This content is from: Portfolio

Rush to Join AIIB Reflects China’s Growing Financial Clout

Dozens of countries sign up for new infrastructure bank despite concerns over governance, deciding it’s smarter to work with Beijing.

As a demonstration of China’s growing economic and political clout, few things rival the launch of the Asian Infrastructure Investment Bank, Beijing’s challenge to the U.S.-dominated international financial order. What started modestly with the signing of a memorandum of understanding by 21 mostly Asian nations last October turned into a rush last month as 47 countries — including the U.K., Germany, Brazil and South Korea — announced their intention to participate before the March 31 deadline set by Chinese officials. In the end, only Japan among major economies sided with Washington in shunning the AIIB.

“China is now exerting more influence,” Eisuke Sakakibara, a former senior Japanese Finance Ministry official, tells Institutional Investor. China is “now No. 2 in the world, and it will probably surpass the U.S. within 20 or 25 years” in terms of gross domestic product, he adds.

China’s diplomatic success in attracting supporters still leaves several big unanswered questions about the AIIB, including how it will be governed, whether members other than China will have a significant say over its operations, and how quickly and effectively it can start financing projects. Some answers may emerge in Washington later this week when Finance ministers and central bank governors from around the world gather for the spring meetings of the International Monetary Fund and the World Bank Group, where the AIIB promises to be a major topic of discussion.

China’s failure to win greater influence and voting rights at the IMF and World Bank are a major factor behind its decision to launch the AIIB, officials and analysts say. IMF members agreed in 2010 to quota reforms that would increase the voting rights of fast-growing emerging economies such as China and India, but the reforms haven’t taken effect because the U.S. Congress has refused to ratify them. The U.S. dominates the Fund through its 17.69 percent quota and voting rights; although China is now the world’s second-largest economy, it ranks sixth at the IMF — behind Japan, Germany, France and the U.K. — with a 4 percent share.

“The Chinese government is determined to set up the AIIB because China has been a rising economic power and the global community has expected China to provide a lot of public goods, but the post–Bretton Woods system is completely controlled by the U.S. and the World Bank, IMF and Asian Development Bank,” says Yuqing Xing, director of Asian Economic Policy at the National Graduate Institute for Policy Studies in Tokyo. “For China, the issue is how we can use our money more productively, not just in the traditional sense of return on capital but also to strengthen China’s influence and its soft power and to promote its economic development and globalization.”

The last-minute rush to join the AIIB was set off in mid-March when chancellor of the Exchequer George Osborne announced that the U.K. would become the first Western nation to sign the MoU and begin entry negotiations with the AIIB’s interim secretariat in Beijing. The move angered Britain’s European Union partners. All of the countries had agreed to stay on the sidelines until China provided assurances that governance and transparency standards at the new bank would match those of existing multilateral lenders, says a senior German official who spoke on condition of anonymity, but London “jumped the gun in order to gain advantage.” Sources say the U.K. hopes to house a European office of the AIIB and attract more renminbi-denominated business to London. Ultimately, a number of EU countries — including France, Germany, Italy, Luxembourg, the Netherlands and Sweden — decided it was also in their interest to join the new bank, which could help their companies win contracts for some of the AIIB’s projected multibillion-dollar infrastructure projects.

In the closing days of March, a string of countries announced their intention to join the AIIB, including Brazil, Russia and India, which have also agreed to set up a so-called BRICS bank with China; Australia and South Korea, key U.S. allies in Asia that Washington had urged not to participate, and Egypt and Turkey. China rebuffed a membership bid from North Korea because of the country’s lack of transparency and its debts, and turned away Taiwan because of its one-China policy, according to sources who attended a closed briefing on the AIIB given in November by the bank’s president-designate, Jin Liqun, a former deputy Finance minister.

That left the U.S. and Japan as the principal holdouts. On March 30, U.S. Treasury secretary Jacob Lew paid a surprise visit to Beijing to meet with Premier Li Keqiang and other senior officials. He said Washington looked forward to cooperating with the AIIB and welcomed any proposals that would promote infrastructure development. Such cooperation could be carried out through the U.S.-China Strategic and Economic Dialogue, the World Bank and the ADB, Lew said, according to Chinese vice minister of finance Zhu Guangyao.

Washington has the most to lose from a successful AIIB, given that the U.S. designed the Bretton Woods architecture of the international financial system, is the only country with veto power at the two institutions and by tradition has named the World Bank president and IMF deputy managing director.

In Japan, Finance minister Taro Aso said on March 31 that the government remained “very cautious” about the China-led bank and had concerns regarding the AIIB’s governance and its policies on debt sustainability in borrowing countries and environmental and social safeguards in infrastructure projects. “Unless these conditions are secured, Japan has no choice but to be very cautious about joining,” Aso said.

