AIIB offers mix of risks and opportunities for investors

AIIB offers mix of risks and opportunities for investors

The AIIB seeks to promote multilateralism in the Asia-Pacific region, spur loan competition, and reform Chinese approaches to finance and lending.

Many of the prospective Asian members and non-Asian partners of the Chinese-led Asian Infrastructure Investment Bank (AIIB) are committed to making the bank genuinely multilateral. Other multilateral banks, like the World Bank and ADB, have offered to collaborate.

While China’s Finance Ministry announced that the 57 founding members had agreed upon a charter on May 23, 2015, it has not yet made it public. The actual document is scheduled for signing at the end of June. There also may be an additional lag as some members will require approval by their legislatures.

China has reserved 75% of the shares for Asian countries. Reports indicate that China will be the largest shareholder, with 25-30% of the shares. Since the shares are based on Asian location and national GDP, India will be the second largest shareholder, with 10-15%. A South Korean source has predicted that the next largest shareholders will be Indonesia, Germany and South Korea, at roughly 4%. It is unclear whether Russia will be counted as European or Asian.

Still undisclosed is whether China will have a veto like the U.S. in the IMF. Xinhua reports that the loan approval process will prioritize urgent loans. It will also be more streamlined. Chinese spokesmen hold that this streamlining is in contrast to the “inefficient” practices of the World Bank and the ADB.

However, officials also stress that the process will maintain transparency, and meet labor and environmental standards consistent with concerns raised by the U.S. and Japan. Bank officials also favor a basket of Asian currencies for loan settlements, rather than arranging these in renminbi or dollars.

The main financial instruments of the bank will be loans, equity investments, and guarantees. However, beyond the capital subscribed by member states, the bank plans to issue bonds on financial markets, and arrange inter-bank market transactions to help increase capitalization.

Since the Asian Development Bank estimated the region’s infrastructure needs $800 billion between 2010 and 2020, the bank could serve a huge potential market. AIIB’s initial capitalization is authorized at $100 billion with China contributing $50 billion. Interestingly Japan and the ADB have just announced reforms that will allow an increase to $110 billion in new loans this year. This suggests that new competition might yield more loan opportunities.

Risks

While the bank marks an opportunity to invest in Asian infrastructure projects, it also involves some risks. Many turn on China’s own economy and its experience in multilateral or global leadership. It’s now commonly acknowledged that China will continue to experience lower growth rates. Knowing this, China has engaged in macroeconomic measures they hope will lead to a “soft landing.”

These measures have included a new $200 billion stimulus program, and lowering interest rates three times in six months. They have recently announced that small state and private industries will be allowed to fail rather than roll over their debts into new loans.

However, they have also continued to let recapitalized banks assume more debt by rolling over loans for large state companies. Municipalities have recently been bailed out by the state absorbing their debts, while providing them the authority to raise money with low interest municipal bonds.

The central question is whether China’s massive total government, commercial, and household debt of $28 trillion, or 282% of its $10.4 trillion annual output, will lead to a financial crisis. Those who think not point to China’s massive $3.4 trillion foreign exchange reserves as a source of assurance.

Both debt and reserves have been growing since 2000, but reserves have recently dropped off. In one sense, much of this will turn on whether all the infrastructure improvements in China and the region will have a sufficient growth effect on the economy to outrun the debt that’s been created.

Fitch dropped China’s sovereign credit rating from AA- to A+ in April 2013 because of the rapid expansion of credit and low average incomes. They were particularly concerned with the increases in “shadow banking,” where non-banking commercial trusts provide high interest loans to risky ventures, often real estate, to maximize investor profits. The low “average wages” reflect the poverty of average Chinese who do not live on the export-oriented coast. This translates into lower demand and lower growth.

China’s mistakes parallel mistakes seen elsewhere. Overcapacity and resultant deficits in large state-owned enterprises; refinancing to hide these problems is similar to the practice of Japanese keiratsu Korean chaebols. The assumption of debt during high growth periods is similar to U.S. deficit financing during the 1960s.

A major difference is that the yuan’s value is determined by the government, rather than by the world currency market. This frees it from speculation. Indeed, one harsh but experienced critic has also claimed that the government has been padding growth rates and corresponding energy use data to obscure problems.

Government control may at least offer the government additional time to implement a recovery. It’s also likely that like the U.S., Japan and South Korea, China could be too big to fail.

Opportunities

The good news is that the AIIB will not be solely dependent on China’s largesse. Indeed, one reason for China’s shift to multilateral lending was to share responsibility while also quelling accusations of dominance and imperialism brought on by its bilateral funding in Africa.

More importantly, China and its many Asian partners have a real stake in the growth of Asian infrastructure. Projects will soak up some of China’s overcapacity, but roads and ports will also facilitate the growth of regional production and trade networks. This should provide benefits for all Asian shareholders, and even a free ride for nonmembers.

India’s presence is particularly helpful, since if set up properly, projects in India will be protected by enforceable common law contracts. Even Chinese firms with good track records may offer opportunities. The bank’s bonds will also bear watching.

Analysts have also pointed to the INDXX India Infrastructure Index Fund, an exchange traded fund that should do better with Indian infrastructure growth. A few others are the iShares Emerging Markets Infrastructure Fund, a general emerging market fund (36% of which is made up of Chinese companies), and the Global X Uranium Fund, since AIIB will likely finance new reactors.

 

Categories: Asia Pacific, Finance

About Author

Lawrence Katzenstein

Lawrence Katzenstein has taught at the University of New Orleans and the University of Minnesota. Through an affiliation with the Humphrey Institute he was one of the trainers for the initial Chinese WTO delegation. He has been an exchange professor at the Consolidated Universities of Shandong Province and an embedded social scientist with the U.S. Army in Iraq. He earned a B.A. in political science from CCNY and an M.A. and Ph.D in political science from Rutgers University. While at the University of Minnesota he also completed a teaching post doc in International Business.