AIIB: Taking Everyone Along?

Economic Diplomacy By Dr. Priyadarshi Dash

“While business considerations will be the operating principles, the apolitical nature of Asian Infrastructure Investment Bank (AIIB) may remain questionable as two important regional players such as India and China are key founding members of both AIIB and New Development Bank. As long as business continues to dominate the functioning of these two entities, there will be little room for jurisdictional conflicts.”

Apparently, the supply of infrastructure finance globally is short of the ever-increasing demand. This trend has been observed for so many years in the past all over the world across different sectors. Given severe infrastructure bottlenecks particularly physical infrastructure in the emerging and developing economies, financing requirements is expected to climb up in the future. However, the demand-supply mismatch in infrastructure finance should not be interpreted as a cause of low global savings even though some countries suffer from perennially low rate of savings. It is actually due to flaws in mobilisation of resources by the multilateral development banks, regional development finance institutions and special infrastructure funds for the investible pool. Moreover, untapped savings are not yet fully channelized through instruments such as bonds, equity and other debt instruments. The provision of infrastructure financing by sovereign wealth funds, pension funds and insurance companies is growing but still far from the desired level. In short, the whole range of financing options are not entirely exhausted, hence the need for bundling of instruments for raising resources for financing infrastructure development in the economies with abundant savings, both at the household and the firm level.

For long, the multilateral development banks, including the World Bank, Asian Development Bank, African Development Bank and Inter-American Development Bank, were engaged in infrastructure finance. Since private sector participation was very low, the loans and other forms of support by these institutions remained the most important traditional sources of infrastructure finance for many countries of the world complementing public resources. With opening of financial sectors and increased access to international private finances, the universe of infrastructure financing both in terms of sources and instruments widened in the 2000s. In the recent past, two new development financing institutions in Asia, namely the New Development Bank (NDB) established by the BRICS countries and the Asian Infrastructure Investment Bank (AIIB) created by 57 countries from different regions of the world have generated hopes for injection of additional resources in the global corpus of infrastructure finance. Both conventional and new sources and forms of financing would remain vital for balanced and sustainable development of the less developed regions of the world. While all the above mentioned institutions are important for meeting the growing demand for financing and technical assistance, we briefly mention here some of our observations about the role, importance and contribution of AIIB in infrastructure finance in Asia and other parts of the world.

A worldwide survey conducted by the World Bank reveals interesting findings relating to the perception of firms about infrastructure. Globally, about 31 and 18 percent firms identify electricity and transportation as major infrastructure constraints for business. It is higher for Latin America and Caribbean, Middle East & North Africa, South Asia and Sub-Saharan Africa. The losses due to electrical outages turn out to be more than 5 percent of annual sales. Likewise, water shortage in a month is comparatively higher for most of the regions mentioned above (see Table 1). These trends signal the need for building robust and sophisticated infrastructure in order to expand business opportunities in the less developed regions of the world.

It is undoubtedly clear that private participation is critical for sustaining the growing infrastructure financing requirements. However, the status of private sector participation in infrastructure projects is not very impressive even though this segment witnessed remarkable growth in certain infrastructure sectors in the recent past. Data for three sectors such as energy, telecommunications and transport show an upward drift in private sector financing during 2006-10 (See Fig.1 for telecommunications). In the post-recession years, Latin America and Caribbean (LAC) region remained relatively more insulated than South Asia and Sub-Saharan Africa. For instance, the volume of investment declined after 2010 in energy and telecommunications for South Asia and in telecommunications for South Asia and Sub-Saharan Africa whereas it increased in both the sectors for the LAC region. Further, investment in telecommunications had contracted by more than 50 percent in South Asia and Sub-Saharan Africa in the post-recession period. Unlike these two sectors, private investment in transportation remained healthy except some moderation in 2013 and 2014. In addition, the least developed countries and the heavily-indebted poor countries for which financing options are limited have not experienced any discernible growth in infrastructure investments. It is surprisingly disappointing even for the low & middle income countries (See Table 2 & Fig. 2).

In general, infrastructure financing has not undergone any major diversification over time. Public resources still dominate with a share of more than 60 percent while private sector and ODA/MDB account for around 27 percent and 7 percent of total annual infrastructure spending. New Development Bank (NDB) is emerging as a promising supplementary source of funding infrastructure. Surprisingly, the contribution of other developing country finance is less than $20 billion which is miserably low given the size of current infrastructure finance (See Table 3). May be this gap in financing will be filled by the new institution such as AIIB and other private equity & venture capital funds.