Japan has long played a leading role in Asia’s economic development agenda through the Asian Development Bank. It is a dominant shareholder in the Manila, Philippines–based lender, alongside the U.S., and has traditionally nominated its president. The current president, Takehiko Nakao, is a former top official at Japan’s Ministry of Finance. His predecessor, Haruhiko Kuroda, is now governor of the Bank of Japan. Apart from regarding the AIIB as an upstart, some Japanese officials at the ADB fear that the new bank could grab the best and most bankable projects in the region by offering better financial terms.

But existing players seem to be adjusting quickly to the newcomer. In an appearance in Beijing in late March, managing director Christine Lagarde said the IMF would be “delighted” to cooperate with the AIIB, while in Washington last week World Bank president Jim Yong Kim welcomed the creation of the AIIB and the BRICS nations’ proposed New Development Bank, calling them “potentially strong allies in tackling the enormous challenge of bringing much-needed infrastructure to Asia.”

China has said very little so far concerning the precise role of the AIIB and how it will complement or compete with the existing array of multilateral development banks. At the Asia-Pacific Economic Cooperation summit meeting in Beijing late last year, President Xi Jinping said the AIIB would focus on transportation infrastructure linking Asia and Europe and would work alongside the China-funded $40 billion Silk Road Fund. Chinese officials say the AIIB will lend mostly to the public sector, as the World Bank and ADB do, while the Silk Road Fund will concentrate on aiding the private sector, like the International Finance Corp., the World Bank’s private sector lending arm.

The ADB’s Nakao has also raised the possibility of co-financing projects with the AIIB. “It is not a zero-sum game,” he said in Beijing in March after talks with Finance minister Lou Jiwei.

Western countries apparently agreed to join the AIIB without resolving a number of key issues surrounding its governance and potential domination by China.

Beijing has proposed that China provide up to 50 percent of the initial $50 billion capital of the AIIB, an amount that could be expanded to $100 billion under its draft articles of association. The institution will be based in Beijing and run by Jin, a Chinese national. Chinese officials also appear intent on dispensing with the practice at most other multilateral banks of having major shareholders appoint resident executive directors (EDs) to supervise operations at the bank’s headquarters and ensure that projects comply with transparency and environmental standards. Beijing-appointed executives will be able to exercise strong control over the bank in the absence of a board of EDs, says Masahiro Kawai, a former senior ADB official.

Jin, who previously chaired state-controlled investment bank China International Capital Corp. and the sovereign wealth fund China Investment Corp., reportedly gave assurances at the closed seminar in Beijing that the AIIB would observe internationally accepted governance standards. But Jin, who also spent several years as a vice president at the ADB, is reportedly skeptical about the merits of having resident EDs, regarding them as an unnecessary layer of bureaucracy that slows down project approvals at other multilateral development banks.

In an address in Singapore in early April, Jin said that China would have the biggest share in the bank, based on the size of its economy, but would not dominate its operations, according to China’s official Xinhua news agency. “China is just a leading member,” he was quoted as saying. He also promised that the AIIB would be “clean, lean and green,” with “zero tolerance” of corruption and strict observance of environmental standards.

“Right now China’s influence [in the AIIB] is too big, so that it would not become a genuine international organization,” says Japan’s Sakakibara. “China has to reduce its shares and to ask other big countries, like the U.S. and Japan, to participate with significant shareholdings. Moreover, they have to come up with some kind of board where decisions are made. Right now it looks as though the decisions will be made solely by China.”

Other Chinese sources predict the government will take steps to address the concerns of other countries on governance issues. China has “no choice” but to do so, Xing-Guang Ling, a member of the China-Japan AIIB Joint Research Group of academics and former diplomats, said at a briefing in Tokyo in February: “Developing countries also want to see a debate on these issues.”

Xing of the National Graduate Institute for Policy Studies says other nations would stand a greater chance of influencing the AIIB’s final structure if they joined by March 31, a viewpoint that many countries appear to have adopted. But China would insist on having a “controlling stake” in the bank, he adds.

With nearly $4 trillion of foreign exchange reserves, China has no financial need of outside members at the AIIB. According to Kawai, Jin told the Beijing seminar that the AIIB would borrow dollar funds within China, tapping banks and state-owned enterprises, rather than seek such funds on international bond markets, where the AIIB’s lack of a triple-A credit rating could be an obstacle. With such financial wherewithal, Beijing can afford to call the shots in the new bank.

Get more on emerging markets.

Related Content