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May 16, 2014

Does Asia need another development bank?

India’s best response to China’s AIIB voting structure and decision hierarchy is to reform, reduce inflation and grow strongly.

The Asian Development Bank (ADB) met for its annual meeting in early May in Astana, capital of the Republic of Kazakhstan. Finance ministers, diplomats and development bankers popped the proverbial bubbly and exchanged notes.

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The ADB has grown from 31 members at founding in 1966 to 67 members today – 48 from the region and 19 outside. Georgia, Armenia and Palau are the newest countries to join the bank. The stated mission of the ADB is for an “Asia and Pacific region free from poverty”. The ADB was conceived and launched in a post-war world.  Japan was a rising economy at the time. Given that most other Asian countries were impoverished (Singapore’s GDP per capita was the same as that of Madras) Japan and the US were (and are still) the dominant players in the ADB. The ADB has ‘elected’ eight Japanese Governors since it’s founding. The ADB’s charter requires that a departing Governor’s replacement be elected by all of the bank’s governors and that candidates be nationals of regional member countries.  In practice though Japan has nominated its choice and it has been rubber-stamped by every member country.

Vote weights in the ADB parallel the equity share of member countries.  Japan and the United States lead the vote table with 12.8 percent each, China and India follow next with (approximately) 5.4 percent each.  Australia, Indonesia, South Korea and Canada form the next group with between 4 percent and 5 percent each.  So the bank is decentralised in character but has a material Japan/US flavour to it.

In India, ADB has been involved in many types of projects. For instance, the Government of India (GoI) and the ADB recently entered into a $350 million loan for selective transmission and distribution improvements critical for meeting the growing power requirements in Madhya Pradesh.  Another recent project is a $130 million loan to upgrade railway infrastructure along key routes.  In an engagement of a different sort, ADB has been appointed transaction advisor to help attract a commercial consortium leader of global repute that will build, own and operate the planned 1,800-kilometer Turkmenistan–Afghanistan–Pakistan–India natural gas pipeline.  Approximately a third of ADB assistance to India has been for energy, and another third for transport.

Over time and across the region, the performance of the bank is probably best described as satisfactory, but an answer to the strategic question about the bank and its relevance is answered in the bank’s own evaluation in this way, “while Strategy 2020 remains relevant to Asia and the Pacific, it needs to be updated operationally to deliver stronger outcomes. Amid ADB’s great strengths, there remains an important gap to be addressed in gearing the institution’s operational priorities more squarely with its strategic agenda of social inclusion and environmental sustainability.”  In English, that translates to maybe, maybe not.

Fast forward to 2014.  China is the rising economic power.  At $9.2 trillion, China’s nominal GDP has long since crossed Japan’s and is racing to catch up with the US.   Over the last thirty years, China’s real GDP has grown at an average of nearly 10 percent a year.  According to the World Bank, China has been responsible for the reduction of more than 600 million people living in poverty.

Against this background, it is not surprising that the Chinese Finance Minister, Lou Jiwei, convened an invitation only meeting in Astana to discuss the setting up of an Asian Infrastructure Investment Bank (AIIB) to be substantially funded by China. Pakistan, South Korea, Sri Lanka, Mongolia and Kazakhstan were invited. The United States, Japan and India were not.

China argues that infrastructure investment capital demand in Asia each year is greater than 50 times what the ADB is able to provide. There is need therefore for not one more bank, but fifty banks the size of the ADB.  China’s initial idea is to set up the AIIB with about $50 billion of capital, a third the size of the ADB at the moment (the ADB started much smaller).  Despite China’s fantastic track record in poverty reduction, the AIIB will focus on infrastructure not poverty reduction.  Left unsaid, of course, is that the bank will be lead managed by the Chinese. Think of it as a regionally blessed sovereign fund.

Does Asia need another development bank?

The economic answer is a resounding yes. Asian countries need a lot of capital to improve their lot. Estimates suggest that nearly $8 trillion of capital will be required over the next decade for infrastructure alone. India’s requirement itself is easily for $2-3 trillion – think about broad gauging and electrifying railway tracks, completing the road network, building logistics for a soon to be $3 trillion economy and so on. If capital can be had on favourable terms, then whether it comes from the World Bank, the ADB or the AIIB should be of little relevance to each developing country.

The geo-political and strategic answer will depend. Where you stand will indeed depend on where you (strategically fit and) sit. For Pakistan and Sri Lanka this is a welcome move. They are each strengthening their relations with China and will welcome the move. The China-Pakistan relationship is already likely to see a disbursement of $25 billion over the next few years primarily through the China Pakistan Economic Corridor.  This is a series of road and rail networks which stretches from Kashghar in Xinjiang all the way to the port of Gwadar in southern Pakistan.

For India, this is another case where China has pushed ahead.  There is not much that India can do either about the AIIB or getting invited to China’s party.  China may invite India and Japan at a later stage in the evolution if it needs to buy some multi-lateral credibility.  But the voting structure and decision hierarchy of the AIIB will likely have been set by then.

India’s best response to this is to reform, reduce inflation and grow strongly. Of course to enable that growth some capital is required. India should find ways to mobilise its vast savings pool. It should also use other multilateral agencies like the World Bank and ADB and friendly countries like Japan as sources of fixed income capital where necessary (such as for building metros in cities).  Only a reduction in the need for that capital and/or negotiation from a position of economic strength in a few years can India hope to remain a factor in an Asia slowly getting crowded with economic powerhouses.

The AIIB was conceived and is being born early in the term of the new Chinese President, Xi Xingping.  Since President Xi has many years to go, my guess is that the AIIB will indeed be set-up.  For China, it sets up the opportunity that the AIIB will be a professionally run multi-lateral organisation that truly partners with its member countries.  Only time will tell whether China will choose that model or the model where it exerts subliminal power through its capital links.

India should engage carefully in the process, balancing its need for capital with the inevitable soft power that China is likely to exert through the AIIB.     

Photo: Kyle Pearson


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