May 3, 2015

China’s $100 Billion Infrastructure Bank: Bumpy Road Ahead

Hilton Root

Senior Research Fellow
Summary

Has the Asian century finally arrived? You might think so, reading the international media’s take on the rush to join the new Chinese-led Asian Infrastructure Investment Bank (AIIB). To date, some 58 countries, including almost every country in Asia plus 18 European countries, have queued up for membership. Is this the start of an epochal global power shift that — to paraphrase Chinese President Xi Jinping — signifies the rise of new regional order, better for Asia and better for the world?

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Has the Asian century finally arrived? You might think so, reading the international media’s take on the rush to join the new Chinese-led Asian Infrastructure Investment Bank (AIIB). To date, some 58 countries, including almost every country in Asia plus 18 European countries, have queued up for membership. Is this the start of an epochal global power shift that — to paraphrase Chinese President Xi Jinping — signifies the rise of new regional order, better for Asia and better for the world? 

The claim heard in Asia is that it’s time for China to share its expertise and help others. By spending nearly 8.5 percent of its GDP on infrastructure, while its neighbors never exceed 4.0 percent, China has been spectacularly successful building an infrastructure for a modern economy in record time. By comparison, the U.S.-led World Bank and the Japanese-led Asian Development Bank are slow and bureaucratic, preventing both organizations from meeting Asia’s needs, which exceed trillions of dollars. 

Surprisingly, the momentum to join the bank is creating apprehension within China itself. At a time when China’s portfolio of projects overseas is suffering from scrutiny, stalls, setbacks and local opposition, Chinese enterprises were looking forward to a feeding frenzy of subsidized projects that international oversight of the proposed new bank could stymie. 

Meanwhile, a Chinese Treasury Department official revealed to Internet service portal Tencent that an estimated 70 percent of $671 billion in bilateral loans disbursed to support the overseas operations of Chinese firms between 2001 and 2011 are performing below expectations. The problem is that China’s expansion of overseas lending is conducted without any risk assessment being in place. 

The reality is, the Chinese are learning the hard way that they’re no better at overcoming the same difficulties that handicap the World Bank and Asian Development Bank in local environments where fiduciary standards are unreliable, corruption is unavoidable and weak local management makes project completion and maintenance problematic. Managerial capacity, it turns out, is not as easy as bricks and mortar to transfer overseas. 

But the most tenacious risk is political. Despite China’s goal of avoiding local politics, its infrastructural initiatives embroil China in the politics of its neighbors. 

In Sri Lanka, alleged corruption in the $5 billion investment portfolio of Chinese projects helped the opposition defeat President Mahinda Rajapaksa. In Myanmar, the mega Myitsone dam project has been suspended since 2011 due to negative environmental and social impacts that provoked protests among local populations who asked why they should bear the environmental costs for a project that would deliver 90 percent of its output to China. In the Philippines, the newly elected Aquino government in 2012 cancelled the Northrail project due to allegations of corruption in the procurement process conducted by its predecessor. Allegations of corruption turn Chinese investment into a domestic political issue that harms bilateral relations. 

The Chinese are confident that AIIB can get off to a fast start by going after “low-hanging fruit” and addressing the long-term issues later. This is an illusion. If such “low-hanging fruit” ever existed, it would have been snatched long ago, but the difficulty in making accurate assessments about project costs and commercial viability keeps investment at bay. 

Equity — how the benefits are distributed socially — can also be intractable. Making infrastructure work for the poor is not just an exercise in engineering or financing. A half-century of experience has taught the mature development organizations that local governance failures contribute to the uncertainty of infrastructure investment success. 

Here’s the biggest snag that will bedevil the Chinese concept of its new global institution: The Chinese decry the fact that World Bank’s president is traditionally American, the head of International Monetary Fund traditionally European and the Asian Development Bank is always headed by a Japanese president. China’s share of voting on the governing boards of these institutions is kept low. 

Yet China’s insistence on the right to appoint the head of the AIIB, and its desire to exercise veto power over bank management, compromises the bank’s professionalism and its ability to operate autonomously, free of political pressures. 

Why does China want to replicate the same prejudice for which it criticizes the other multilateral institutions?