April 14, 2015
China's rise to mega economic powers shifts financial balance of power to emerging economies, providing options for finance and development.
Since China embraced a market economy in the end of the 90’s, prior to join in the World Trade Organization in 2001, it has always spoken for a need to create a new financial institution, specially developed to assist third world nations growing out of poverty. It was said through observing the South East Asian Tigers namely Indonesia, Thailand, Malaysia, Philippine , going through the Asian Financial Crisis of 1997, China had concluded developing economies require special dosage of remedy addressing issues relating to their social, political, cultural and economic conditions, only faced in emerging economies. China had argued traditional package solutions prescribed by existing multilateral organization could not effectively address the multi facet issues that are more commonly plaguing in developing nations, than in western nations. If Europe has the EBRD, European Bank for Reconstruction and Development, then Asia too must have one similar bank of its own, rationalize the Chinese.
On October 24 2014, Chinese President Xi Jinping talk the talk and walk the walk in the presences of Asian delegates by announcing his country and India are leading a 21 founding member country in developing a new $ 100 billion Asian Infrastructure Investment Bank ( AIIB). Flush with the world’s biggest foreign exchange reserves, China is expected to bulk a larger of the capital. The bank will initially be capitalized with $ 50 billion, with plan to increase authorized capital to US $ 100 billion.
UK, Germany, France, Italy and South Korean have recently signed on to the new AIIB, to the dismay of the United States. Former US Secretary of Treasury Larry Summers criticized the Obama administration for not backing the creation of a new China-led international bank that would finance major infrastructure projects across the Asia Pacific Region, calling it a failure of strategy and tactic. The Chinese initiative has set off a heated diplomatic battle. Critics raised concerns that a China led bank could not meet environmental, labor and procurement standards that are essential core values of the industrial world lenders.
The US is not alone abstaining from supporting the Chinese initiatives. Japan, China’s main rival in Asia, who dominates the Asian Development Bank along with the United States , has not signed on as a member but pledged cooperation, albeit only recently. Asian Development Bank has always been led by a Japanese official where Japan’s voting share is more than twice of China. The US has always held a tight grip on the IMF, not allowing developing economies with a say in directing policy. The creation of AIIB could dilute Japan’s influence in the Asian market and undermined the US’s influence the developing economies of Asia Pacific.
The Australian Financial Review reported that John Kerry, US Secretary of State, had been in continuous contact with Tony Abbot, steering Australia away from supporting the AIIB. Australia and South Korea have pledged their support as founding members. Many European nations believe since the bank was going to be created sooner or later thus it would be better to join in the governance, as France, Italy, UK and Germany signed up as founding members.
Furthermore Jim Yong Kim of the World Bank and Christine Laggard of the IMF endorse development bank AIIB, saying new initiative could held end extreme poverty if it ensures high standards for projects. The United States whilst not joining the AIIB has pledged supports in co-financing project with it and existing multilateral institutions such as the World Bank and Asian Development Bank. North Korea has been rejected as a Founding Member while Taiwan, not surprisingly, was also rejected.
New World Banking Order in the Making
The Asian Infrastructure Investment Bank is not the only Chinese initiative to challenge the World Bank and Asian Development Bank. The BRICS Bank ( Brazil, Russia, India, China , South Africa) with US$ 100 billion planned authorized capital is also being set up along with Shanghai Cooperation Organization Development bank and Silk Road Fund with US $ 40 Billion are also being set up. Analysts believe these Chinese initiatives are partly a response to the slow pace of reform at the international financial institutions and partly as response for China’s quest to attain global supremacy. The US Congress has been perceived to be the culprit in the snail pace reformation within the IMF, which would give greater power to emerging economies.
Given Asia’s inexhaustible appetitive for investment in infrastructure, China claims Asia has a massive infrastructure funding gap which could not be possibly filled without the participation of other Non-OECD nations. The World Bank and the Asian Development Bank list of projects runs far greater than the scope of AIIB, who will only concentrate its financial armory on infrastructure development with $ 50 billion initial capital, albeit a fraction of what is needed, would still be refreshing boost for cash strapped developing nations.
Analysts also believe China’s decision to fund and create a new multilateral bank rather than funding existing ones and creating the BRICS Bank reflects its exasperation with glacial pace of global economic reform. These new institutions reflects China’s ‘One belt One Road’ policy announced by President Hi Jinping in 2013 in Kazakhstan to rejuvenate China’s historic golden era through a “New Silk Road” strategy. The belt links China to Europe and to trade and transport corridors across Central Asia and Russia, akin to the Silk Road during the Han dynasty from 206 BC to 220 AD. It is little of coincidence that in 2016, China will take over from Turkey the presidency of the G20.
