China’s success in securing 57 founding members for its new regional lending institution, the Asian Infrastructure Investment Bank (AIIB), signals the real limits of U.S. influence in the region in the post-Cold War era. As of the March 31 deadline for initial applications to join the AIIB, among major industrial powers only U.S. ally Japan, so far, has spurned Beijing’s plan.
Britain, Germany, France, Italy, Australia and South Korea are among the dozens of countries that have signaled their intention to be founding members of the new bank. China’s coup in economic diplomacy comes as negotiations for the U.S.-backed Trans-Pacific Partnership, or TPP, once again appear stalled, with little prospect for a consensus in coming months.
China’s plans call for setting the AIIB’s initial authorized capital at $100 billion, with China providing up to 50% of that amount. Subscribed capital is set at $50 billion. It is still too early to say if China’s new lending institution might supplant the International Monetary Fund (IMF) and World Bank as a major source of financing for infrastructure projects, analysts say. The outcome will depend partly on the ground rules, or “articles of association,” for the AIIB Charter.
What is certain is that the AIIB as envisaged so far dovetails with China’s own geopolitical and commercial interests in expanding its economic reach and trade networks in Southeast Asia, South Asia and Central Asia.
Japan Holds Out
Japan has so far hedged its bets, refraining from joining, but saying it is awaiting a reply from China to questions it has raised over how the AIIB will be run. A decision to not join in the long run could put a dent in Prime Minister Shinzo Abe’s effort to boost exports of major Japanese infrastructure services, products and technology. Japanese media have cited officials saying that Tokyo is still considering whether to sign on. But Japan lacks the ability to defy the U.S. in setting its own policy on such issues, says Kazuo Yukawa, an expert on contemporary China and professor at Asia University in Tokyo.
The AIIB is part of a grand scheme rolled out by President Xi Jinping beginning in 2014 for developing a modern “Silk Road Economic Belt” and 21st century Maritime Silk Road to finance construction of a network of highways, railways and other infrastructure linking China to Central and South Asia, the Middle East and Europe. At the annual APEC (Asia-Pacific Economic Cooperation free trade association) summit in Beijing in November, Chinese President Xi announced that China would contribute the entire $40 billion in its new Silk Road Fund to improve trade and transport links in Asia.
“The AIIB is motivated by multiple factors, one is geopolitical and one is purely economic, because once this bank exists, combined with the Silk Road Fund, it will begin to finance a lot of infrastructure, particularly railway infrastructure, in Central Asia, Western Asia and South Asia and even in the Middle East,” says Pieter P. Bottelier, a former senior World Bank official. “If that works, it will enable the Chinese to export excess capacity of large industry, such as the state-owned railway manufacturing industry.”
While it is clearly in Beijing’s commercial interest, the plan also is presented as a way to bridge shortages of infrastructure financing across the region, ideally, enabling countries that lag behind to close their development gap. Given that strong selling point, experts say U.S. objections to the plan rang hollow and reinforced Chinese convictions that Washington is seeking to “contain” China.
“The probable explanation would be that U.S. did not want China to have such a very powerful instrument for foreign policy such as AIIB. Staying out and recommending allies to stay out — Japan, South Korea, Australia and European countries — in China’s eyes, that confirmed that [the U.S.] wants to limit the rise of China,” says Bottelier, who is now a senior professor of China studies at the School of Advanced International Studies at Johns Hopkins University in Baltimore.
Failed U.S. Strategy
The consensus in the field of international finance and Asian diplomacy is that the U.S. strategy toward AIIB so far has failed. “I think China has played this quite ably and the U.S. played it about as badly as it possibly could,” says one former senior official of a multinational development bank, who declined to be named. Franklin Allen, a Wharton professor of finance agrees. “America just looks so silly because the U.S. asked other countries not to go in, but now all those countries except Japan are going in. It has been a very successful Chinese move,” Allen says. Allen is also a professor at Imperial College in London and head of its Brevan Howard Centre.
“America just looks so silly because the U.S. asked other countries not to go in but now all those countries except Japan are going in.”–Franklin Allen
China has been seeking for years to gain a bigger role in existing institutions such as the International Monetary Fund, the World Bank and the Asian Development Bank (ADB). China has only a 4.2% stake in the World Bank while the U.S. has a 15.8% stake and Japan has a 6.8% stake. The U.S. and Japan have 15.6% and 15.7% stakes, respectively, in the ADB, while China’s is just 6.5%.
