Britain, longtime partner in an Atlantic-spanning “special relationship” with the US, threw its ally and the world for a loop in March by announcing it would apply to join the new Beijing-backed Asian Infrastructure Investment Bank (AIIB). The move opened the floodgates, and by the time the deadline for submissions arrived a total 56 prospective members had thrown their lot in with China’s new international financial institution, much to America’s chagrin.
But if Washington wants to pin the blame anywhere for what is now widely viewed as an unmitigated diplomatic implosion, it might want to think back to November, when the head of the International Monetary Fund (IMF) offered to do an exotic dance for the US Congress if it would just pass a much-needed and long-overdue set of reforms.
“I will do belly-dancing if that’s what it takes to get the US to ratify,” IMF Chief Christine Lagarde told the AFP shortly after Republicans finished cleaning up in the latest round of legislative elections. That conservative victory had further dimmed hopes of pushing through measures doubling the IMF’s financial resources and increasing the voting power of emerging economies like China, which has long felt it is underrepresented at said US-backed institution and at the Japan-led Asia Development Bank.
Thus was American ignominy sown at home, and while it is far from clear exactly what kind of impact the AIIB will ultimately have, a subscribed capitalization of US$50 billion – with a view to doubling that figure – has made it too big to ignore. Making its debut on a regional stage occupied by (presumably) more cautious, bureaucratic organizations like the Washington-backed World Bank and the Tokyo-controlled ADB, Beijing’s new financial champion offers China the chance to prove its foreign policy mettle afresh by advancing both regional and national interests through a multilateral institution of its own making. Yet a guarded approach will be needed in analyzing the impact the AIIB has on developing countries’ growth—as is already true of more august institutions.
“Countries that have developed successfully such as South Korea and China generally say that they would have developed with or without the World Bank, but that they did so faster and with fewer costly mistakes than if the Bank had not existed,” said David Dollar, 20-year veteran of the World Bank in Asia who is now a senior fellow with the John L. Thornton China Center at the Brookings Institution. “To shorten the development path is a useful contribution, but in my view it would be a mistake to attribute too much development success to the World Bank.”
The world was was engulfed in war when the IMF and what would eventually become the World Bank were created in 1944 in Bretton Woods, New Hampshire—though the Republic of China was a founding member of both. The IMF was created to lend money to countries that encountered severe financial difficulties, while the International Bank for Reconstruction and Development was intended to help fund the reconstruction of a war-torn Europe and provide investment in developing countries with an eye toward their becoming developed.
That second ambition hasn’t always panned out despite international financial institutions’ best intentions, said Michael Pettis, an economist and commentator at Peking University who recently penned a skeptical evaluation of the AIIB. Aside from South Korea and Taiwan, Pettis said it was “hard to think of many cases in the 20th century of poor backward countries becoming advanced economies.” He held that developing countries had a limited capacity to absorb significant amounts of external debt before the debt itself became a growth concern, bringing the underlying assumptions of the current loan-based development model into question.
Yet China may have benefited more than most from such international aid. After Mao’s death in 1976 the country’s ties with the World Bank and IMF proved a boon in helping it avoid serious economic missteps. When the bank visited in 1980 on its first economic mission to China, government officials were surprised to learn that their country was expected to become a net importer of oil by mid-decade—they had, after all, just signed a long-term agreement to export oil to Japan on the assumption that the mainland would have surpluses of the resource indefinitely, according to an account (pdf) from Pieter Bottelier, former senior adviser to the vice president for East Asia at the World Bank and senior adjunct professor of China Studies at Johns Hopkins University.
Beijing never used any of the IMF’s financing facilities, instead seeking its help in figuring out how best to develop major economic institutions and policy through extensive consultation. China did become the World Bank’s top borrower and received substantial technical assistance during the 1990s, though these roles later shrank as its economy matured. Even after China snagged accession to the World Trade Organization in 2001, reforms intended to give it and other emerging economies a greater voice at the IMF and ADB ultimately stalled. This logjam continued despite a study published by the latter in 2009 estimating that Asia would need about US$8 trillion in national infrastructure investment between 2010 and 2020.
