By Erik Berglof
It has been clear for some time that China is turning outward, leaving its traditional position, once formulated by Deng Xiaoping, of “hiding our capabilities and biding our time”. In fact, the “Go Out” policy encouraging direct investment abroad and strengthening financial channels with respect to the domestic market has been in place since 1999. But efforts have accelerated in recent years, with the record acquisition offer of Syngenta by ChemChina as a powerful illustration.
The country has been part of the global order for three decades and has learnt how to manoeuvre in multilateral settings, but the recent flurry of activity has taken engagement to a new level – China has significantly increased its involvement in international financial institutions. China’s policymakers have concluded that the country can no longer hide and bide its time in these institutions, because of its impact on the rest of the world and its global interests. This has manifested itself in more aggressive international financial mobilisation and interventions in the global financial architecture.
Much attention has focussed on China’s role in the creation of new international development institutions like the Asian Infrastructure Investment Bank and the New Development Bank (often called the BRICS bank because of its membership of five large emerging economies). But China’s engagement goes much beyond the creation of new institutions – it ultimately wants to change existing institutions. The new institutions are a response to the frustration with the lack of progress in these institutions and an attempt to accelerate change.
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What Do International Financial Institutions Do?
To understand the importance of the international financial institutions and how they are relevant to China it is useful to explain what makes them work.
A key feature of the international development institutions is that only a small part of their capital is “paid-in”, i.e., actually transferred to the institution, while the bulk is “callable”, i.e., committed but only payable in case of a call by the institution. For example, the Asian Infrastructure Investment Bank (AIIB) has $100 billion in authorised capital, $50 billion in subscribed capital, and $10 billion in paid-in capital; and the New Development (or BRICS) Bank has $50 billion in authorised capital and $10bn paid-in capital. The callable feature allows these institutions to lend much more than if they had to rely on paid-in capital alone in calculating their leverage.
The capital structure is important for the credit rating of the institution. Achieving and maintaining a high credit rating, AAA for the better institutions, is essential for the sustainability of their operations. They essentially finance themselves from the difference between their rating and the rating of the countries in which they operate. It is mainly this difference that allows the institution to cover its costs – its staff, the maintenance of its accumulated experience, the costs accrued due to the weaker local knowledge etc.
An institution’s rating is thus a function of, on one hand, the credit ratings and commitment of its shareholders, primarily its most important and highest-rated shareholders, and on the other, its balance sheet, profit and loss statement, and credit history. The latter is an issue for the new institutions. Establishing the highest credit ratings would normally take some time – understandably rating agencies would like to see some record of its activities.
The international debate tends to focus on the global financial institutions, but the fact is that despite a short resurgence in the global financial crisis they are becoming increasingly irrelevant. This is less true for the IMF which after a disastrous beginning managed to recover and in parts reinvent itself during the crisis, but it still faces existential issues in the places that will matter in 25 years, particularly in Asia. The World Bank expanded in the crisis but is now suffering the consequences of over-extension – on top of that it is in the middle of what looks like “institutional hara-kiri”. The Chinese government is looking at the global institutions with a combination of consternation and frustration, blaming at least in part their problems on the failure of the dominant shareholders to shift voting power in favour of China and other emerging economies.
The role of the global institutions has rapidly been overtaken by the regional financial institutions and, particularly, the mushrooming national development institutions. China has for several decades engaged with the regional institutions, most recently it joined the European Bank for Reconstruction and Development. As earlier in the African Development Bank and the Inter-American Development Bank China was content with a very small initial share, but it has then participated in successive capital increases to increase its share. It has also signalled that it is interested in pursuing various co-investment programs with EBRD like it has with AfDB and ADB.
What About The New Institutions?
The most conspicuous aspect of China’s global financial mobilisation is undoubtedly the launch of new multilateral institutions – the launch of AIIB in 2014 and the New Development Bank BRICS in 2015. The AIIB is clearly intended to show that China can initiate and successfully manage a state-of-the-art institution. As such AIIB is not moving the frontier of global institutions, but attempts to rectify some of the more absurd features of existing institutions like the resident boards and the restrictions on hiring to nationals of the shareholders of the institution. The NDB BRICS is still largely an unknown – it is less clear how it will operate and what it will do. (Its official website has two projects listed, both in Russia and both without total projects amounts unknown).
