Infrastructure and Asian Infrastructure and Investment Bank. Some Scattered Thoughts.

What is Infrastructure?

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Infrastructure, though definitionally an elusive term, encompasses an economic standpoint consisting of large capital intensive natural monopolies. The term attains it heterogeneity by including physical structures of various types used by many industries as inputs to the production of goods and services. By this, it has come to mean either social, or economic infrastructure, wherein, in the former, are schools, hospitals etc, while in the latter are energy, water, transport, and digital communications, often considered essential ingredients in the success of the modern economy. Conceptually, infrastructure may affect aggregate output in two main ways: (i) directly, considering the sector contribution to GDP formation and as an additional input in the production process of other sectors; and (ii) indirectly, raising total factor productivity by reducing transaction and other costs thus allowing a more efficient use of conventional productive inputs. Infrastructure can be considered as a complementary factor for economic growth. How big is the contribution of infrastructure to aggregate economic performance? The answer is critical for many policy decisions – for example, to gauge the growth effects of fiscal interventions in the form of public investment changes, or to assess if public infrastructure investments can be self-financing.

Let us ponder on this a bit and begin with the question. Why is infrastructure even important? Extensive and efficient infrastructure is critical for ensuring the effective functioning of the economy, as it is an important factor determining the location of economic activity and the kinds of activities or sectors that can develop in a particular economy. Well-developed infrastructure reduces the effect of distance between regions, integrating the national market and connecting it at low cost to markets in other countries and regions. In addition, the quality and extensiveness of infrastructure networks significantly impact economic growth and affect income inequalities and poverty in a variety of ways. A well-developed transport and communications infrastructure network is a prerequisite for the access of less-developed communities to core economic activities and services. Effective modes of transport, including quality roads, railroads, ports, and air transport, enable entrepreneurs to get their goods and services to market in a secure and timely manner and facilitate the movement of workers to the most suitable jobs. Economies also depend on electricity supplies that are free of interruptions and shortages so that businesses and factories can work unimpeded. Finally, a solid and extensive communications network allows for a rapid and free flow of information, which increases overall economic efficiency by helping to ensure that businesses can communicate and decisions are made by economic actors taking into account all available relevant information. There is an existing correlation between infrastructure and economic activity through which the economic effects originate in the construction phase and rise during the usage phase. The construction phase is associated with the short-term effects and are a consequence of the decisions in the public sector that could affect macroeconomic variables: GDP, employment, public deficit, inflation, among others. The public investment expands the aggregate demand, yielding a boost to the employment, production and income. The macroeconomic effects at a medium and long term, associated with the utilization phase are related to the increase of productivity in the private sector and its effects over the territory. Both influence significantly in the competitiveness degree of the economy. In conclusion, investing in infrastructure constitutes one of the main mechanisms to increase income, employment, productivity and consequently, the competitiveness of an economy. Is this so? Well, thats what the economics textbook teaches us, and thus governments all over the world turn to infrastructure development as a lubricant to maintain current economic output at best and it can also be the basis for better industry which contributes to better economic output. Governments, thus necessitate realignment of countries’ infrastructure in tune with the changing nature of global political economy. Infrastructure security and stability concerns the quantity of spare capacity (or security of supply). Instead of acting on the efficiency frontier, infrastructure projects must operate with spare capacity to contribute to economic growth through ensuring reliable service provisions. Spare capacity is a necessary condition for a properly functioning system. To assure the level of spare capacity in the absence of storage and demand, the system needs to have excess supply. However, no rational profit-seeker will deliberately create conditions of excess supply, since it would produce a marginal cost lower than the average cost, and to circumnavigate this market failure, governments are invested with the responsibility of creating incentives ensuring securities of supply. This is seeding the substitutability of economics with financialization. 

