Close on the heels of the announcement at the BRICS Summit in July that the five-nation group would set up a development bank, another similar initiative has been set in motion. Last week, India, China and 19 other Asian countries signed an agreement to set up the Asian Infrastructure Investment Bank, or AIIB, with an initial capital base of $50 billion, to be subscribed by the member countries in proportion to their gross domestic product (measured in purchasing power parity terms). By this formula, China will be the largest shareholder, by a significant margin, while India will be next on the list. Both the BRICS Development Bank and the AIIB are essentially motivated by the same concerns. The global financial system in general and the multilateral financial institutions (MFIs) in particular are dominated by the developed economies, particularly the United States. These are now consumed with a set of financial challenges somewhat removed from the development agenda. Even relatively small steps to reform their governance structures to give emerging economies a larger role are being stonewalled. Meanwhile, the need for large investments in infrastructure in these countries is becoming more and more pressing, if reasonable growth and development objectives are to be met. The solution so far has been to form your own bank. And now that both the BRICS Development Bank and the AIIB are a reality, questions on whether they offer a genuine alternative to the established MFIs are likely to be raised.
It is to be noted that the great strength of the MFIs is their ability to access global capital on the sovereign ratings of their largest shareholders. Even the regional institutions are predominantly owned by developed economies. In effect, they have been intermediating between savings in the developed economies and investment in emerging ones. Without these high-rated economies, the new institutions are constrained in their ability to raise funds by the relatively lower ratings of their shareholders. Of course, this is not their intent in any case. In both institutions, Chinese resources, as reflected in their huge foreign-exchange reserves, will constitute a significant proportion of the capital base. But without the capacity for leverage that the MFIs have, the lending capacity of these new institutions will be relatively small. Then, of course, there is the concern that China will effectively control the lending agenda, ensuring that all the projects financed are consistent with its strategic interests. As lopsided as the governance structure of the MFIs may be, there is some protection against its complete capture by a single dominant interest. This will be much more difficult in institutions owned and financed by a smaller number of countries, with one of them clearly dominant.
Nevertheless, in a larger picture, these banks can be seen as the first steps in creating a financial architecture based exclusively on development objectives and funded exclusively by emerging economies. Governance and operating principles will take time to emerge through what will almost certainly be a contentious process, but that is how things work. India's need for infrastructure finance is so large that no door should be closed. These experiments may or may not work, but the process has to be set in motion.
It is to be noted that the great strength of the MFIs is their ability to access global capital on the sovereign ratings of their largest shareholders. Even the regional institutions are predominantly owned by developed economies. In effect, they have been intermediating between savings in the developed economies and investment in emerging ones. Without these high-rated economies, the new institutions are constrained in their ability to raise funds by the relatively lower ratings of their shareholders. Of course, this is not their intent in any case. In both institutions, Chinese resources, as reflected in their huge foreign-exchange reserves, will constitute a significant proportion of the capital base. But without the capacity for leverage that the MFIs have, the lending capacity of these new institutions will be relatively small. Then, of course, there is the concern that China will effectively control the lending agenda, ensuring that all the projects financed are consistent with its strategic interests. As lopsided as the governance structure of the MFIs may be, there is some protection against its complete capture by a single dominant interest. This will be much more difficult in institutions owned and financed by a smaller number of countries, with one of them clearly dominant.
Nevertheless, in a larger picture, these banks can be seen as the first steps in creating a financial architecture based exclusively on development objectives and funded exclusively by emerging economies. Governance and operating principles will take time to emerge through what will almost certainly be a contentious process, but that is how things work. India's need for infrastructure finance is so large that no door should be closed. These experiments may or may not work, but the process has to be set in motion.
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