Verdict on AIIB unaided by Singapore summit

Articles of agreement have been finalised and a year-end start-up confirmed, but voting and veto rights of the China-led multilateral lender remain unclear.

Delegates to the recently concluded summit to establish the Asian Infrastructure Investment Bank (AIIB) put the finishing touches on the lender's articles of agreement (AOA) and were briefed on the bank's operational timeline by Jin Liqun, secretary general of the AIIB's interim secretariat and a person widely touted to head the multilateral institution.

But while the AIIB is gathering steam and taking shape questions linger over the bank's structure, and if China will retain formal or de facto veto rights.

The AOA will be ready to be signed in June and the bank will be operational by the end of this year, Jin told the 5th Chief Negotiators Meeting on Establishing the AIIB in Singapore last week.

Several delegates, including Philippine Finance Minister Cesar Purisima, indicated the AIIB's governance mechanism would prevent any one country from dominating the bank's board of directors.

China's official state media, however, has not commented on the AIIB's ownership structure, although reports from the sidelines of the summit indicate China will hold up to 30% of the bank.

AIIB Delegates in Singapore on May 22
A source with close ties to US diplomatic channels told FinanceAsia last week it was still unclear whether China would hold veto power at the new multilateral lender. "China may not hold a formal veto," he said, " but it may have voting shares that effectively give it the power to block decisions."
 
With only 16.4% of the total votes in the World Bank, the US can block major decisions of the bank's board of governors -- a fact which has long irked China.
 
China rising

 
 

Over the past few decades China has succeeded in building infrastructure that is the envy of the developing – and the developed - worlds.

But exporting that success story has not worked out so well.

Recent infrastructure investments abroad, exposed to the vagaries of opposition politics and other risk variables, stand out as costly failures for Beijing.

Among the more stunning overseas reversals is the decision by Myanmar in 2011 to drop a $3.6 billion hydroelectric dam project on environmental grounds.

The Northline rail project in the Philippines was also suspended on account of corruption allegations in 2012. And early this year a $3.7 billion Sino-Mexican high-speed rail deal fell victim to Mexican government austerity.

Most recently a $1.4 billion port project in Colombo, Sri Lanka, hit the skids – prey to domestic politics.

Hilton Root, professor of public policy at George Mason University, said the China-led AIIB will encounter more of the same unless it develops a risk model to determine project viability.

Despite decades of experience in emerging market infrastructure plays, multilateral lenders like the World Bank, Asian Development Bank and International Monetary Fund have poor success and completion rates. “About 50% of Word Bank infrastructure projects have failed,” said Root, formerly chief governance advisor of the Asian Development Bank and author of its governance policy. “These projects are enormously difficult to cost out.”

Evaluations by the World Bank and ADB indicate that over time more than 50% of projects in places like Pakistan fail to attain their financial objectives and fail to be maintained once donor money is removed, according to Root. “Most importantly, these projects fail to reach poverty-reducing goals,” he added, expressing doubt that the China-led lender will be a game-changer in this regard.

                          Hilton Root

Image issues
There are also image issues. China comes to the multilateral lender table with a lot of baggage. Its overseas infrastructure investment deals are “prey to accusations of abetting local corruption” due to “single sourcing, rigged bidding and undisclosed financing arrangements,” said Root.

Beijing has taken preliminary steps to address a lack of transparency that fosters suspicion, making good on a pledge in a 2011 white paper to disclose foreign aid figures. But the fact that it operates outside of the Development Assistance Committee of the OECD, a body which applies economic, ethical and sustainability standards to development finance, does little to dispel negative perceptions.

Under China’s socialist market economy, it is often unclear what constitutes government-sponsored investment activities, so-called Other Official Flows (OOF) and foreign aid in the form of concessional loans and preferential export buyer credits.

The country’s natural resource plays in Africa, which have built-in infrastructure components that benefit the local market to a degree, are routinely criticised for a lack of concern for social and environmental impact.

To China’s credit, its financial commitments to the continent have been substantial. The country deployed approximately $75 billion to 1,673 projects in Africa from 2000 to 2011, according to a research report by Japan International Cooperation Agency. Analyses of these investments have shown that while African countries do gain vital infrastructure, the projects are clearly undertaken to secure vital resources for China and increase Beijing’s sphere of influence.

