says Ms Heep.

At any rate, China still has various means of pursuing projects that other AIIB members might find more contentious. “[China] can afford to be more relaxed about AIIB governance and strategy,” says Mr Young, “Its deep foreign exchange reserves can fund infrastructure investment that does not meet these [world] standards via other vehicles like the China Development Bank, the Exim Bank and state-linked enterprises.”

This reflects a broader issue, as such projects are often problematic for a number of reasons. “Infrastructure projects (particularly large-scale ones) are prone to controversy around issues of corruption, environmental issues and problems in the local community problems—managing all of these risks continues to be a challenge for existing MDBs and will no doubt be challenging for the AIIB,” says Morris.

Even then, Mr Young points out that infrastructure projects can encounter “institutional weaknesses in recipient countries, such as a weak bureaucracy that cannot carry out project studies and project design”. Taken together, that means there is a likelihood that not all of the AIIB’s investments will be successful.

Although the impact on recipient countries might be mixed—and previous cases, such as South Korea and China, would arguably have developed successfully anyway without the aid of international institutions—the AIIB is certain to lead the way in remedying shortfalls in funding.

CKGSB Knowledge is the quarterly English language publication of the Cheung Kong Graduate School of Business (CKGSB). Providing Chinese business insight, CKGSB Knowledge reaches an international audience across China, North America and Europe in print and online via knowledge.ckgsb.edu.cn.