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China Financial Services Sector
Isaac Leung

China’s New Infrastructure Bank Rattles Financial “Order”

by Isaac Leung | Dun & Bradstreet Editor

April 17, 2015 | No Comments »

China Financial Services SectorThe Asian Infrastructure Investment Bank (AIIB) is already making waves even though it has yet to publish a charter, announce member-country shareholdings, take in a single dollar, or loan any money on a project.

After an uncertain start, China’s plan to create a rival to the World Bank and the Asian Development Bank (ADB) is attracting interest in Europe and the Asia/Pacific region — even though the Chinese government will be the majority shareholder.

The need for more capital to finance improvements in the region is driving changes in the traditional model. Typically, governments and multilateral lenders award infrastructure contracts to the private sector, and that is where business involvement begins — after the project parameters have been decided.

But building out Asia’s infrastructure alone for 2011-20 is estimated at US$8 trillion, or US$800 billion per year, according to the ADB.

Private sector involvement is still at a low base. The US-dominated World Bank’s Private Participation in Infrastructure database shows just US$14 billion in investments in this category in 2013, albeit rising to US$19 billion in 2014.

Given Asia’s infrastructure gap, landmass, and population, this is not adequate. Meanwhile, on the more conventional development finance track, the World Bank itself has only awarded US$160 billion in major contracts for the Asia/Pacific region — for all project types — since 2000.

A New Multilateral Development Finance Bank

Demand for new capital for infrastructure is likely behind China’s decision to launch a bank of its own that defies the norm.

But China’s move also can be attributed to the US Congress’ delay in reallocating shareholdings in the Bretton Woods institutions — the IMF and World Bank — to reflect China’s increased weight in the global economy. Rival Japan’s lock on the presidency of the Philippines-based ADB since it was formed in 1966 didn’t help either.

The impact of China’s bank so far has been mostly diplomatic. European governments, South Korea, and Australia have pledged capital in defiance of US wishes. By stepping out of the framework of the existing multilateral lending institutions (with their mid-20th century allocation of shareholdings by country), they are backing China’s sudden move from client to patron country in the development finance scene.

Infrastructure Finance Impacts Growth and Poverty

The Beijing-headquartered AIIB is to have initial subscriber capital of some US$50 billion, with an option to double that amount. This will make it about 30% the size of the ADB’s main fund at launch. As of the end of 2014, the ADB’s “ordinary capital resources” were the base for an outstanding loan portfolio of US$55.9 billion, with callable capital of US$153.1 billion. This excludes some US$27.5 billion in concessional nonleveraged lending to low-income countries.

If the AIIB had a capital structure identical to the ADB’s ordinary capital resources, the AIIB’s lending portfolio would have an initial cap of US$18.3 billion, with the potential to double over the medium to longer term. Even at maximum, this would be just over 1% of outstanding local currency bonds issued in the Asia/Pacific region as of 2014.

However, public infrastructure has such powerful effects on capital and labor productivity — and in lowering poverty — that policy makers have a disproportionate interest in pushing such projects. The availability of capital for infrastructure will affect medium-term growth projections for regional countries.

A Bailout for Chinese Construction Companies?

Ironically, China’s economic problems and excesses may be another key to the creation of the AIIB. The new bank could provide Chinese companies mired in overcapacity with a fresh source of contracts in infrastructure-poor Asia.

China, for example, produced more cement in the past few years than the US did in a century. This is unsustainable, and China’s upstream industries need to reduce capacity and write off huge chunks of capital. In this context, Chinese construction companies need to help build Asia or face going bust. Southeast Asia alone will require US$60 billion in new infrastructure financing per annum to 2020, the ADB estimates. It will now have to compete head-to-head or share opportunities with AIIB financing.

The upshot for companies in the construction, engineering, utilities, and power sector? Chinese companies will be in a stronger position to win contracts, which means much more competition for non-Chinese firms.

Chinese companies already have a sizable footprint in multilateral development contracts: 25% of all World Bank major contract awards in 2000-15 and over 70% of ADB contracts awarded in January 2015. China is second in the region to Australia, which has the most World Bank contracts by percentage (55%) and value (US$93.3 billion) in 2000-15.

With Beijing ruling the new AIIB, Chinese contractors will be well placed to take over from Australian, South Korean, and local contractors as the new development bank initiates new lending. Fear of losing out is one reason the US has been unable to prevent its allies from joining the new bank.

Companies such as Sumitomo, GE, AREVA, Alstom, Vestas, and POSCO that were previously awarded contracts of US$50 million or larger by the World Bank may have to build a new set of relationships with the AIIB’s main shareholder — the Chinese government.

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