China's entry to global financial architecture

The big idea received mixed reactions as it was floated in 2013. When China announced its plan to launch the Asian Infrastructure Investment Bank (AIIB) with an initial capital of USD 50 billion, an international financial institution similar to the World Bank, the International Monetary Fund and the Asian Development Bank, countries were not too sure as to whether and why should they join. After several months now at the time of finalisation it seems that many countries across Asia and Europe have much interest in the AIIB. So they have joined as its founding members. The USA, sceptical from the beginning, continues to be frosty and has refrained from becoming a member of this bank. 

Though uncomfortable initially, the World Bank says that it sees the AIIB as a complement for undertaking development activities. But what is the need for the AIIB when there is the ADB for Asia? The answer is simple: the huge funding gap that countries face in undertaking their development programmes. Political and diplomatic analysts, however, may see much more beyond this straightforward economic justification. That is, since China is awash with foreign exchange reserves it wants to use this economic strength in the global power play. 

Sticking to purely an economic angle of the AIIB, one would see more positives in this move. While developed countries are still struggling to recover from the shock of global financial meltdown of 2008 and many 'are highly likely to be entrapped in secular stagnation' (ESCAP 2015), China's growth was robust at 7.3% in 2014 with the projected growth of 7% in 2015. Though lower than 10% during the previous three decades, with the new normal growth of 7.0–7.5% at present, China leads the global economy in terms of both size and rate of growth. China is now the largest economy in the world. In 2014, with a Gross Domestic Product of USD 17.6 trillion, China just surpassed the US economy which had a GDP of USD 17.4 trillion. In other words, China's share in global economy is 16.5% compared to USA's 16.3%. The IMF expects that this trend of Chinese GDP growth will continue.

Coming back to the question: why does Asia need another bank? A widely circulated figure is that the region needs an investment of USD 8 trillion during 2010- 2012 for its economic development (ADB 2010). So efforts towards meeting the finance gap should be pursued. In this context, it is a welcome move on many accounts that the AIIB is going to provide support to Asian countries to build infrastructures such as roads, railways, power and telecommunications. This initiative could be complementary to the New Silk Road initiative of China which also aims to improve infrastructure and connectivity in Asia.

Though China has been investing heavily in Africa in a number of sectors including natural resource extraction, finance, infrastructure, power generation, textiles, and home appliances, it has not done so in Asia, particularly South Asia.  In case of Bangladesh, China has recently expressed its interest in investing in five priority sectors such as commerce, agriculture, industry, energy and infrastructure. Though sporadically China provided support in infrastructure, Chinese investment in Bangladesh was not particularly noteworthy till 2010 despite the fact that China is a major trade partner of Bangladesh. However, since 2010, China has significantly increased its FDI flow to Bangladesh. As a result, FDI inflow to Bangladesh from China rose approximately by four-folds between 2008 and 2012. With the launch of the AIIB, it is expected that Bangladesh will have more infrastructural support from Chinese sources. 

Globally, the implications of the AIIB are also crucial. As the world is set to adopt a number of ambitious Sustainable Development Goals during the post-2015 period the need for adequate and additional resources has become more prominent.  During the run up to the adoption of SDGs, world leaders will meet at the Conference on Financing for Development in July 2015 in Addis Ababa, Ethiopia in order to design a comprehensive financing framework for achieving sustainable development outcomes. There has been emphasis on diversifying sources of finance and explore new and innovative finance. However, success in mobilising additional resources for development has been limited. 

Existing sources of finance are fraught with difficulties. A major component of public resources such as official development assistance and concessional lending from public institutions are deficient compared to the need. Now emphasis has been put more on domestic resource mobilisation effort through taxation which is another source of public resources. This again is extremely difficult as tax evasion is high in many countries without having any efficient tax system supported by modern tax infrastructure. Private sources of funds such as credit from banks, remittances and foreign direct investment are also inadequate and, more importantly volatile. Other sources including public private partnership, south-south flow and capital markets could not show much promise as yet in low income countries. In view of such a limited financial landscape the AIIB can substantially contribute towards scaling up resources for post-2015 sustainable development agenda.

However, many challenges lie ahead of the AIIB. The most important one is to ensure good governance. While many countries including the USA have expressed doubts on the governance and accountability of the initiative given China's somewhat unfavourable reputation in implementing infrastructural projects, it is also reassuring that participation of many developed countries in the AIIB will have positive influence in following global standards. Therefore, it is expected that funds will flow only to those projects that will not have any negative impact on human lives and the environment. Corruption, wastage and misuse of resources are also serious issues attached to Chinese construction projects that will have to be washed down. 

But what will be the lending model of the AIIB? Will loans be given in Chinese currency or basket of currencies? Will it be able to mobilise adequate resources? What will be the incentive structure to attract projects? Can the bank maintain high standards in terms of governance and quality of loans? Will the guidelines for loan consider issues such as human rights, labour and environment? As the institutional framework and operational modalities will be developed in the course of time, these issues have to be made transparent.
 

The writer is Research Director at CPD, currently a Visiting Scholar at the Earth Institute, Columbia University, New York.