Those long-running slights may have helped spur President Xi Jinping to propose creation of a multilateral financial institution on a visit to Indonesia in 2013, but according to unnamed policymakers cited in a recent report by respected finance and economics magazine Caixin, Beijing has been mulling such a bank for more than a decade. That would help explain some of the AIIB’s resonance with other new policy drives out of China.
“The AIIB has to be seen in a strategic context” said Professor Lye Liang Fook, assistant director and research fellow at the National University of Singapore’s East Asian Institute. Lye, whose research focuses on China’s relations with countries in the region, pointed to the broader picture including other initiatives that have been announced since Xi took office: the maritime and overland Silk Road initiatives and their accompanying Silk Road Fund, as well as the BRICS-funded New Development Bank.
By relying on economic strength, Lye said, China is deliberately avoiding confrontation with the US on a balance-of-power basis. “Economic cooperation is an area where countries can easily find mutual benefits. They tend to think less in terms of an ‘I win, you lose’ mentality,” Lye said; from a participating country’s perspective, “even if I earn less, I still earn.” Lye also considered it significant that the first group of 21 countries that agreed to join the AIIB was largely made up of smaller countries that stood to benefit from infrastructure investment. Dollar at the Brookings Institution said that rush may have been intensified by the lack of reform at the ADB and IMF.
“Even with thorough reform of the existing instit
utions, China may well have started a new bank such as AIIB,” Dollar said. “But it is likely that the response of other developing countries would not have been so enthusiastic if reform of the existing institutions were proceeding well.”
The memory of the IMF’s role in the Asian Financial Crisis is no doubt also fresh in the minds of leaders from the region. Many of the so-called Asian tigers had pegged their currencies to the dollar before the crisis hit, and when its value rose sharply in the lead-up to 1998 their export sectors became untenable. Trade deficits grew, and once stopgap funds from private capital dried up most turned to the IMF for billions of dollars in loans.
The ultimate cost went far beyond the sticker price: As it had during the Latin American debt crisis of the 1980s, the IMF adhered to a set of economic principles known as the Washington Consensus in formulating the conditions of each deal. The fund demanded that countries receiving loans cut government spending, sell off state-owned enterprises and generally take every conceivable measure to reduce government regulation of the economy.
In another parallel with the Latin American debt crisis, these policies made things far, far worse as loosened capital controls allowed a crippling flight of funds from countries that needed the money most. Combined with fiscal austerity the IMF’s policies hit the region’s economies like a sledgehammer—except for Malaysia. Acting in defiance of IMF prescriptions, stricter capital controls helped the country keep a hold on funds it needed to bounce back more quickly.
Whatever drew the influx of applications for membership in the AIIB, it wasn’t details on how the bank would be structured or function. The Caixin report cited unnamed officials as saying the bank will have a bank president heading up an executive council, a board of directors, and a management team. It’s not clear how the board or management team will represent member nations, though if the bank follows the precedents set by the IMF and ADB its president will be from the mainland. Founding members have expressed concerns, as in an email to the magazine from Australia’s Department of the Treasury which said it did not want the new bank to be controlled by any single country.
Lye said it was important to allow founding members to play a role in terms of shared responsibility for the institution and for Beijing to let them be seen as partners in getting the bank up and running. The key question, he said, was “how does China, even though likely the majority shareholder, imbue in other founding members that they are also critical members of the AIIB?”
Whether the party leadership is comfortable with it or not, China can certainly afford to allow other founding members to exert some influence on the bank’s decisions. That would broaden the spotlight beyond just Beijing in the event of inevitable issues with infrastructure projects, and would fit nicely into an array of foreign policy fronts that allow China to more nimbly pursue its goals.
“The Silk Road Fund (SRF) allows China the flexibility to tap it in terms of speed of dispensation and how to compliment the more orderly decision-making process of the AIIB,” Lye said. “[The bank] should not be seen as isolated, but as complimentary, allowing China the flexibility to engage in bilateral projects using either [institution].”