So far, so good, but then, so what? This is where social analysts need to be incisive in unearthing facts from fiction and this faction is what constitutes the critique of development, a critique that is engineered against a foci on GDP-led growth model. This is to be done by asking uncomfortable questions to policy-makers, such as: What is the most efficient way to finance infrastructure spending? What are optimal infrastructure pricing, maintenance and investment policies? What have proven to be the respective strengths and weaknesses of the public and private sectors in infrastructure provision and management, and what shapes those strengths and weaknesses? What are the distributional consequences of infrastructure policies? How do political forces impact the efficiency of public sector provision? What framework deals best with monopoly providers of infrastructure? For developing countries, which have hitherto been plagued by weaker legal systems making regulation and enforcement more complicated, the fiscally weak position leads to higher borrowing costs. A most natural outcome is a systemic increase in financial speculation driven by deregulation transforming into financial assets. Contrary to common sense and what civil society assumes, financial markets are going deeper and deeper into the real economy as a response to the financial crisis, so that speculative capital is structurally being intertwined with productive capital changing the whole dynamics of infrastructure investment. The question then is, how far viable or sustainable are these financial interventions? Financialization produces effects which can create long-term trends (such as those on functional income distribution) but can also change across different periods of economic growth, slowdown and recession. Interpreting the implications of financialization for sustainability, therefore, requires a methodological diverse and empirical dual-track approach which combines different methods of investigations. Even times of prosperity, despite their fragile and vulnerable nature, can endure for several years before collapsing due to high levels of indebtedness, which in turn amplify the real effects of a financial crisis and hinder the economic growth. 

Role of Development Banks and AIIB

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Where do development banks fit into the schema as regards infrastructure investment? This question is a useful gamble in order to tackle AIIB, the new kid on the bloc. As the world struggles to find funds to meet the Sustainable Development Goals (SDGs), development banks could be instrumental in narrowing the gap. So, goes the logic promulgated by these banks. They can help to crowd-in the private sector and anchor private-public sector partnerships, particularly for infrastructure financing. However, misusing development banks can lead to fiscal risks and credit market distortions. To avoid these potential pitfalls, development banks need a well-defined mandate, operate without political influence, focus on addressing significant market failures, concentrate on areas where the private sector is not present, monitor and evaluate interventions and adjust as necessary to ensure impact, and, finally, be transparent and accountable. All of these are the ideals, which more often than not go the other way. China-led Asian Infrastructure Investment Bank (AIIB), despite having no track record still enjoys the highest ratings on par with the World Bank. This has fueled debates ranging from adding much-needed capital augmenting infrastructure to leniency in observing high standards of governance, and possibly ignoring environmental and societal impacts.

The AIIB was officially launched in Beijing on January 16th, 2016, with 57 founding members, including 37 in Asia and 20 non-regional countries. Being the largest shareholder of the AIIB, China has an initial subscription of $29.78 billion in authorized capital stock in the AIIB out of a total of $100 billion, and made a grant contribution of another $50 million to the AIIB Project Preparation Special Fund on January 16th, 2017. India is the second-largest shareholder, contributing $8.4 billion. Russia is the third-largest shareholder, contributing $6.5 billion, and Germany is the largest non-regional shareholder (also the fourth largest shareholder), contributing $4.5 billion. While being open to the participation of non-regional members, the AIIB is committed to and prioritizes the ownership of Asian members. This is reflected in the capital structure requirement and the requirements for the composition of Board of Governors in the AIIB’s Article of Agreement (AOA), which requires no less than 75 percent of the total subscribed capital stock to be held by regional members unless otherwise agreed by the Board of Governors by a Super Majority vote. The AOA also requires that 9 out of the AIIB’s 12 members be elected by the Governors representing regional members, and 3 representing non-regional members. The prioritization of Asian-members’ ownership of the AIIB does not necessarily mean that the AIIB’s investment is restricted only to Asia. According to its AOA, the AIIB aims to “improve infrastructure connectivity in Asia,” and it will invest in Asia and beyond as long as the investment is “concerned with economic development of the region.” The bank currently has 64 member states while another 20 are prospective members for a total of 84 approved members. 

The AIIB’s EU/OECD members potentially could have some positive influence over the institutional building and standard setting of the young institution. The European Commission has recognized that an EU presence in China-driven institutions would contribute to the adoption of best practices and fair, global standards. Adherence to such standards will be promoted by the AIIB entering into partnership with existing Multilateral Development Banks. It has also been argued that joining the AIIB would give the European countries access to the decision-making process within the AIIB, and may even allow the European countries to play a role in shaping the AIIB’s organizational structure. As an example of EU/OECD members’ activism in monitoring the AIIB’s funds allocation, both Denmark and the UK, who are AIIB’s OECD members, proposed that contributions to the AIIB would qualify as official development aid (ODA). After a thorough review of AIIB’s AOA, mandate, work plan and other available materials, the OECD’s Secretariat of the Development Assistance Committee (DAC) recommended including AIIB on the List under the category of “Regional development banks,” which means the OECD would recognize the AIIB as one of the ODA-eligible international organizations. Once approved, the Secretariat of DAC will be able to “monitor the future recipient breakdown of the AIIB’s borrowers through AIIB’s future Creditor Reporting System and thereby confirm that the actual share of funds going to countries on the DAC List of ODA Recipients is over 90%.” That is to say, if approved, there would be additional external monitor to make sure that the funds channeled through the AIIB to recipient countries are used properly. 

