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Demystifying the Asian Infrastructure Investment Bank

by Major

April 21, 2015

Image by Chao Fansen/CKGSB Knowledge

Yukon Huang on the mechanics of the Asian Infrastructure Investment Bank, China’s role in its governance, and comparisons with the World Bank and the ADB.

On April 15, China’s Ministry of Finance made public a list of 57 prospective founding nations of the Asian Infrastructure Investment Bank (AIIB), almost doubling its initial estimate of 35. These nations, mostly from Asia but also including many in Europe, the Middle East and Africa, will work together in the next couple of months to write down policy guidelines and rules, which latecomers in the future will have to follow as non-founding members.

The US and Japan are the two major players that decided not to join the AIIB, at least for now, citing concerns over how the bank will be governed and if it’ll apply the best standards when evaluating which projects to finance. Although the boycotting is widely perceived as political, the Chinese government is responding by assuring member nations that the AIIB will be a transparent and democratic organization.

To understand how the AIIB will be governed and its relations with existing institutions like the World Bank and the Asian Development Bank, we recently sat down with Yukon Huang, a senior associate at Carnegie Endowment for International Peace, for his views on the China-led initiative. Huang was the former Country Director for China at the World Bank and is now an advisor to the organization as well as the Asian Development Bank (ADB).

Huang says that the AIIB represents the change in economic positions globally and if successful, would contribute to the World Bank and the ADB’s efforts to seek better standards of their own operations.

Edited excerpts:

Q. Chinese Finance Minister Lou Jiwei said that the AIIB is a complement of rather than a competitor of the World Bank and the ADB. What do you think the AIIB’s role is?

Yukon Huang, Senior Associate at the Carnegie Endowment

A. I think the AIIB will in a way complement the ADB and the World Bank because it will not be doing certain kinds of projects the others are doing, and they will not duplicate certain things that the other banks are doing.

The World Bank and the Asian Development Bank do lending across a broad spectrum. They get much more involved in social programs, such as health, education and environmental issues. They also get involved in writing economic reports and program loans, which are essentially loans that provide money for the general budget that can be used for any purposes. I think the AIIB will focus on specific projects, building a road, a bridge or a power plant. It will not get into program loans or balance of payment loans, which are designed to support certain policy changes.

The AIIB will draw upon the World Bank or the IMF for general economic reporting information. They won’t have to duplicate it. Their modus of operation may be simpler, more efficient and faster. That’s actually a good thing because it gives borrowers a choice. In that sense it puts pressure on the system for everyone to be more efficient.

Q. What are the challenges that the AIIB faces?

A. The critical test of the AIIB will actually be who are the clients, what do they want. The AIIB will have to cover its cost. So whatever its cost of raising capital, they have to cover that margin. The quality of the loans and the borrowers need to be carefully considered. You’ll find that institutions like the World Bank and the ADB essentially never have a default. So the AIIB has to make sure that its loans will be repaid. If it doesn’t, it would have a hard time borrowing on capital markets and the interest rates of the bond it sells would be too high.

Q. Some people may have the concern that China will enjoy a dominating role within the AIIB and, therefore, they have concerns about governance transparency. Do you foresee that as a problem?

A. The weight of the shares of the AIIB will be determined by the size of the economy, so China will have a large share, but not a veto share. Asian countries as a whole will have majority voting rights. In the World Bank and the ADB, the donor countries, Europe, the US and Japan together have enough voting power essentially to determine [their operations].

[The key difference in governance] is that the AIIB may not have a so-called resident board of directors, who sit in the headquarters of the World Bank and the ADB everyday. And the AIIB is trying to go for a structure where the board meets periodically, like in most corporations.

The resident board of directors exerts a lot of influence but they also make it very difficult to get a focus because they may have very different views, giving the management and staff a very hard time to figure out what they should do. In corporations, the board usually establishes the rules, the policies that give the president guidance. But afterwards they let the management run the organization. The AIIB is looking for a similar structure where the board is less active and less intrusive on a daily basis.

Q. Another concern people have is that the AIIB will not hold the high standards that the World Bank does. Is there going to be a conflict between efficiency and human rights here?

A. The concept that people have been critical of, that the AIIB should have the highest standards, is actually wrong. It should be the right standards, which generally refers to social safeguards or protection to people who are affected by the environmental damage [caused by infrastructure projects]. The question is what are the right standards to view these issues.

Certain projects have higher environmental risks, others do not. So the right standard is developing what you need to do in line with the real risk of the project, rather than just having standards that you legally apply in everything. The World Bank and the ADB… tend to have guidelines that apply to all projects, which leads to higher cost and lower efficiency. So I hope the AIIB will establish more flexible guidelines, which allow you to do more for high-risk projects and process other things more quickly. The rates of return on infrastructure projects are essentially determined by how long it takes to process them—the longer it takes, the lower the return.

That’s an interesting objective for the AIIB to work on. In that sense, maybe the existing institutions like the World Bank and the ADB could benefit from this. From my experience at the World Bank, they also realized that some of the rules are too rigid. They actually have been trying to refine them and move them to the right direction.

Q. Some view the AIIB as a challenge to the existing global governance structure and they worry that it will result in a more fragmented world. What do you think?

A. The AIIB is trying to reflect the change of the economic positions of countries globally, because the World Bank, the ADB and the IMF do not. The voting share of countries like China, Brazil or Indonesia in those institutions is less than the size of their economies because the shares were established 50 years ago and the world has changed. There was a proposal at the World Bank and the IMF to give emerging market economies a greater share—it hasn’t happened only because the US Congress hasn’t approved it. So I don’t think the AIIB will cause more confusion [for world governance] because it basically reflects realities. Not to do that actually doesn’t make sense.

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