Inadequate Reform Is AIIB’s Biggest Challenge

 The idea of establishing the Asian Infrastructure Investment Bank (AIIB) came up in Mumbai, India. At the end of 2012, Zheng Xinli, vice chairman of the China Center for International Economic Exchanges (CCIEE), met Jin Liqun, then chairman of the Supervisory Board of China Investment Corporation, at the Asia Financial Cooperation Conference in Mumbai. Talking about underdeveloped infrastructure in Southeast Asia, they both proposed to set up an investment bank for this purpose.

Later, the CCIEE submitted a report on the setting-up of AIIB, which was revised several times, to the Chinese authorities. After the report was ratified, preparations moved into the fast lane. In October 2013, when visiting Indonesia, President Xi Jinping proposed establishment of AIIB for collaborating with multilateral development banks in Asia and beyond to promote the region’s economic development.

On December 25, 2015, AIIB was officially established, with 57 countries as founding members. The figure was two times more than expected. India is among the first group of the 21 Prospective Founding Members of AIIB. Despite Washington’s opposition, some U.S. allies including Britain decided to join AIIB, followed by many other developed countries. This came as a shock, as Akshay Mathur, head of research and geo-economics fellow at Gateway House: Indian Council on Global Relations, said, “AIIB, dismissed just months ago by Western countries as another flamboyant plan by China, is now clearly accepted as a tangible game changer in the multilateral financial architecture.”

After the 2008 global financial crisis, infrastructure has been deemed as a driver for the world economy’s substantive recovery. Many multilateral institutions recognized the infrastructure underdevelopment and inadequacy in the Asian region. A report jointly released by the Asian Development Bank (ADB) and the ADB Institute in August 2009 shows that the Asian region including China will need infrastructure investments totaling US$ 8 trillion between 2010 and India, whose foreign exchange reserves added up to US$ 361 billion in 2015, will suffer an infrastructure deficit of US$ 1 trillion. In this context, foreign investments will be the main source of the funds that India needs for developing domestic infrastructure and regional connectivity. Given that the current development institutions have neither adequate funds nor expertise in infrastructure construction, China has acted as a global governance reformer in its most competitive economic field by initiating AIIB.

In recent years, debates over whether developing countries deserve a greater say in the global financial system have heated up. At the 2012 Asia Financial Cooperation Conference in Mumbai, more than 500 political and business leaders reached a consensus that Asia should have a bigger voice in the formulation of major international mechanisms and rules. Perhaps this is the major reason why India finally chose to join AIIB, despite the fact that it hesitated for a while. David Daokui Li, a prominent Chinese economist, points out that the current U.S.-led global economic system is facing three basic problems: First, it doesn’t respond to the appeal of emerging economies represented by China. Second, the U.S. is unwilling to give up its veto power in the International Monetary Fund (IMF) and the World Bank. Finally, the U.S. has yet to take responsibilities matching its status as the world’s largest currency printer. In view of

the ongoing Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP) negotiations and other issues involving the U.S., Chinese international relations expert Pang Zhongying used the word “gravedigger” to describe the U.S.’s role in global governance, remarking that the U.S. is abandoning the international organizations and rules that it ever initiated, founded and protected while seeking to “reinvent the wheel.”

Against such a backdrop, although China reiterated on many occasions that AIIB is merely a “supplement” to existing international financial institutions, no one doubts that China has begun playing the role as a reformer of global governance. India, the world’s second largest developing country, as well as some EU countries, expressed support for the reform of global governance by joining AIIB. Hari Bansh Jha, professor of economics and executive director of Centre for Economic and Technical Studies in Nepal, remarks, “Only time will tell how the New Development Bank (NDB) and AIIB emerge as alternative sources of funding in the international financial market. But it has almost become certain that the era of the West’s control over the international financial resources has started eroding.”

Joining AIIB doesn’t mean that India has shed its doubts on potential risks. According to Indian media, India’s biggest concern is AIIB’s relationship with China initiated Belt and Road Initiative, especially with the China-Pakistan Economic Corridor. As a matter of fact, AIIB has adhered to the rule of “not stepping into any disputed territories and waters.” Responding to worries about China as the biggest shareholder of AIIB, Jin Liqun, president of the bank, has said many times that as a multilateral financial organization with 57 founding members, AIIB will always operate according to the corporate governance framework agreed upon by all of its members and in conformity with the best international standards. Of course, the “best international standards” include development experiences of developing countries, especially China, over the past more than three decades.