AIIB does, at least on paper, add to the financial capacity for infrastructure investment, and it has already announced its first investments, but it will take time before it reaches scale. The overall question is whether it will address the more binding constraints of identifying and structuring projects. It is still not clear to what extent the AIIB will add to the stock of project structuring capacity. In any case, AIIB has undoubtedly put competitive pressure on existing institutions, and it has clearly signalled that initially it wants to co-invest with them so as not to ruffle feathers, but also to learn and commit to certain standards on governance and the environment, where much of the scepticism has been about China’s intentions.
The economically and financially more important story is the rapid growth of China’s national development institutions. CITIC and China Development Bank both have balance sheets that surpass that of the World Bank, by a wide margin. Its main sovereign wealth funds, SAFE and CICC, have also rapidly expanded their portfolios in recent years. But probably the most consequential institutional development is the rapid launch of the $40bn Silk Road Fund whose investors include the China Investment Corporation (China’s sovereign wealth fund) and China’s two leading policy banks (the Export-Import Bank of China and the China Development Bank), but with the capacity to grow its investments more quickly. The Silk Road Fund has already announced large investments in Pakistan and signalled that it intends to develop a very large portfolio in the country. The first big project, a hydroelectric power plant, also shows how the Silk Road Fund invests both in the project itself and in the companies involved.
What Will Be The Impact?
China is already having and will have more impact on the international financial institutions, but in the end the effect is likely to be modest. The Chinese government is proceeding carefully so as to allow for meaningful learning and not ruffle feathers of incumbents. China has achieved some moderate changes in the governance of the existing institutions, most recently in the IMF, and it is expanding its activities involving the regional institutions. For example, in a very short space of time it has increased its engagement with the EBRD, exploring participation in equity and debt co-investment funds but also exploration of projects with Chinese companies. Yet, China’s role is likely to remain peripheral to EBRD and other regional institutions for the foreseeable future.
The establishment of AIIB clearly has shaken up existing institutions, but its capacity is not very large compared to the overall infrastructure needs or to China’s activity in this space. The new bank is also modest when seen against the rapidly expanding national development institutions in emerging economies more generally. The significance of AIIB and the New Development Bank is more about what it could represent in the future. China has sent a message to the dominant advanced economies – we can do it, and now that we have done it once, we can do it again. Ironically, Chinese policymakers may be more capable of forming such institutions than their advanced-economies counterparts. Getting them up and running takes a long time – often exceeding the time horizon of policymakers in democracies with frequent elections. The ten-year cycle of Chinese politics and the long-term perspective of its policymakers are likely to be more conducive.
The most important impact from the accelerated Chinese international financial mobilisation is likely to be on China itself. Chinese policymakers are learning quickly from its forays into the global financial architecture. Some feel that many of China’s investments in the developing world have not had the same economic, and political, returns once visualised. The record so far from investing in advanced economies is more encouraging, but China recognises that it still has a great deal to learn about how to select and structure projects before it can turn all the opportunities into economic successes. These insights will prove helpful as Chinese policymakers try to deal with mounting problems of excess manufacturing capacity and failed public-private partnerships in infrastructure, particularly at the local level.
More generally, China is learning to understand better the development process in other parts of the world . Through its deeper engagement with the international development institutions it may get a better sense of what has worked and what has not. This improved understanding of development is also likely to ‘spill over’ to domestic policies. If China can manage to integrate these lessons with its own successful development record to date, its international financial mobilisation will have an even more profound impact on global growth and development.
Featured Image: Chinese President Xi Jinping unveils a sculpture during the opening ceremony of the Asian Infrastructure Investment Bank (AIIB) in Beijing, China, January 16, 2016.
Photo Courtesy: REUTERS/Mark Schiefelbein/Pool
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About the Author
Professor Erik Berglof is Director of the Institute of Global Affairs at the London School of Economics and Political Science.
