The new multilateral financial architecture

The announcement by Britain, France, Germany, Australia and Brazil to join the China-promoted Asian Infrastructure Investment Bank (AIIB) has taken the world by surprise. AIIB, dismissed just a few months ago by western countries as another flamboyant plan by China, is now clearly accepted as a tangible game-changing development in the multilateral financial architecture.

What really reveals the scope and potential of AIIB, however, is Beijing’s brilliant and calibrated March 29 vision document for transnational economic corridors for Asia, where the world is invited to participate in this ambitious web of cross-border physical, financial and business connectivity[1].

A China-influenced global financing architecture is set to emerge. India, along with 45 other countries including Indonesia and Singapore, is a founder member of the AIIB. AIIB’s voting structure may be based on Purchasing Power Parity (PPP) and GDP. If that happens, India, a founder member of AIIB, will become the second largest shareholder, and if it moves smart, it will have a real chance to influence the formation and functioning of these institutions[2].

China’s intended role for AIIB is not so different from the existing lending institutions, which have configured the system to suit their needs. In AIIB, China has replicated the formation and functioning of the Bretton Woods institutions.

In formation, there are three similarities:

1. The IMF and WB were post-war efforts by the US to capitalise on a fiscally-weak Britain and extend control over the Sterling Area[3].  AIIB is a post-recession effort by China to capitalise on a fiscally-weak US and EU, and limit US economic influence in Asia. The IMF and WB did that by internationalising trade rules (e.g. reduction of tariffs) and foreign exchange rules (e.g. no devaluation) while financing post-war economic growth[4]. AIIB hopes to achieve that by internationalising infrastructure development. Infrastructure is to China in the 21^st century, what trade was to the US in 20^th century.
2. The AIIB focus on infrastructure is a masterstroke. Infrastructure is, after all, China’s competency, which it has been successfully building globally. The China Development Bank (CDB) already has 16% committed abroad. [5]. By some estimates, CDB and China’s EXIM Bank, together provide more aid to Asia than the World Bank and the Asian Development Bank, combined[6].  Also, in 2014, G20 leaders pledged to advance global GDP by 2% by using infrastructure as a key instrument and the World Bank has created the Global Infrastructure Facility for private investors to participate. But World Bank efforts will now be overshadowed by the AIIB.
3. As the US did with the World Bank and IMF, China wants to keep majority shareholding, so it can influence AIIB’s course – an opportunity it did not get with the World Bank and IMF (both under 5%) or the BRICS’ New Development Bank (NDB), given the equal 20% shareholding amongst the five members. China is rumoured to be seeking a 50% voting share[7] of AIIB’s initial subscribed capital is $50 billion[8].

China is leveraging off legitimate concerns. Developing countries are frustrated with the unfair governance standards and ineffective aid policies of the IMF and World Bank, and their interference in local policy making. The pressure on South Korea and Indonesia to open specific domestic industries to foreign investments in return for financial assistance during the Asian Financial Crisis in 1997 has not been forgotten.

There’s also China’s strategic interest looking for multilateral legitimacy and funding. Global participation in China-led projects, it hopes, will dilute China’s reputation in parts of Africa and Asia (e.g. Myanmar), of being abrasive on development and for demanding market access and natural resources in return.

In functioning, three similarities can be expected:

1. The AIIB and China’s vision transnational infrastructure projects like the Maritime Silk Road, Silk Road Economic Belt, and Pakistan-China Economic Corridor, coincide.  This is exactly how the US uses IMF multilateral funding for projects in Ukraine, Iraq and Afghanistan.  Naturally, most of the Asian infrastructure projects will be awarded to Chinese companies and financial institutions. China Development Bank already has a program called “Go Global” to support Chinese’s companies in foreign ventures[9].
2. The World Bank and IMF co-opted countries. China will go beyond, to co-opt pension funds, sovereign wealth funds and insurance companies – all long-term financial investors eager to invest their $50 trillion capital in infrastructure.  China will also invest its own $3 trillion reserves in projects with higher returns than the US Treasury Bills it is currently bound to. The US has done that successfully for decades by recycling petro dollars into developing countries[10].
3. AIIB will be a platform for Renminbi internationalisation, just as the IMF and World Bank were for dollar internationalisation. It can then raise and extend loans in Renminbi on a large scale, an experiment that China Development Bank has already undertaken[11].

Thus, like its Bretton Woods counter parts did with trade a century ago, China seeks to do with infrastructure globally but with greater multilateral legitimacy, on commercial terms, for strategic interests, with global capital.

The formidable intentions of the AIIB and the new transnational corridors project are both a caution and an opportunity for India.

If AIIB takes equity stakes in transnational infrastructure projects, becoming part owners, then it has geopolitical implications. Equity ownership is a high-risk, high-reward form of financing but a worthy option nevertheless for developing Greenfield infrastructure in developing countries when bank financing is not available[12]. When Islamabad awarded management control of the Gwadar Port in Pakistan to China Overseas Port Holdings Limited in 2013, it created a stir in India and the West[13]. Imagine the clout China will have within India when it owns or manages India-located projects like the Bangladesh-China-Myanmar-India (BCIM) corridor, and the many internal industrial corridors that Prime Minister Modi has planned with foreign funding.

Also, government-driven infrastructure projects can result in over-investment and under-utilisation since they are not bound by market supply and demand. There are indications that this is now happening with China’s real estate sector, and AIIB may be saddled with non-performing assets if it takes the same approach.

The opportunity for India then, is to influence and partner both the AIIB and the nascent BRICS bank on favourable terms. Infrastructure is the focus of BRICS Bank too, but so is sustainable development.  Developing countries, including India, can seek financing for climate change technologies, environment protection, affordable drugs and other technology-based public service delivery solutions. This will leverage India’s IT prowess and Brazil’s sustainable development experience. The first President of the BRICS bank from India should set this course.

As with AIIB, the BRICS Bank also has a provision for lending in RMB and taking equity stakes in infrastructure projects[14]. Yet, unlike the AIIB, the push by all five countries will most likely result in a multi-currency architecture that also includes Rupees, instead of just Renminbi. Similarly, diversified ownership should also make equity ownership less threatening. That is why equal shareholding is important and India should staunchly defend it.

The role of the BRICS Bank could have been bigger than that of the AIIB. The BRICS bank was conceived in an atmosphere of dissatisfaction with the existing western financial frameworks, and the lack of alternatives that left developing and non-NATO-leaning countries exposed to western biases. That is what happened with the unilateral economic sanctions imposed by the west on Iran and Russia in 2011 and 2014. With BRICS, Russia was able to rely on the $100 billion BRICS currency reserve arrangement in case its economy tanked sharply due to the economic sanctions – without a quid pro quo. Now, however, it seems that the BRICS Bank will also be overshadowed by the AIIB.

India is at a critical juncture. It is one of the largest recipients of World Bank aid, loans which can be cannibalised as these new institutions emerge, so it must capitalise on its early placement in the new multilateral financial architecture. Else, as the experience with UNSC, ASEAN, APEC and SCO, has shown, a missed opportunity in the beginning will take years to make up – if ever.