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Asia

A look at the new China-led financial institutions

Touted as alternatives to the World Bank and IMF, many nations seek to join China-led financial institutions such as the AIIB. But what do they offer and what challenges do they face? DW speaks to economist Rajiv Biswas.

The BRICS New Development Bank (NDB), the Asian Infrastructure Investment Bank (AIIB), and the Silk Road Fund are all international initiatives spearheaded by China over the past months that symbolize Beijing's growing influence in providing development funding and potential new sources of financing for developing countries.

While the initiatives have been criticized by some as a way for Beijing to challenge Western-backed institutions such as the World Bank or International Monetary Fund (IMF), there are others who believe these new development banks may have a positive impact on emerging economies. In fact, more than 30 countries have already announced their intention to join the AIIB as founding members, including some of Europe's largest economies.

In a DW interview Rajiv Biswas, Asia-Pacific Chief Economist at the analytics firm IHS, talks about the purpose of these institutions, the challenges they face and the opportunities they may offer both to developing nations and the global economy.

Rajiv Biswas

Biswas: 'The decision by the UK to apply for AIIB membership is likely to considerably change the eventual structure of the AIIB'

DW: What led China to initiate the creation of these financial institutions?

Rajiv Biswas: China has led a number of initiatives to create new multilateral development financing institutions. Although these initiatives were all launched in 2014, the decisions to create these new institutions reflect the growing discontent for many years amongst developing nations that the governance structure of the IMF and World Bank has not evolved to reflect the increasing weight of emerging markets in global GDP.

China, in particular, has a disproportionately low share of voting rights in the Bretton Woods institutions, with only 3.81 percent of IMF voting rights even though it accounts for an estimated 12.4 percent of world GDP. These new institutions, if successfully implemented, could hence give developing nations greater influence in global development financing.

What is the main purpose of these institutions?

One of the major barriers to economic development in low and middle income developing countries is the lack of critical infrastructure such as ports, railways, roads and power. The AIIB, NDB and Silk Road Fund are all intended to provide development financing for infrastructure projects in these developing countries.

How will these institutions be capitalized?

The BRICS are establishing the NDB with initial capital of $50 billion to be subscribed in equal shares by Brazil, Russia, India, China and South Africa. Its creation was already approved by Russia's State Duma and the Indian cabinet in late February 2015.

China has committed $40 billion to the establishment of the Silk Road Fund, which has already become operational. The Fund has already raised $10 billion, from China's foreign exchange reserves as well as capital from China Investment Corporation, the Export-Import Bank of China and China Development Bank.

China will provide up to $50 billion of the authorized initial capital for establishing the AIIB, which already has 23 founding member countries plus new membership applications from the UK, Germany, France, Italy and Luxembourg, with more developed countries expected to also apply to become members. The AIIB is due to become operational by the end of 2015 and will be headquartered in Beijing, with initial subscribed capital of $50 billion.

Altogether these three new development institutions will create over $100 billion in funding for infrastructure projects in Asia over the medium term, representing a significant boost to regional infrastructure development.

When these institutions seek to raise capital from international capital markets they will need to obtain ratings from international rating agencies in the same way as other multilateral financial institutions.

How much say does Beijing like to have in these institutions?

The decision by the UK in early March to apply for AIIB membership is likely to considerably change the eventual structure of the AIIB. This has triggered applications to join the AIIB by other EU nations, including Germany, France, Italy and Luxembourg, which means that many developed nations are likely to be AIIB members, subscribing capital and contributing to the development of governance standards for the AIIB.

The exact governance structure and voting rights of individual countries will be determined through negotiations amongst AIIB members during the coming months.

For the NDB, the initial subscribed capital will be provided in equal shares by the five founding BRICS countries, with all these five countries likely to play a key role in the governance structure and voting rights for the NDB, although other developing countries will also be able to subscribe capital and play a role in the governance structure.

What challenges are these new China-led financial institutions likely to face?

A key issue will be to establish credible, high-quality governance structures that will ensure that the lending activities of these institutions are conducted in a fair, transparent and ethical manner. For the AIIB, one of the major challenges could be in determining the allocation of voting rights now that a number of major developed countries have applied to join.

How are these institutions likely to help development in Asia?

The establishment of these institutions will significantly increase development finance for developing countries. Initial capital of over $100 billion is expected to be deployed to fund infrastructure development projects in Asian developing countries. The AIIB and Silk Road Fund together will provide a major boost to infrastructure funding for transport and energy infrastructure in Southeast Asia and Central Asia.

The Fund will focus on the Silk Road Economic Belt from China to Central Asia and the Middle East, as well as the Maritime Silk Road from China to Southeast Asia and is expected to significantly improve infrastructure connectivity and help accelerate trade and investment flows between these regions.

To which extent could these banks be used as vehicles to spread China's influence or its soft power?

China's President Xi Jinping (front C) guides guests at the Asian Infrastructure Investment Bank launch ceremony at the Great Hall of the People in Beijing October 24, 2014 (Photo: REUTERS/Takaki Yajima/Pool)

Biswas: 'A key issue will be to establish credible, high-quality governance structures'

Much will depend on the eventual membership and capital subscriptions by various member countries. If China contributes a high share of the total capital, as is currently the case in the first phase of the Silk Road Fund, then it may be expected that China could have a high degree of influence over the decisions and perhaps use the organization as an instrument of soft power.

However, the BRICS Development Bank is already established with equal capital subscriptions by the five BRICS countries, which will mean that the governance and decision-making of the NDB will well distributed amongst the BRICS countries, and other countries joining will also play a role in the governance and standards-setting.

The AIIB already has a wide membership base of 23 founding countries from the Asia-Pacific region, and a number of major EU countries including the UK, Germany, France and Italy have applied to join. This indicates that the AIIB will have quite a wide membership with many countries involved in the standards-setting and governance structure. It is therefore unlikely to be solely a China-led vehicle.

What challenges are they likely to pose to the IMF and World Bank?

The members of the AIIB and NDB are also members of the Bretton Woods institutions, which increases the likelihood that the new banks will work in a complementary manner to the Bretton Woods institutions rather than as competitors.

From the point of view of the developing countries, these new institutions will increase the total flow of international capital for infrastructure development. Therefore a pragmatic co-operation is likely to emerge between the Bretton Woods institutions and these new development finance institutions.

Rajiv Biswas is Asia-Pacific Chief Economist at IHS, a global information and analytics firm. He is responsible for coordination of economic analyses and forecasts for the Asia-Pacific region.