The AIIB’s initial total capital is $100 billion, equivalent to about 61 percent of the ADB’s initial total capital, 43 percent of the World Bank’s, 30 percent of the European Investment Bank’s (EIB), and more than twice of the European Bank for Reconstruction and Development’s (EBRD). Of this $100 billion initial capital, 20 percent is to be largely paid-in by 2019 and fully paid-in by 2024, and the remaining 80 percent is in callable capital. It needs to be noted that according to the AOA, payments for paid-in capital are due in five installments, with the exception of members designated as less developed countries, who may pay in ten installments. As of any moment, the snapshot of AIIB’s financial sheet includes total assets, members’ equities and liabilities, the last of which has negligible debt at the current stage since the AIIB has not issued any debenture or borrowed money from outside. However, to reduce the funding costs and to gain access to wider source of capital, the AIIB cannot rely solely on equity and has to issue debenture and take some leverage, particularly given that the AIIB intends to be a for-profit institution. In February 2017, the AIIB signed an International Swaps and Derivatives Association (ISDA) Master Agreement with the International Finance Corporation (IFC), which would facilitate local currency bond issuance in client countries. Moreover, AIIB intends to actively originate and lead transactions that mobilize private capital and make it a trusted partner for all parties involved in the transactions that the Bank leads. In the long term, the AIIB aims to be the repository of know-how and best practices in infrastructure finance. 

It is widely perceived that the AIIB is a tool of Chinese foreign policy, and that it is a vehicle for the implementation of the Belt and Road (One Belt, One Road) Initiative. During a meeting with global executives in June 2016, the AIIB President Jin Liqun clarified China’s position, saying the AIIB “was not created exclusively for this initiative,” and that the AIIB would “finance infrastructure projects in all emerging market economies even though they don’t belong to the Belt and Road Initiative.” It is worth pointing out that despite the efforts on trying to put some distance between the AIIB and the Belt and Road Initiative, there is still a broad perception that these two are closely related. Moreover, China has differentiated AIIB projects from its other foreign assistance projects by co-financing its initial projects with the preexisting MDBs. Co-financing, combined with European membership, will make it more likely this institution largely conforms to the international standards” and potentially will steer the AIIB away from becoming solely a tool of Chinese foreign policy. This supports China’s stated intention to complement existing MDBs rather than compete with them. It also means that the AIIB can depend on its partners, if they would allow so, for expertise on a wide range of policy and procedural issues as it develops its lending portfolio.

Although AIIB has attracted a great number of developing and developed countries to join as members and it has co-financed several projects with other MDBs, there is no guarantee for any easy success in the future. There are several formidable challenges for the young multilateral institution down the road. Not all the infrastructure investment needs in Asia is immediately bankable and ready for investors’ money. Capital, regardless it’s sovereign or private, will not flow in to any project without any proper preparation. Although Asia faces a huge infrastructure financing gap, there is a shortage of ‘shovel-ready’ bankable projects owing to the capacity limitations. The young AIIB lacks the talent and expertise to create investor-ready bankable projects, despite that it has created a Project Preparation Special Fund thanks to $50 million by China. The AIIB aims to raise money in global capital markets to invest in the improvement of trans-regional connectivity. However, infrastructure projects are not naturally attractive investment due to huge uncertainties throughout the entire life cycle as well as unjustified risk-profit balance. Getting a top-notch credit rating is just a start. The AIIB has to find innovative ways to improve the risk-adjusted profitability of its projects. This issue itself has been a big challenge for many MDBs who engage in infrastructure financing for a long time. It is uncertain if the AIIB could outperform the other much more matured MDBs to find a solution to tackle the profitability problem in infrastructure financing. The highest rating it has received from ratings agencies could pose a challenge in itself. The high rating not only endorses the bank’s high capital adequacy and robust liquidity position, but also validates the strong political will of AIIB’s members and the bank’s governance frameworks. A good rating will help the AIIB issue bonds at favorable rate and utilize capital markets to reduce its funding costs. This certainly will contribute to AIIB’s efforts to define itself as a for-profit infrastructure investment bank. However, there is no guarantee that the rating will hold forever. Many factors may impact the rating in the future, including but not limited to AIIB’s self-capital ratio, liquidity, management, yieldability, risk management ability, and its autonomy and independency from China’s influence. 

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