AIIB: Now Comes the Hard Part
February 18, 2016
Last month the Asian Infrastructure Investment Bank (AIIB) filled its senior management roles, following news reports of Chinese concerns about the qualifications of the candidate put forward by the United Kingdom. Getting through this political minefield with a respectable slate of Asian technocrats and Western ex-officials was the first of what will be many challenges President Jin Liqun and the fledgling bank will face in the coming months and years. Most analysis of the AIIB has focused on concerns about commitment to environmental and resettlement safeguards, but there are in fact many greater challenges the new institution faces.
First, let’s look at the positive contributions the new bank can make. The additional capital that the AIIB brings to the table for infrastructure financing in Asia, while helpful, is not the most important of these. A $100 billion bank would probably fund about $20–$25 billion of projects annually, roughly the same order of magnitude as supplied currently by the Asian Development Bank (ADB) and World Bank in Asia each. This is a drop in the bucket of the $700–$800 billion the region needs for infrastructure development each year.
More important than the additional capital is the opportunity to build from scratch a better development bank. Indeed, President Jin brings to his new job valuable experience as both a lender of development assistance (as vice president of ADB) and a borrower (as China’s vice minister of finance). The AIIB is an opportunity to experiment with different governance and operational approaches. Many have criticized China for forgoing a resident board, for example, but it is arguably worth trying, given the downside risk of highly politicized resident executive directors micromanaging the institution.
Speedier project preparation, approval, and implementation is clearly an area for improvement in the existing multilateral development banks (MDBs). China is arguably the most effective borrower in the world in preparing and implementing development projects. Solid project management, use of local design institutes, and strong local buy-in result in faster, cheaper, and better project execution, without sacrificing the quality of environmental and resettlement safeguards. The AIIB can see if the China experience is replicable in other borrowing countries.
The AIIB can also pioneer new approaches to working with the private sector, particularly long-term capital from pension funds and insurers. The bank may be forced to do more lending alongside the private sector as the demand for traditional sovereign lending is likely to wane in the coming years due to rising public debt levels and higher interest rates. Asian borrowing from MDBs exploded from 2004 to 2008 as countries started investing in infrastructure again following years of austerity in the wake of the Asian financial crisis, but now fiscal space is tightening. In fact, China has reportedly already faced growing resistance to sovereign borrowing from Central Asian countries for the One Belt, One Road initiative.
The challenges facing the AIIB are mainly how to deliver on these opportunities. Let me touch on seven challenges.
Human Resources: Building an effective institution with good staff and good governance is President Jin’s number one challenge. The task starts at the top. The process of apportioning the lead management positions among key shareholders is inherently political and enormously distracting. Some MDB leaders are more successful than others in insisting on merit. As World Bank president, Robert Zoellick found excellent officials like former finance ministers Sri Muliani and Ngozi Okonjo-Iweala, who provided talent, emerging market representation, and gender diversity. But often the process devolves into a political scrum and tokenism, with the result that less-than-qualified people end up in senior positions in MDBs. The process demotivates permanent staff and erodes the institution’s credibility. President Jin will have to work hard to balance the interests of shareholders while assuring high-quality leadership and staff—beginning, not incidentally, with his own government.
Another human resources challenge will be location. Beijing is a world-class city, but its pollution, traffic, and restrictive Internet access will make it tough to attract good candidates with families. The AIIB will also find it difficult to attract investment bankers and lawyers, critical to boosting private-sector operations.
Cost of Funds: The AIIB can operate initially by lending its paid-in capital, but at some point it will need to go to the market to float bonds. Its lending rate will be linked to the price it has to pay on those bonds plus a margin to cover the cost of the institution. The AIIB is likely to face a lower price for its bonds than the other MDBs and will have higher costs than the ADB, so its lending rates are likely to be higher, which could be a competitive disadvantage.
Creditor Status: A related problem is the AIIB’s creditor status and how that relates to its creditworthiness. The World Bank and ADB enjoy an informal “preferred creditor” status that is not likely to extend to the AIIB (this will depend on the attitude of borrowers). That will make it vulnerable to sovereign defaults and raise its cost of capital as investors factor its creditor status into their pricing. In this context, it will be important for the AIIB to pay close attention, in contrast to past Chinese bilateral lending, to World Bank/International Monetary Fund debt sustainability analyses.
Private-sector Operations: Public-private partnerships (PPPs) and other private-sector lending are far more complicated than sovereign lending. PPPs take more time, need expertise that many MDBs do not have, are prone to corruption, and require a sound regulatory framework. What will be the AIIB’s role in improving the governance around PPPs? President Jin will have to resist pressures from his members, starting with his own government, to do deals that benefit business interests but may not make sense from a commercial or development point of view.
Conditionality: China has led criticism of Bretton Woods institutions for conditioning lending on policy reforms. Though the AIIB will probably not undertake policy loans, it will still face the problem of how to improve governance and policy needed to make infrastructure investment work. For example, a power project cannot succeed without an effective energy policy framework governing off-take and pricing. A water project cannot work unless farmers pay enough for water. China has not been a fan of policy loans to support reform, but interestingly, it has recently agreed to its first policy loan with the ADB. Could this be an attempt to prepare the ground for a reversal of China’s “hands off” approach to policy assistance in the AIIB?
Country Ownership: Country ownership is the central tenant of the Paris Declaration on Aid Effectiveness (2005). Putting countries in the driver seat to draw up their country strategies, identify projects to be financed, and implement those projects is sound theory, but weak capacity, a highly politicized decisionmaking process, and corruption make true country ownership of development highly problematic in practice. The answer is technical assistance to improve capacity and the policy framework. Will China’s outspoken support for country ownership lead to failed projects because local capacity is simply not up to the task? Will it invest in capacity building? If the latter, how would it fund that training?
Safeguards: The AIIB’s approach to environmental and resettlement safeguards has received the most attention to date. I don’t doubt President Jin’s commitment to international standards, but meeting those standards while streamlining the project process will be a major challenge. The bank will have scant resources, particularly in its early days, to ensure compliance. Equally problematic is China’s uneasy relationship with nongovernmental organizations, which are the main monitoring entity for MDB compliance globally and best insurance to stop small problems from becoming big ones. The AIIB will inevitably have a slip or two on safeguards, as all MDBs have had. What matters is attitude and commitment, not an impossible zero tolerance threshold.
What are the prospects for AIIB dealing effectively with these challenges? So far so good. President Jin has announced that he will follow international safeguards, will cofinance and otherwise work closely with the existing MDBs, will push for more private-sector lending, and may open the bank to worldwide procurement (which the ADB shamefully has not). He has in place what appears to be a workable arrangement for the board and is hiring some good staff. He has wisely forgone the ADB’s policy of forced retirement at age 60 and is picking up experienced retirees from the ADB and World Bank. Running an MDB is tough work. Though the U.S. government took some time to get to the right place, I hope Washington will continue to wish President Jin and the AIIB well in undertaking its critical but very difficult mission.
Larry Greenwood is a senior adviser (nonresident) with the Simon Chair in Political Economy at the Center for Strategic and International Studies in Washington, D.C., and a former vice president of the Asian Development Bank.
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