China practices a form of merchant-state capitalism and - altruistic rhetoric aside - these projects are about securing commodities for the home market and offshore construction projects for state-owned companies. Soft loans for overseas infrastructure projects are provided by China’s state-owned banks, primarily the China Development Bank and the Export-Import Bank of China, and are often structured to benefit China’s state-owned construction firms. CDB and Eximbank provide project finance for overseas investment projects, but funding also comes from a variety of governmental and quasi-governmental sources.

Root cites a 2009 US Senate Committee on Foreign Relations finding that China’s infrastructure projects in Sri Lanka are not structured as grants but as commercial projects that are highly inflated to make allowances for kickbacks. Much the same has been said about its Africa projects, often won in tenders that see state-owned construction firms submitting extremely low bids, back by government subsidies, that global firms can’t compete against.

From 2010 to 2012, China committed a total $14.41 billion in foreign assistance, 55.7 percent of which was in the form of concessional loans for medium-sized infrastructure and manufacturing projects, according to a 2014 white paper by the information office of the State Council, China’s cabinet.

There are a host of other reputational bobbytraps, such as the aid-conflict nexus, which the China-led AIIB will need to address going forward.

Forked tongue
Kenneth Jarrett, president of the American Chamber of Commerce Shanghai and former US diplomat in China, said the country’s interactions with multilateral lenders have been fraught while its failure to live up to international agreements may  colour perceptions of the new institution.
“Beijing is quite smart about foot-dragging [on its international commitments],” said Jarrett, whose career in China dates to the country’s opening to the West. “The character of its interactions with institutions like the Asian Development Bank may foreshadow its regional infrastructure investment approach.”

Jarrett was referring to Beijing’s shrill reaction to the ADB’s proposed $2.9 billion India Partnership programme, which included projects in the vicinity of territory disputed by the two countries.   
China’s long-standing and highly charged territorial disputes with many of its neighbours will undoubtedly complicate the bank’s processes and investment decisions. It has become increasingly assertive in recent years, facing off with Japan over the Senkaku/Diaoyu Islands in the East China Sea, and with the Philippines and Vietnam in the South China Sea, were tensions over its land reclamation projects in the vicinity of Mischief Reef in the Spratly Islands surfaced at a recent Asean summit in Kuala Lumpur.

Controlling stake
China will anchor the AIIB with $50 billion, while forty-six other participants from the Asia Pacific region and Europe will ante up an aggregate $50 billion. Investment decisions will likely mirror the structure of existing multilateral lenders like the ADB, which accords voting rights in proportion to the size of a member state’s contribution.

How China exercises its control position in the AIIB has been a contentious issue. EU member states joined the bank after assurances they would be able to influence investment decisions. China has long bristled at the US veto power in the IMF and Jarrett said EU countries may have been “snookered” by Beijing, which now appears to be stepping back from a pledge not to act unilaterally.
China believes the time is ripe for a new multilateral infrastructure lender. The Asian Development Bank pegs the demand for infrastructure investment at $730 billion a year for the next decade. Other estimates go even higher, indicating ample room for more players.

“If you believe that there is $11 trillion worth of infrastructure funding required over the next 10 years in Asia, the AIIB will be a welcome addition,” James Cameron, head of project and export finance across Asia Pacific at HSBC, said.

“But I don’t think anyone really has visibility on how it [AIIB] will impact funding for infrastructure projects within the region. It really has to work out what its strategy will be first,” Cameron said.
Root said the success of multilateral infrastructure investment projects hinge on a thoroughgoing approach that includes the development of a risk model, engagement with the private sector and NGOs to understand local conditions, and governance mechanisms to ensure projects are sustainable, transparent and, most importantly, effective at lifting people in Asia out of poverty.

The AIIB should take on projects beyond the private sector’s capabilities, he said, noting there has been a tendency for multilateral infrastructure banks to go after “low hanging fruit” - deals which could more readily and more successfully be funded by the private sector.
“Multilateral infrastructure banks should be about more than building roads,” he added.

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