The Need for a Flexible Japanese Approach to the Asian Infrastructure Investment Bank

The Purpose of the AIIB

As interest mounts in the Asian Infrastructure Investment Bank being promoted by China, the Japan-led Asian Development Bank held its annual general meeting in Baku, Azerbaijan, in early May. Here the ADB emphasized its reform efforts, such as the expansion of lending capacity and the strengthened assistance of public-private partnerships.

When the AIIB comes under discussion, it is frequently portrayed as China’s endeavor to challenge the global financial system, which is dominated by the United States. Another issue that is often raised is the question of how Japan should relate to the AIIB, such as whether it should be a participant in the bank. While this question of how to relate to the AIIB is significant, it is equally important to consider what the future shape of Asia should be. To answer this latter question, it is useful to look again at China’s “One Belt, One Road” initiative, which was a driving factor behind the launching of the new bank. In this process, it will be beneficial to clarify the relationship between the ADB and AIIB, two institutions engaged in the development of Asia.

One Belt, One Road is an initiative unveiled by President Xi Jinping on a tour of Central and Southeast Asia in 2013. This initiative consists of a land-based Silk Road Economic Belt extending from China through Central Asia to Europe and a sea-based Maritime Silk Road reaching out from China through Southeast Asia, the Indian Ocean, the Middle East, and Africa to Europe. By establishing a network of new trade routes over land and sea, China is seeking to promote trade and investment and to develop transportation infrastructure. From China’s perspective, the AIIB is simply a means for realizing One Belt, One Road.

Issues for China’s Economy

One Belt, One Road is complexly intertwined with a range of issues impinging on the Chinese economy. Three are of particular importance: expansion of foreign investment as a response to structural changes in the domestic economy and the control of excessive domestic investment; diversification in investment of massive foreign exchange reserves and the internationalization of the yuan; and the issue of securing resources.

To overcome the decline of the working-age population and the aftereffects of excessive domestic investment in past years, the economic structural reform is an urgent issue for China. The nation also needs to transition to a sustainable growth phase by expanding foreign investment while curbing excessive domestic investment and by promoting Chinese companies’ economic activities in overseas markets. China’s share of global foreign direct investment is increasing year by year, rising from 1.2% in 2007 to 7.2% in 2013.

The Chinese government is also working to diversify investment of massive foreign exchange reserves and to internationalize the yuan. One Belt, One Road is consistent with these efforts. With the growth of transactions in foreign markets and in Hong Kong, the yuan’s share of international payments has risen from 0.6% at the end of 2012 to 2.2% at the end of 2014 according to the Society for Worldwide Interbank Financial Telecommunication, a global platform for international payments and data communication. Britain, which has become the first European nation to participate in the AIIB, had previously signed a currency swap agreement with China in 2013 and begun to issue yuan-denominated bonds. This underscores Europe’s great interest in the internationalization of the yuan.

China’s efforts to secure resources are also worth noting. As a result of high economic growth, China’s global share of crude steel production and coal consumption are both currently about 50%, and the nation’s share of crude oil and natural gas consumption is rising year by year. Although the demand for resources has slowed due to the recent faltering economic growth, there is still a pressing need to secure resources to support a population of 1.3 billion people. The Chinese government is actively investing in and offering aid to resource-rich nations, and one of the objectives of infrastructure investment is to secure transportation routes for resources.

AIIB a Symbol of Multilateral Frameworks

China is developing and utilizing a range of frameworks in tandem with a view to establishing One Belt, One Road. In this context, the AIIB can be viewed as a symbol of diversification in China’s external strategies from existing funds and other bilateral frameworks to multilateral frameworks incorporating other emerging economies and economic zones.

China’s bilateral frameworks include the China Investment Corporation (2007), a sovereign wealth fund investing foreign exchange reserves, the China-ASEAN Investment Cooperation Fund (2009), and the Silk Road infrastructure fund (2014), which decided in April to invest in a hydropower project in Pakistan. As a multilateral framework, the five emerging economies of China, India, Russia, Brazil, and South Africa agreed to the establishment of the New Development Bank in July 2014.