Recently, China-India Dialogue sat down with Professor David Daokui Li, an eminent Chinese economist and director of the Center for China in the World Economy at Tsinghua University, to discuss questions such as how AIIB affects regional order and the relationship between AIIB and India. Li received his Ph.D. in economics from Harvard University in 1992 and ever served as a member of the Monetary Policy Committee of the People’s Bank of China, thus gaining deep insight into China’s economic development modes, changes of international systems, and development strategies of major powers. In his opinion, a major aim of AIIB is to reform the global financial system, but it has no intention to play the role of a revolutionist for replacing the existing international monetary system. Rather, it seeks to supplement the space left uncovered by the World Bank and the IMF, and reform key international rules in the investment field.

What influence will India exert on AIIB? Some economists assert that there is a deep pool of tacit xpertise on the nuts and bolts of development banking that India could deploy in AIIB. What does “tacit expertise” mean?

Li: As the world’s second largest developing country and emerging economy, India is among the group of “market economies that are not in transformation.” There are two categories of emerging economies: One used to be planned economies, such as China, Vietnam, some eastern European countries, and former Soviet republics; The other category, of which India is a representative, has never gone through the planned economy period. The two categories differ in their development systems. To invest in infrastructure projects in those countries, one requires a better understanding of their differences. Thus, it is meaningful for AIIB to have India as one of its members.

In spite of being a country without a powerful government, India has tacit expertise on how to properly deal with the relations between politics and economy, and how to raise funds for infrastructure projects and push them forward. India’s situation is more complicated than that of China. To develop infrastructure projects in India, a foreign investor needs not only to reach an agreement with the government, but also to establish good relations with local legislatures, environment authorities, culture preservation commissions, and even religious organizations.

From the perspective of macroeconomics, countries like India usually suffer overall instability, high inflation, government deficits, and great pressure on currency depreciation. Moreover, India’s central bank is independent of its central government, so its monetary policies don’t conform to its government policies. This just creates another uncertainty. AIIB will accumulate experience of investing in India. In addition, the great number of specialists in India will provide personnel support for AIIB.

How will India benefit from AIIB?

Li: AIIB is important for India. For a long time, infrastructure shortage has been a bottleneck hindering India’s development. Its infrastructure is much worse than that of China. Further, India’s national savings rate is much lower than that of China, so its fund-raising capacity for infrastructure projects is comparatively weaker. Presently, most transnational development institutions including the World Bank are wary of investing in India. Lacking knowledge about developing countries, those institutions typically evaluate the investment environments of target countries according to Western modes.

Since India has become the second largest shareholder of AIIB, it is easier for the bank to understand the South Asian country. India, on the other hand, expects to get more funds from AIIB to invest in its infrastructure. From this perspective, India needs AIIB more than China.

Early this year, D. J. Pandian, former chief secretary of Gujarat, was appointed chief investment officer of AIIB. How do you see his role? What challenges will he face?

Li: His Indian background is important. As a former government official, he knows well the country’s development mode, bottlenecks, and how to break those bottlenecks. The major challenge he may face is how to “translate” India’s infrastructure needs into investment projects which are acceptable for investors.

For instance, traditional banks usually loan funds for a term of 15 years. However, the tenure of an Indian official in a particular post is only four years, so he or she cannot assure investors what will happen in 15 years. In this case, AIIB needs to redesign its loan and investment terms. This is a challenge. Typically, local officials and bank officials are ranged against each other. It is a creative solution to appoint a former local official as a senior executive of the bank. There are also challenges relating to control of project process, handling over-estimates, and how to pay off loans. All of these require breakthroughs in the current contracting methods of international development organizations.

It is reported that AIIB will loan funds totaling US$ 1.2 billion in 2016, and India expects to get half of the amount at a lending rate of no more than 10 percent. What do you think of such an expectation? What lending rate will AIIB adopt?

Li: I understand India’s expectation because it needs infrastructure investments very much. But frankly, AIIB is a newcomer, and it will take at least a few years for the bank to achieve profitability. To this end, its investment projects need full support from local governments and communities. It isn’t easy for India to do so. Over the years, the World Bank and the ADB found it difficult to invest in India. It is impossible to change the situation in the short run.

