Potential Transformational Collaboration Between China and India through the AIIB

June 17, 2015International Organizationsby East Asia Forum

Infrastructure needs in China and India are daunting, but the AIIB can help.

In June 2015, negotiators concluded discussions in Singapore on draft Articles of Agreement of the nascent Asian Infrastructure Investment Bank (AIIB). India is a founding member of the AIIB and expects to have the second-largest shareholding after China. Global media attention has focused primarily on the challenge that the AIIB poses to the US-guided World Bank, and Japan-led Asian Development Bank (ADB), as well as the initially somewhat sour reception the AIIB has received from the US authorities. However, how will agreeing to be the second-largest shareholder in this venture impact India’s own economic and political interests? In addition, what are the risks?

The initial point of reference is inevitably the World Bank. For the benefit of non-specialist readers, it is perhaps worth noting that the ‘World Bank’ refers to a suite of linked but separate institutions. Of these, the International Bank for Reconstruction and Development (IBRD) is the original institution designed to support infrastructure investment at the end of World War II. The Articles of Agreement of the IBRD agreed to at the monetary conference in Bretton Woods, New Hampshire in December 1944 allowing the institution to begin functioning in 1945, 70 years ago.

The IBRD is today flanked by the International Finance Corporation (IFC), brought into being by the IBRD in 1956, and the International Development Association (IDA), which came into effect in 1960. Membership of the IBRD is a prerequisite for membership of either of these institutions, which although they differ in instruments from the IBRD are directed at the common purpose of sustainable and equitable economic development. The IFC lends to the private sector without requiring a sovereign guarantee from the host government, and therefore directly carries borrower credit risk on its books. It also largely has an independent staff from the IBRD. While IBRD and the IFC each fund their operations through bond, issues (supported by their pledged capital base) the IDA channels grant funds provided by its richer sovereign members for social sector projects in poor countries, using the staff of the IBRD.

While the US has of course been in the lead at the World Bank, India has played a significant role over these 70 years. India was present at Bretton Woods and became a key borrower once the IBRD shifted its attention from European reconstruction to the larger task of economic development. IDA was invented in part because India ceased to be credit-worthy for IBRD lending. And as the late John Briscoe noted about a decade ago, India is relatively unusual in its multi-dimensional involvement with the World Bank Group — as a founder, a major borrower, an influential board member and in the depth of its involvement at all levels in the staff of the World Bank. Therefore, there is a deep pool of tacit expertise on the details of development banking that India could be deployed in the AIIB, should there be the interest and appetite to do so.

As the new institution takes form, India’s interests can be partitioned into three spheres: political, financial, and intellectual. The political element has been central in the foundation of all multilateral development banks. The Cold War in Europe and the fear of communist insurgency in other parts of the world were dominant factors in setting up the ADB and the other regional development banks in the 1960s and 1970s, all the way until the European Bank for Reconstruction and Development (EBRD) was established in 1991.

Unlike Britain and the US (who jointly piloted the Bretton Woods conference), China and India have not been allies in war. Indeed, they have significant (if currently dormant) bilateral security issues. Moreover, there have been well-publicised diplomatic skirmishes between the two countries at the ADB. It is therefore bold, if risky, for India to partner with China in demonstrating its impatience with the governance deadlock in the established multilateral development banks.

The financial sphere (together with associated equipment procurement) has multiple dimensions. The IBRD was set up at a time when global capital markets had been destroyed by depression and war, and when infrastructure provision was seen as an essential state activity. In the intervening 70 years, global finance has gone from being underdeveloped to arguably hyper-developed, while the primacy of state monopolies in financing and operating infrastructure has come under scrutiny. These issues converge on the issue of the sovereign guarantee. From press reports, it is not clear whether the AIIB will model itself more along the lines of the IBRD, which by its articles insists on a guarantee by the host sovereign, or along the lines of the IFC and the EBRD, which do not.

This decision in turn will drive both the scale and the business model of the AIIB. In India, there is considerable disillusion with the promise of public–private partnerships even as fiscal space for public infrastructure remains constrained. The impact of flirting with public–private partnerships on the banking system has been near ruinous. Yet there is little confidence that the execution capabilities of the Indian public sector in infrastructure have improved significantly. Despite these misgivings, the AIIB would do best to dispense with the sovereign guarantee because this would permit greater flexibility in types of financing.

Finally, there is the potential intellectual role of the AIIB. The World Bank judges that its primary contribution to economic development is through the spread of best practice, and that its financing role is primarily a sweetener for the dissemination of standards and ideas. Given the scale of Asia’s infrastructure needs, no amount of funding by the AIIB will be material except in the smallest countries. Therefore, the most important long-term challenge facing the AIIB will be to fashion its own distinctive perspective on what works in fostering development. It is in this sphere that collaboration between China and India could be truly transformational.

Why the AIIB could work for India is republished with permission from East Asia Forum

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