The NDB is planning to begin lending in 2016. Parallel to this development, the Chinese government proposed the establishment of the AIIB during President Xi Jinping’s tour of Southeast Asia in autumn 2013. Member nations of the Association of Southeast Asian Nations and Middle Eastern nations were quick to express their support, and China has been laying the groundwork for the bank’s establishment with leading member nations. Founding members now total 57 nations, and the first preparatory meeting with founding members was held in Beijing on April 27. And reports indicate that China is continuing to explore Japanese participation in the bank.

Emerging Economies Welcome AIIB

With their growth restricted by the shortage of funds for infrastructure development, emerging economies have broadly welcomed the formation of the AIIB. The ADB estimates that about $8 trillion will be needed for infrastructure investment in the Asian region between 2010 and 2020. It is widely accepted that this enormous demand cannot possibly be met through existing international financial institutions. While such issues as the governance and lending standards of the AIIB will require thorough debate, the appearance of the AIIB and the expansion of infrastructure investment in Asia is a desirable development for the ADB.

The ADB was founded in 1966 with the aim of an Asia and Pacific free from poverty. A total of 67 countries and regions are members of the ADB, and it is capitalized at around $160 billion. The AIIB is planning to raise its capitalization to around $100 billion in the future, and it may one day rival the size of the ADB. The AIIB plans to specialize in infrastructure lending. Meanwhile, infrastructure lending by the ADB grew from 67% of total lending between 2003 and 2007 to 72% between 2008 and 2012. As such, priority areas can be said to overlap between the ADB and AIIB.

Evaluating Infrastructure Investments

Should infrastructure lending by the AIIB increase, there is concern among some observers that the ADB’s presence will be threatened. Is this really the case? In making infrastructure investments, it will be extremely important for the AIIB to build cooperative relationships with other international financial institutions, particularly the ADB. While the ADB will also need to institute reforms, its role is certain to grow in importance as it collaborates with the AIIB.

Medium- to long-term growth will not be achieved in Asia merely through the quantitative expansion of infrastructure investments. International financial institutions have established the objective of inclusive growth in recent years, and the ADB is endeavoring to invest in infrastructure through a more inclusive framework. For example, a hydropower project in Bhutan was accompanied by expansion of the local power grid. The ADB is using infrastructure investment as an opportunity for implementing projects in such areas as education, finance, and health. By encouraging and supporting local autonomous growth, the bank is working to increase the efficiency of its overall lending.

Whether investments in emerging economies are public or private, it is usually the case that their performance is strongly influenced by the economic and social environment and by the efficiency of markets and government. Evaluating the appropriateness of projects by focusing solely on individual infrastructure deals is fraught with risks. Hence, the evaluation of infrastructure investments should proceed from multiple angles, such as whether borrowing nations are fully capable of repayment, including such indicators as the macroeconomic environment and the external debt balance, whether the grand design for medium- to long-term infrastructure development is appropriate for the nation and region, and whether the project has a high priority. In the longer term, it will be desirable for the ADB and AIIB to come to share a grand design for inclusive infrastructure development in the Asian region.

Contributing Through Multiple Channels

Given the relationship between the ADB and AIIB, there are many ways that Japan can contribute as one of the largest shareholders of the ADB. Japan has been involved in Asian development projects over the last 50 years through loans from international financial institutions and private-sector investments. By utilizing the experience and networks it has built up during this time, Japan will be able to contribute to the long-term development of Asia as a whole.

While attention is frequently directed solely at infrastructure investment, the smooth operation and management of infrastructure once it is built is also extremely important. Japan possesses strengths in operating and managing infrastructure, and it will be able to support performance improvements in infrastructure investments by offering human resource support and technical assistance.

There is little to be gained from becoming distracted by the question of whether or not to participate in the AIIB. Japan should become actively involved in the development of a new framework for global finance and in the development and realization of a grand design for regional infrastructure. It can do so through multiple channels—such as official development assistance, technical assistance, human resource support, strengthening of public-private partnerships, and collaboration with the ADB and other international financial institutions—with a view to achieving the sustainable growth of the Asian region.

(Originally written and published in Japanese on May 26, 2015)