Customarily, a Japanese official chairs the ADB — Japan’s central bank governor, Haruhiko Kuroda, was president of the ADB before returning to Tokyo, when he was succeeded by a finance ministry official, Takehiko Nakao. “It is kind of strange that China is so underrepresented at the IMF and World Bank,” Allen says. “It is not surprising that China is doing this.”
Since the U.S. has so far failed to win approval by Congress for IMF reforms, it was in no position to oppose the AIIB, says the former senior official of a multinational development bank. “U.S. government officials could have just asked the question, ‘What is China’s vision for the new bank and how would it be different from the ADB and World Bank?’ and then sat back and seen how things developed. But they attacked it instead, lobbied others not to join and, having failed to stop the Brits from joining, committed the original sin of whining to the world about their failure. It’s embarrassing.”
“This is a huge mistake that the U.S. made and it cannot be corrected,” adds Bottelier. “Even if the U.S. applies for membership now, I think the damage has already been done. I do not understand it at all. Whoever recommended that President Obama do what he did should be fired. I think it was one of biggest foreign policy blunders that U.S. has made in years.”
In opting to back the AIIB, Britain and other major Western nations were not joining a “gold rush” but were acting on the premise that the American approach was mistaken, Bottelier adds. “Europeans want to do more business with China and they do not have security concerns about China,” says Allen. “I think that they realized that China is not a threat to them at all, so they are better off to join. In fact, they would like to balance the Russians with the Chinese, so they are quite willing to do this.”
Another of Xi’s aims is to undermine President Barack Obama’s “pivot to Asia” and the push for the dozen-nation TPP, an Asia-Pacific rim trade zone that so far excludes China. Awkwardly for the U.S., almost all of the countries participating in the TPP talks plan to join the AIIB, which is lacking the “high hurdles” laid out by the U.S. as a condition for joining the pan-Pacific trade bloc.
Apart from pushing ahead with its own trade pact, the Free Trade Area of the Asia Pacific, Beijing is tapping its $3.89 trillion in foreign exchange reserves to set up multinational bodies like the AIIB, the BRICS Bank and a bank for the Central Asian-oriented Shanghai Cooperation Organization Bank, while still seeking to increase its influence at the ADB and the World Bank. In July, the BRICS group, which also includes Brazil, Russia, India and South Africa, agreed to set up a bank to be based in Shanghai by 2016.
Questioning the need for yet another multilateral lender, Japan and the U.S. have raised concerns over whether the AIIB would have a transparent governance structure and adequate standards for project selection, preparations, procurement, and environmental impact and resettlement. After years of working to reform and improve standards at the World Bank and other lenders, the worry is that AIIB might undercut them for the sake of commercial or political expedience.
“This is a huge mistake that the U.S. made and it cannot be corrected.”–Pieter P. Bottelier
China Forgoes Veto Power
To assuage such concerns, China offered to forego veto power at the AIIB, in a move that helped win over major European countries, according to a March 23 report by The Asian Wall Street Journal. That would be a change from IMF practice, where the U.S. holds the right to nix big decisions despite holding less than 20% of voting shares, a structure that has long raised complaints.
“My understanding is that the Chinese have agreed that they will not have similar clauses in the charter of the AIIB, which is being drawn up,” Bottelier says. “By giving up veto power, China is teaching the U.S. a lesson on multilateralism.”
The AIIB is bound to give strong voting rights to Asia, says Rajiv Biswas, Singapore-based chief Asia Pacific economist at IHS Economics. “China will have a big role as they are putting up half of the money and they are going to need reasonable voting rights. They will not want a situation where the U.S. and Europe will hold most of votes. But we do not know. A lot of discussion has to take place about how to distribute the voting rights. So far, it is not clear what the rules of governance will be.”
One reason many European countries joined the AIIB from the outset is to have a say in how it is structured and governed. “If they wait until later on, it may be too late to change the structure. Now is the time to join, before it is established, if you want to have influence,” Biswas says.
A team in Beijing, led by AIIB Secretary General Jin Liqun, a veteran of the Chinese central bank, China’s sovereign investment fund, the China Investment Corp., the World Bank and ADB, with help from several Chinese and American retired World Bank staffers, is drafting Articles of Association that will have to be approved by the AIIB’s founding members before the Bank can formally open for business, says Bottelier. “All these concerns are expressed without any knowledge of what the final charter of this bank will look like,” he says. “So the criticism is premature. Once we know the charter, it will be time to express our opinions.