Together with the AIIB the US$40 billion SRF fits into a broader strategy outlined in a recent policy document published by China’s Foreign Ministry, according to an April piece by Tom Miller, senior Asia analyst and editor-at-large of China Economic Quarterly. “China’s success is the latest piece of evidence that it is finally developing a coherent set of political, economic and diplomatic policies to advance its national interest—a so-called ‘grand strategy,'” Miller wrote.
Some analysts have suggested that the SRF’s infrastructure focus will help absorb overcapacity from China’s glut-laden manufacturing and construction sectors. But in a recent analysis (pdf) for Bloomberg Brief, Dollar wrote that any fears the AIIB will do the same make little sense: “The point is that the bank is just way too small to make any dent in the excess capacity problem, even if China were the sole supplier for these projects, which it won’t be.”
The bank may yet tie into other policy goals being eyed by Beijing, among them furthering the internationalization of the yuan, said Dr. Damian Tobin at the China Institute of the University of London’s School of Oriental and African Studies.
Tobin, whose research focuses on the renminbi’s internationalization, said substantial policy movement in that direction is the result of incremental steps made by programs like the stock connect, Silk Road programs, and even earlier initiatives like the qualified investor scheme – all of which have a quota of renminbi. But he added the AIIB almost certainly won’t start out using the yuan.
“The transaction cost of using renminbi as reserve currency for the AIIB would be very expensive and very high, just as it would be for any other trade settlement or any other form of investment,” Tobin said. “I think what a lot of people are saying is that the easiest route is to use the [US] dollar, [which is] more liquid and freely available, and convertible, obviously.”
For those same reasons Tobin suggested it wasn’t likely that the yuan will be accepted for membership in the IMF’s Special Drawing Rights (SDR) basket of reserve currencies when the fund reviews the system at the end of this year. He cited the continued lack of full convertibility as a key shortcoming unlikely to be overcome in the interim.
“All we can go by is the history of these things,” Tobin said, “and the history of the past few years suggests that the Chinese leadership prefers these sort of incremental steps based on quotas and based on offshore pools of renminbi that they can control the interest rates of. Underpinning all of this is a big fear that if they go for full convertibility, capital will flow out—and if you look at the banking system in China at the moment, it really doesn’t seem ready to deal with that.”
Chinese officials have repeatedly said the AIIB will follow international best practices while seeking a more efficient and less risk-averse outlook than those the World Bank and ADB have come to adopt. Dollar, while supportive of these goals, is content to wait and see.
“It will be important to monitor AIIB to see if it really can be faster and more efficient, while at the same time respecting environmental and other standards,” he said. Lye explained that while countries in the region were looking for funding from an institution less bogged down in bureaucracy, that didn’t preclude due diligence.
At all such banks, Lye said, “the lender has to be sure there is a proper mechanism in place to not only dispense the loans but recover the loans over time.” He said the onus was on founding members to come up with standards for governance, environmental impact and how projects should benefit local communities instead of just the state or local companies.
But he warned that rapid, total industrialization wasn’t always the best choice. Totally abandoning agriculture and failing to develop the services sector in favor of high-speed industry building could lead to externalities like pollution and over-exploi
tation of resources (à la present-day China). For that reason, Lye said, the onus was on the governments receiving loans to decide their own economic models.
More of the bank’s key features should come into focus as its launch draws near, though said date remains a bit fuzzy itself. State news organization Xinhua has only ever stated that the bank “looks set to be launched by the end of the year,” though a memorandum of understanding has already been signed by members. It will take even longer to determine whether it will make a difference in the region and on the world stage.
“Infrastructure projects have a long gestation so it may take a decade or more to really see what the scale of AIIB will be and what its real impact is,” Dollar said.
Pettis was less genteel.
“We are very much in early stages, which you know, is fine,” he said, “because that’s when you are able to make all kinds of pronouncements and you don’t have to be worried too much with being consistent with the facts.” ♦
Author: Hudson Lockett (@KangHexin)
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