Future for Infrastructure Financing
Since the Global Financial Crisis in 2007, developed economies rely on the debt market to fund infrastructure project, backed by institutional pension fund. The main traditional source of finance for infrastructure projects has been the government through direct cash participation or through issuing a sovereign guarantee. However, GFC has altered this role as many developed economies went into deficit since 2007. While the US economy is in the process of recovery and recorded consecutive positive growth, the Eurozone is still battling to stand on firmer ground and Japan economy is in no way in better shape than the US. David Stockman, the former Office Management Budget Director of the US during the Reagan administration described the US economy as the ‘cleanest shirt from a dirty laundry’.
Market participants have looked to the capital markets for infrastructure refinancing as a result. Banks still finance large infrastructure projects but it can no longer be expected to provide continuous finance for long term projects. GFC taught the banks a lesson to manage risk better, especially transactions with long tails. Banks need to mitigate risk through the creation of a multi investor institutional debt funds or through structured financial product. Thus the capital market becomes the primary source for infrastructure refinancing,
Developing economies, however, do not have a so called mature financial market. The Asian Financial Crisis of 1997 had taught economic managers in Indonesia, Malaysia , Thailand and Philippine, the need to develop financial markets and instruments, enabling access to alternative source of financing especially for infrastructure finance. Bonds investors and underwriters believe sovereign bonds, if structured properly, would be an attractive form of investment as its risks are less complex to measure and manage.
In less developed economies, the sovereign would obtain financing from a multilateral organization such the World Bank, Asian Development or from another sovereign donor. A special purpose vehicle, normally comprising of a state owned development bank and/or an export credit agency , is set up to manage the facility received from a multilateral body. Private investors also play important role in infrastructure finance.
With the creation of the Asian Infrastructure Investment Bank, AIIB, led by China, some analysts believe government institutions/agencies, state owned companies could be assuming greater role in structuring infrastructure financing once again, a role that was shifted to the private sectors in the late 1990’s. Naturally everything would also depend how the Chinese led AIIB would treat other recipient member, also on the strength of the private sector in managing projects and obtaining external finance and how effective governance is implemented.
Indonesia is in need of some $450 billion for infrastructure projects by 2019 according to Bappenas, the National Development Agency of Indonesia. Joko Widodo (Jokowi), Indonesia’s President, has ordered his ministers to give private investors first pick of money-making projects rather than let state agencies grab them as they usually do. However, this will be easier said than done.
Jokowi will have to change entrenched attitudes at government ministries and state-owned enterprises, which have a vested interest in keeping the best projects for themselves and not to mention managing the attitude of the political parties that awarded him the office. Furthermore resistance could come from old-school politicians and bureaucrats who have used the award of public-works projects to build their patronage networks and earn political favours. Analyst believe that by offering investors projects that are more attractive won't reverse nearly two decades of neglect since the Asian crisis. Stifling bureaucracy, corruption, price controls and problems freeing up land have all hampered investment.
Generally speaking, the World Bank and Asian Development would still retain significant influence as there remains a significant gap for project funding in roads, sanitation, potable water etc. but it will ceased to be seen as a bank of last resort for developing economies. Now developing economies can turn to one of their own for financing and technical assistance. The World Bank, Asian Development Bank and the AIIB could still work together on an infrastructure project and even the US and Japan would be welcome to participate. Thus at first glance the differences would appear to be superficial.
A trustworthy, personal relationship must precede any successful transaction with any Chinese institution. Dating back to 500 BC, China is a Confucian society with a pragmatic set of social rules which permeate their behavior and to the untrained eye, seems purely genetic at times. Filial loyalty, courtesy, and diligence are some of their values which are not dissimilar to other culture. Although some values and norms are shared, they are not based on the same rationale. Some Confucian teachings are at odds with western values.
China is a unique brand of socialism from the Stalinist-Leninist-Maoist society. It has history of entrepreneurial activity and may speak of market principles, but their view of the market is different to that of the traditional view on western capitalism. Furthermore, analysts observed China’s foreign policy has been driven by real politik especially in Southeast Asia where they believe it is their destiny to dominate this area. The Spratly Islands is a case in point.
The Law firms who are appointed in infrastructure projects are usually the firms that represent the Project Manager or operators in their home office. The appointed local lawyers would be either appointed by the international lawyers or by the Project Operators directly. Under the new order, China would be assuming greater autonomy in determining the entire participant in Projects and Infrastructure deals. Each member country will also have greater autonomy in choosing the local counterpart participants. Local private sector participation will also be more active. Law Firms with strong ties to the Chinese Market and have positive experience with Chinese institutions might stand on firmer ground in securing mandates. Law firms with good standing with sovereigns would also retain competitive position as each recipient member country has a voice in managing the project.
At the present moment, we might conclude that there won’t be much significance difference in managing infrastructure project one that is sponsored by the current multilateral organization compare to one that is sponsored by AIIB. One thing is certain, however, understanding Chinese business customs, gestures, speaking the language would be preferred and an advantage, but not a requirement, just yet.