AIIB: A Promising Start

AIIB was established in 2015 by 57 founding members from Asia, Africa, Middle East and Africa. The membership is open to the members of the International Bank for Reconstruction and Development and the Asian Development Bank. As a new generation multilateral development bank, AIIB is being viewed as a major source of development finance with special focus in infrastructure finance. AIIB started its commercial operations in January 2016. In less than six months of operations, four projects have been approved for power, transport and urban investments in Bangladesh, Indonesia, Pakistan and Tajikistan with total financing of $509 million. Of those, three projects are undertaken with co-financing by the existing MDBs such as ADB, EBRD and EIB under the provisions of the recently signed Memorandum of Understanding (MOUs). By their own assessment, the President of AIIB seems to be optimistic of the way the institution has functioned in the past six months and the roadmap envisaged. Since governance and functioning of the institution is at evolving stage, the contribution of AIIB to regional infrastructure and economic development would be clear in the coming years. However, at this stage one can examine the future of AIIB by looking at its structure, composition and functions envisaged in the Articles of Agreement (hereafter Article).

In terms of focus sectors, AIIB is not very different from other multilateral development banks. For instance, infrastructure is priority sector for lending for EIB, EBRD, ADB, World Bank and NDB. Table 4 mentions the focus sectors of a few major development finance institutions. But, AIIB mandate of sector coverage is more targeted towards infrastructure as the Article highlights. Along with ADB and NDB, AIIB will be an important player in the Asian infrastructure financing landscape. While business considerations will be the operating principles, the apolitical nature of AIIB may remain questionable as two important regional players such as India and China are key founding members of both AIIB and New Development Bank. It would be unfortunate to witness any conflict of interests in infrastructure financing by NDB and AIIB as both emphasise infrastructure as priority sectors. As long as business continues to dominate the functioning of these two entities, there will be little room for jurisdictional conflicts.

Whether there are any unique features of AIIB that distinguish it from other multilateral banks is not ostensibly reflected in the Articles. However, we have observed certain features of AIIB that might help the institution to emerge as a world-class development financing institution in the future. Some excerpts from the Articles that broadly indicate the aims and objectives of AIIB are mentioned below:-

• “...to promote investment in the region of public and private capital for development purposes...”

• “...contribute to regional resilience against potential financial crises and other external shocks in the context of globalisation.”

• “...will help to mobilise much needed additional resources from inside and outside Asia...”

• “...contribute most effectively to the harmonious economic growth of the region as a whole and having special regard to the needs of less developed members in the region...”

In addition, the Articles highlight the innovative components of financing, including co-financing, private financing, diversification of equity and debt instruments, etc. Academic literature hints at these aspects of infrastructure finance, which need sweeping reforms. For instance, Inderst (2016) notes that capital market development can bring changes in the current bank-dominated private infrastructure finance. And, private sector is yet to play an active role in infrastructure finance. Moreover, the volume of listed and unlisted investment instruments of project finance and of public-private partnerships (PPPs) is very small compared to the investment needs.

However, Croce and Gatti (2014) mentioned some shortcomings of private sector involvement such as inadequacy of financial resources at their disposal. Arezki et al. (2016) provides further insights about the mode of financing, resource gap and the end-use pattern of infrastructure funds. To them, infrastructure investment in the United States and EU are mostly brownfield in nature whereas it is for greenfield investments in the low-income and emerging markets. Further, although important, private sector involvement in infrastructure finance is not to be exaggerated for the time being. Arezki et al. (2016) is of the opinion that high cost of capital and greater perceived risk has affected the success and efficiency of PPPs. As a result, private sector funding would not be large in the coming years as it is expected to be. AIIB could play a very big role in all these areas of deficiency in infrastructure finance. As Articles of AIIB contain enabling provisions to promote diversification of investment in equity capital, local currency financing, monitoring of end-use of funds, diverse membership, sufficient freedom to the borrowing nations, AIIB takes everyone along with it. Let us hope for the best.

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Author

Bibliography:
Arezki, Rabah et al. (2016), “From Global Savings Glut to Financing Infrastructure: The Advent of Investment Platforms”, IMF Working Paper No. 18.

Croce, Raffaele Della and Stefano Gatti (2014), “Financing Infrastructure: International

Trends”, OECD Journal: Financial Market Trends, Vol. 2014/1, pp. 123-138.

Inderst, Georg and F. Stewart (2014), “Institutional Investment in Infrastructure in Emerging Markets and Developing Economies”, PPIAF Publication, World Bank Group.

Inderst, Georg (2016), “Infrastructure Investment, Private Finance, and Institutional Investors: Asia from a Global Perspective”, ADBI Working Paper No. 555.

www.aiib.org

Databases:
The World Bank, World Development Indicators.

The World Bank, Enterprise Surveys (http://www.enterprisesurveys.org).

The writer is with Research and Information System for Developing Countries (RIS), New Delhi. He holds a PhD in Economics from Indian Institute of Technology (IIT), Bombay. His research interests broadly cover foreign exchange reserves, macroeconomic issues, international trade and finance. The views in this piece are personal.

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