Tuesday 31st March 2015 marked the last day that countries could submit their applications to become founding members of the new China-led Asian Infrastructure Investment Bank (AIIB). As of this writing, a little over 40 nations have either already been approved or have applied for membership, including strong U.S. allies such as Britain, Germany and Australia, triggering a global powershift. Notable absentees are the U.S. and Japan.
Conceived to serve as an alternative to Western-dominated sources of credit such as the World Bank, International Monetary Fund and Asian Development Bank, the AIIB will aim to invest in regional infrastructure projects ranging from energy to transportation to telecommunications.
The new development bank, which is expected to launch later this year, will have $100 billion in capital to begin with—a massive mountain of money, to be sure, but it falls far short of the estimated trillions that will be necessary to fund Asia’s astronomical infrastructure demand.
China’s creation of its own global bank highlights the country’s desire to wield more control over funding such projects and trigger a global powershift. It currently commands only 5.17 percent of the vote in the World Bank and 3.81 percent in the IMF.
China’s move demonstrates its ongoing efforts to establish the yuan as a global reserve currency on par with the U.S. dollar. It’s no secret that the country wants the yuan to become part of the IMF’s Special Drawing Right (SDR), a composite currency unit that now consists of the dollar, Japanese yen, British pound sterling and euro. The founding of the AIIB might very well bring the country closer to realising these goals.
Asian -Shares Headed Higher
Chinese stocks are currently having a moment. Mainland A-shares, as measured by the benchmark Shanghai Composite Index, are up an incredible 92 percent for the 12-month period on the back of strong recent performance in the financial, property and infrastructure industries.
There’s generally a high correlation between the A-share market and China and Hong Kong, but the A-shares have outperformed by a wide margin over the past year.
Chinese policymakers have recently eased quota controls for foreign investors in mainland stocks and bonds, as they promote the yuan to be accepted as an SDR. The potential for greater inflows into the market should help the Shanghai Composite head even higher.
Will It Undermine The World Bank?
No one doubts the enormous infrastructure needs of Asia — the Asian Development Bank (ADB) estimates the region will need as much as $8 trillion to address critical infrastructure needs by 2020. To date, much of the work in creating the capital to address those needs has been done by multilateral development institutions like the World Bank and the ADB. While these institutions have made some headway in meeting the infrastructure needs of Asian countries, some critics of the World Bank and ADB argue they are slow and bureaucratic, and impose stifling environmental and social constraints which deter investment.
In part to address Asia’s growing infrastructure needs, Beijing has championed a new player in the region, the Asian Infrastructure Investment Bank (AIIB). Beijing has pledged to contribute much of the initial $50 billion in capital to the AIIB, which plans to offer long-term financing for transportation, telecommunications and energy projects in countries throughout the region. China is also expected to be the AIIB’s largest shareholder, with an equity stake of as much as 50 percent. The AIIB is expected to be formally established by the end of 2015.
The deadline for countries to join the China-led AIIB passed on Tuesday, with 47 countries and territories having applied for Prospective Founding Member status. According to Chinese foreign ministry spokesperson Hua Chunying, 30 countries had been approved, with more being considered before April 15. Recent weeks have seen a number of countries scramble for membership, following the unexpected announcement from Britain it would join in mid-March and the announcement by Beijing that China would forgo veto power.
Beijing now backs several development institutions, including the New Development Bank (along with Brazil, Russia, India and South Africa) and the Silk Road Fund, which can draw on funds from China’s foreign-exchange reserves, Export-Import Bank of China, China Development Bank and the country’s sovereign wealth fund, furthering the global powershift.
Outside of Beijing, the AIIB is perceived by many as a counterweight to Western-backed international development banks, and as a reaction to the reluctance of those institutions to grant Beijing a bigger role. Despite having an economy equivalent in size to the U.S., China has voting rights equivalent to only 5 percent at the World Bank (the U.S. has 12 percent), and the Japanese maintain their lock on the presidency of the Asian Development Bank.
While the creation of additional sources of capital would be welcomed in any region, Washington has expressed its concern over the potential for the AIIB to undermine the current efforts of the ADB and World Bank in adopting best practices in procurement, social safeguards, and environment. Reports are Washington has been lobbying furiously against the creation of the bank.
Fracture of the ‘Special Relationship’
Washington has not been successful, however, in lobbying another important nation, the United Kingdom, from announcing its application last month to be a founding member of AIIB. The U.K. government’s participation is significant given it is the first G7 country participant and can be expected to bring good governance to the AIIB’s operations, as stated on the U.K. government website, GovUk, promising “the UK will play a key role in ensuring that the AIIB embodies the best standards in accountability, transparency and governance.” Western nations France, Germany and Italy were quick to follow the lead of Britain and announce joining the AIIB.
Ensuring best practices will be a difficult task. In the past, the U.S. has opposed financing of coal-fired power plants by the ADB over concerns of global warming, refting a global powershift and refused to support construction of dams that intend to displace people from their homes. Washington ‘s fear is of a “race to the bottom” in environmental and social safeguards during the AIIB’s rush to build infrastructure, and the continued degradation of the environment in Asia — home to some of the highest levels of air, water and land pollution in the world. No one disputes Beijing ‘s track record in environmental protection throughout China leaves much to be desired, not even Beijing.
But the degradation of environmental and social safeguards need not take place should the AIIB adopt a co financing approach — participating and contributing capital in cooperation with the World Bank and ADB. Infrastructure projects often involve large amounts of investment, and limits on loan size and country exposure often require joint participation of several lenders and equity investors. Under a co-financing approach, the stricter of local or World Bank guidelines are often written into co financing agreements.
Unfortunately, to the extent the AIIB participates in co-financings, it will also be hindered by the slow and bureaucratic process of the existing development institutions, thereby undermining its determination to fund projects quickly. The AIIB has also been rightly noted by some as a deliberate political effort to pull Southeast Asian countries closer into China’s orbit, and co-financings will weaken its claim for greater political influence in the region, unless it takes a lead role in the arrangement of capital – something the World Bank and ADB will be reluctant to give up.
More likely, the AIIB will not seek to reduce its political influence on Asian nations by participating in co-financings. Rather the AIIB will strive toward maximum influence and expediency by having Beijing control the purse strings and avoiding the stricter environmental and social standards imposed by other developmental institutions. In the rush to quickly roll out major infrastructure projects, Asian nations may face the same problems China has experienced with its own infrastructure, including forced evacuations, quality problems and investment in uneconomic “white elephants.” A report released last year by the Natural Resources Defense Council, a U.S.-based environmental advocacy group, revealed Chinese ships leaving China using a cheap, high-polluting “bunker” oil and then switching to a higher grade fuel prior to entering a foreign port, in order to meet their stricter foreign environmental standards. A single container ship, according to the report, emits as much fuel pollution as 500,000 new Chinese trucks in a single day.
With ample support for the AIIB flooding in from many Western nations, the Obama administration has been forced to rethink its stance and is now proposing a partnership between the AIIB and the Washington-backed development banks such as the World Bank. Washington should use its influence, in conjunction with Asian and European countries, to foster a more collaborative approach designed to ensure the new institution adheres to stricter environmental and social safeguards in the bank’s prospective Articles of Association, lest Asian countries experience the very serious pollution and social problems Beijing is now trying to confront.