“I don’t think we know yet on what terms the newly established Silk Road Fund will make available funds for infrastructure financing outside China. It could be tied loans; it could also be untied loans and/or grants,” Bottelier adds. “The AIIB has not yet been formally established.”
Politics and governance aside, the need for infrastructure investment and financing is massive not only in Asia, but also other parts of the developing world. The Asian Development Bank estimated its region alone faces an annual financing shortfall of $800 billion. McKinsey & Co. estimates the global infrastructure investment requirement through 2030 at $57 trillion to $67 trillion. “The reality is Asia needs a lot of money for infrastructure development and the ADB does not have enough money to provide that kind of funding,” Biswas says. “Asia needs trillions of dollars over the next 10 years. The AIIB is only $100 billion, but it helps.”
The ADB has adopted a neutral attitude toward the AIIB plan. ADB President Takehiko Nakao said in a statement after a March 24 meeting with Chinese Premier Li Keqiang, “When the Asian Infrastructure Investment Bank (AIIB) is formally established, adhering to international best practices in procurement and environmental and social safeguard standards on its projects and programs, ADB will be happy to consider appropriate ways of cooperation.”
On March 24, Obama’s administration, seeing that all America’s allies except Japan are applying to be founding members of the AIIB, proposed that the AIIB work in partnership with the World Bank and ADB. “The U.S. would welcome a new multilateral institution that strengthens the international financial architecture,” said Nathan Sheets, the U.S. Treasury’s undersecretary of international affairs. “Co-financing projects with existing institutions like the World Bank or the Asian Development Bank will help ensure that high quality, time-tested standards are maintained.”
Said the former senior official of a multinational development bank: “I had also heard that the U.S. was encouraging the ADB and AIIB to co-finance projects in the near term until AIIB has some staff and experience. That’s a great idea and I hope it happens. I do not know how Japan’s [Ministry of Finance] feels about it, but I would guess Nakao is open to it.”
Environmental and governance issues actually are hindering financing for infrastructure development in developing countries, “so to a certain degree what China is saying is true, that there is a big need to provide infrastructure investment in the developing countries,” the official notes.
“The reality is Asia needs a lot of money for infrastructure development and the ADB does not have enough money to provide that kind of funding.”–Rajiv Biswas
Environmental Work-around?
But U.S. officials worry that China may provide money to some countries with dictatorships or may ignore environmental issues and lend the money, said a China expert who declined to be named. “Initially, there was concern because people thought it will be mainly an organization controlled by China, with many developing countries as members.”
Now, however, it looks like a lot of European countries will be members as well. So the standards will be set according to the agreement of all these countries, says Biswas. “The chances are high that the standards will be set high.” Much will become clear in the next several months as the organization negotiates over voting rights, governance and lending standards.
Toshiya Tsugami, a China expert and managing director of Tsugami Workshop Co., a consulting company, says that if China tries to use AIIB in tandem with the Silk Road Fund to pursue Beijing’s “One Belt and One Road” investment strategy, it could lead to conflicts of interest.
China has been clear about its other motives: opening up new markets for domestic industries troubled by excessive production capacity; growing the outbound investment of its state enterprises, and diversifying the use of huge foreign currency reserves.
China has serious excess capacity problems in heavy equipment manufacturing (including train and locomotive manufacturing) and in construction, Bottelier points out, so the motivation for setting up the AIIB may well be partly related to that. “Wouldn’t you try to do something like that if you had China’s excess capacity problem and nearly $4 trillion in forex reserves that earn almost nothing?” he asks.
But he expects that despite the obvious self-interest, contracts for AIIB loans will likely be based on international competitive bidding, as is the case for the ADB and the World Bank. “Otherwise, the 57 other founding shareholder countries would not agree to its articles,” Bottelier says.
Still, China is maneuvering from a position of strength, having already set up the $40 billion Silk Road Fund, which is financed and completely controlled by Beijing.
“China is a big player in providing development finance for other Asian countries and that may mean that those countries are using the money to buy Chinese railways, or using Chinese engineering companies to build the railways,” Biswas says. “China wants to play a greater leadership role in the Asia Pacific region and in emerging markets around the world. In Asia, China is a big lender and that will increase its influence in the region.”