Back in April, China was flying high. The stock market had reached dizzying heights on the back of an unprecedented surge in margin debt, creating billions in paper profits for millions of farmers and housewives turned day traders. Around the same time, Beijing had accidentally pulled off a major diplomatic coup. The China-led Asian Infrastructure Investment bank had just wrapped up a wildly successful membership drive after a surprise decision by the UK to back the new venture opened the floodgates and emboldened other US allies who, despite Washington’s best efforts to convince them otherwise, decided to join up.
The effort to recruit members was in fact so successful, that Beijing went out of its way to dispel the notion that the new bank represented an attempt on China’s part to usher in a new era of yuan hegemony and rewrite the rules of the post-War global economic order.
Despite the Politburo’s best efforts to toe the line between acknowledging the bank’s early success and unnerving Western members who, although happy to participate, are still acutely aware that a dying hegemon is still a hegemon and therefore would prefer it if Beijing didn’t rub the whole thing in Washington’s face, it was abundantly clear to everyone involved that the AIIB represented no less than a changing of the guard and a revolution against the US-dominated multilateral institutions that many emerging countries believe have failed to respond to seismic shifts in the global economy.
Unfortunately for China, the AIIB was forced to take a back seat in terms of media coverage to the country’s dramatic equity market meltdown and, subsequently, to the devaluation of the yuan which, you’re reminded, will play an outsized role in any financing extended by the new lender. But as the carnage in financial markets grabs the headlines, the AIIB is quietly making preparations to officially commence operations and as Reuters notes, China is set to “rewrite the unwritten rules of global development finance” by doing away with certain conditionalities required by Western multilateral lenders. Here’s Reuters with the story:
The Asian Infrastructure Investment Bank (AIIB) will require projects to be legally transparent and protect social and environmental interests, but will not ask borrowers to privatize or deregulate businesses for loans, four sources with knowledge of the matter said.
By not insisting on some free market economic policies recommended by the World Bank, the AIIB is likely to avoid criticism leveled against its rivals, who some say impose unreasonable demands on borrowers.
It could also help Beijing stamp its mark on a bank regarded by some in the government as a political as much as an economic project, and reflects scepticism in China about the virtues of free market policies advocated in the West.
"Privatization will not become a conditionality for loans," said a source familiar with internal AIIB discussions, but who declined to be named because he is not authorized to speak publicly on the matter.
"Deregulation is also not likely to be a condition," he added. "The AIIB will follow the local conditions of each country. It will not force others to do this and do that from the outside."
A reduced focus on the free market could give the AIIB greater freedom to run projects, said a banker at a development bank who declined to be named.
For example, development banks that finance a water treatment plant may require the price of treated water to be raised to recoup costs, even if local conditions are not conducive to higher prices.
The AIIB, on the other hand, could avoid hiking prices and rely instead on other sources of financing, such as government subsidies, to defray costs, he said.
A successful AIIB that sets itself apart from the World Bank would be a diplomatic triumph for China, which opposes a global financial order it says is dominated by the United States and under-represented by developing nations.
Criticism of international development lending is not new, said Susan Engel, a professor at Australia's University of Wollongong who has studied the impact on the World Bank of free market ideas often referred to as the Washington Consensus.
"It's a religion - this commitment to the involvement of the private sector even in sectors where, in fact, their involvement is shown to do harm," Engel said of the U.S.-based lender.
By not insisting on privatization for funds - which has recently manifested itself in the auctioning of Greek state assets in exchange for loans from Brussels and ultimately, from the IMF - the AIIB will give borrowers a choice, which will in turn allow them to select the financing option that they believe best fits their particular circumstances. This echoes comments made by Nomura's Rich Koo in July. Recall:
Until now the IMF was the only choice for countries in need of financial assistance, which meant they had no choice but to accept the economic and fiscal reforms it demanded.
But if the IMF has competition, countries in need of help will most likely shop around for the institution offering the easiest terms.
While that choice may, as Koo goes on to note, lead some countries to "delay necessary reforms," it may also allow everyone involved to avoid the type of mistakes that are inevitable when decisions are made unilaterally. That is, to the extent the IMF is fallible (and if they are anything, it's fallible), the existence of an alternative could prove invaluable in a crisis scenario. We go briefly back to Koo:
There is something to be said for the US argument that there should be only one refuge for economically troubled nations which takes responsibility for ensuring they carry out necessary reforms. However, that view is based on the underlying assumption that the US and the IMF will correctly diagnose the problems it encounters.
In reality, the US and the IMF completely misread the Asian currency crisis that began in 1997, and their errors caused tremendous damage to crisis-struck countries in the region.
The decision of many Asian countries to participate in the AIIB is probably due in part to a distrust of the US born during the currency crisis.
And with that, we will conclude with the following question: How ironic will it be when the first loans China makes through the AIIB are to the very same Asian countries who supported the new lender because of their negative experience with US-led institutions during the last Asian Financial Crisis, but whose descent into a replay of that crisis is the direct result of China's move to devlaue the yuan?