All borrowers want low loan rates. The final lending rate depends on whether AIIB is willing to lose money. As a non-profit organization, AIIB will adopt a low lending rate in the event that the project it is financing and its operation costs are under control. Currently, the financing cost isn’t high because the interest rates on the U.S. dollar and other major reserve currencies remain low. There are some uncertainties in the future. Perhaps, AIIB will adopt flexible lending rates ranging from 5 to 10 percent.

What is your view on the link between AIIB and the internationalization of RMB? It is reported that AIIB will settle deals in the U.S. dollar, but raise capital and make loans in RMB. The loan terms of AIIB may be very long. In this case, how would it offset risks from exchange rate fluctuations?

Li: China hopes to provide more public products and services to the world through AIIB, instead of seeking its own interests such as RMB internationalization. Despite the fact that the international monetary market remains complicated, it is believed that it will go toward diversification in the future. Under such a complex, changing environment featuring the decline of the U.S. dollar and the rise of RMB, AIIB is supposed to adopt a diversification strategy when formulating loan interest rates. For instance, it can settle loans in the U.S. dollar while linking the interest rate and repayment amount with the IMF basket of currencies.

What are the risks of AIIB’s cooperation with the private sector for raising funds, and which seems likely?

Li: Infrastructure projects are unsuitable for any single source of private capital because they usually are high risks and time-consuming. I believe AIIB will gradually promote efficient cooperation with private capital, so as to give full play to their advantages and make  investments together. Meanwhile, the bank needs to break current systems if it intends to offer high-quality loan portfolios and provide an early withdrawal mechanism for private capital. There are also many things worth doing to improve investment contracting.

An article published by Gateway House: Indian Council on Global Relations says that developing countries are disappointed at the U.S.- dominated World Bank and IMF. Will emerging economies benefit from AIIB? What changes will AIIB bring to the development of emerging economies?

Li: People’s expectation for AIIB is that emerging economies will benefit. Headquartered in Beijing, the bank is mainly composed of investors and professionals from developing countries. Its staff and decision-makers also primarily come from such emerging economies as China and India. Therefore, AIIB has a deep understanding of the needs of emerging economies, so it may formulate and adopt loan methods, investment terms, and project execution methods different from previous development institutions. The most remarkable change that AIIB will bring to emerging economies is that projects formerly unacceptable to the World Bank and the ADB will become feasible through AIIB’s flexible loan approaches.

Statistics released by the Reserve Bank of India show that the bad debt rate of India’s infrastructure sector is much higher than that in other fields. Other widely-mentioned risks include long capital turnover periods, low loan interest rates, potential waste and corruption, and political unrest. How can AIIB avoid these risks when investing in developing countries?

Li: AIIB is facing two major risks. One is inadequate reform, resulting in AIIB merely repeating practices of the World Bank and the ADB. This risk is tangible because innovation isn’t an easy task. The other is money loss in some investment projects. For example, it cannot recover loans in the event that relevant investment contracts are forced to be terminated due to political turmoil. In other scenarios, some projects, although feasible commercially, cannot be executed due to protests from environmental protection groups and local nongovernmental organizations.

To avoid such risks, AIIB needs to conduct surveys repeatedly and become familiar with the conditions of the countries where it intends to invest. How does the U.S. see India’s participation in AIIB? Li: The U.S. made a strategic mistake when AIIB was still in the process of being established. It misread the founding of AIIB as China’s executed due to protests from environmental protection groups and local nongovernmental organizations. To avoid such risks, AIIB needs to conduct surveys repeatedly and become familiar with the conditions of the countries where it intends to invest.

How does the U.S. see India’s participation in AIIB?

Li: The U.S. made s strategic mistake when AIIB was still in the process of being established. It misread the founding of AIIB as China’s unilateral action and which, for that reason, couldn’t succeed. The U.S. began to regret after countries like India and Britain joined AIIB. Although disappointed by India joining the AIIB, the U.S. found that it could in no way stop it. In fact, India’s participation in AIIB magnified the U.S.’s strategic mistake on the issue of AIIB. It is still not too late to correct the mistake. The U.S. still has the chance to be part of AIIB and a significant investment partner.