The World Bank Group Pivots to Private Sector Solutions

In April 2017 Jim Kim, the president of the World Bank Group (WBG), announced that the institution would become an “honest broker” focused on catalysing commercial capital for infrastructure development. This paradigm shift provides a new impetus for the redeployment of scarce public funds to leverage private investments, including in the poorest, riskiest countries. If realized, the WBG repositioning would mark a significant step in the current transition in development finance. It has the potential to transform the balance sheets of Multilateral Development Banks (MDBs) and to unlock infrastructure markets in developing countries.

What next

In the next few years, the WBG will aim to mainstream its mission as a “facilitator of capital” in addition to maintaining its historic function as a “provider of capital.” To this end, the WBG will scale up the preparation of bankable projects, deploy new facilities and instruments for private sector participation, and increase support for institutional, policy, and regulatory reforms in developing countries. These efforts will result in an evolution of WBG operations, rather than in the transformation of its model. They will facilitate private investments in frontier economies but nowhere near a level sufficient to bridge their infrastructure gaps.

Impacts

  • Scaled-up WBG operations in frontier economies will mobilize and catalyse more private investments, including in fragile and conflict-affected states
  • New WBG facilities and instruments will channel more capital from institutional investors to the infrastructure sector in developing economies
  • WBG repositioning may be emulated by regional development banks, thereby changing the landscape of development finance

Analysis

In 2015, the WBG estimated that $550 billion is invested in infrastructure in Emerging Market and Developing Economies (EMDEs) every year. Of this total 80% is financed by the public sector, 10% of which by Official Development Assistance. By contrast, basic infrastructure needs in these countries range from $850 billion to $2 trillion annually for the period 2017-2030, with an additional $1 trillion required to meet the Sustainable Development Goals.

The public sector faces tight fiscal constraints that make it unable to bridge this financing gap. In the meantime, institutional investors such as pension funds, insurance companies, and sovereign wealth funds hold an estimated $70 trillion in assets that on average yield low returns. The long-term, high-yield profile of infrastructure investments in EMDEs seems well-suited to their mandate. However, an unfavourable business environment and a dearth of bankable projects have prevented these investors from allocating significant resources to this sector.

Recent Initiatives

This situation has long been recognized by MDBs. Since 2011 and under the leadership of the G20 they have increased their efforts to address these bottlenecks.

Establishing project preparation facilities has been part of this agenda. For instance, in 2015 the WBG created the Global Infrastructure Facility (GIF), a $100m platform that helps governments prepare and structure complex public-private partnerships in infrastructure. During the 3-year pilot phase, the GIF aims to support 15 to 20 projects to be financed by institutional investors.

The MDBs have also scaled up pooled investment vehicles that channel third-party capital. For instance, the International Finance Corporation (IFC) – the WBG’s private sector arm – recently launched the Managed Co-Lending Portfolio Program that allows institutional investors to passively participate in IFC’s lending operations.

Standardization and Replication

In parallel, the WBG has developed standardized and replicable models for private participation that aim to reduce risks and transaction costs in order to achieve scale. For instance, in 2015 the IFC launched Scaling Solar, a one-stop-shop program for the development of private, grid-connected solar photovoltaic plants. Scaling Solar is based on standardized procurement, contracting, and financing documents in an effort to go beyond the traditional project-by-project approach.

Honest Broker

In the run-up to the 2017 Spring Meetings, WBG President Kim declared that the WBG would take a more systematic approach to leveraging commercial capital in the infrastructure sector. He pledged to turn the WBG into an “honest broker” that sits between commercial capital and potential investments in EMDEs.

If the ambition and the narrative are new, the idea of facilitating capital is not. The WBG, like other MDBs, already:

  • Mobilizes capital, by co-financing projects and providing guarantees and other instruments for risk mitigation; and
  • Catalyses additional capital, mainly by supporting institutional, policy, regulatory reforms to enable private participation.

This function complements the primary role of the WBG as a provider of capital.

However, President Kim’s statement of intent inverts this ontological hierarchy. By doing so, it heralds potentially far-reaching consequences for the operations of the WBG. This paradigm shift has already been translated into a new priority: de-risking markets and projects, with an emphasis on frontier economies, including fragile and conflict-affected countries.

When de-risking projects, the WBG will maintain a focus on additionality. Its intervention will aim to enable additional commercial capital – not to replace or compete with existing private solutions. This condition means that the WBG’s future operations will increase the flows of private investments into EMDEs, with limited market distortion effect.

Modus Operandi

The WBG repositioning will be operationalized by the “cascade,” a new modus operandi for the preparation of projects supported by the WBG. This set of guidelines will be first applied to infrastructure financing, and later extended to finance, education, health, and agribusiness.

When preparing a project, WBG staffers will have to consider private solutions first. If they are not feasible, they will have recourse to public options.

Project preparation will be carried out according to the following procedure:

Source: WBG, author

The WBG repositioning will be enabled by changes at several levels. Their scope and the pace of implementation will determine the impact of the WBG’s strategic shift on its model and on private investments in EMDEs.

Cultural Evolution

The “cascade” approach calls for a change of mindset and incentives for WBG staffers, who will have to think simultaneously like private investors and public reformers. It will also necessitate more collaboration between the WBG’s public and private sector windows, building on the “One World Bank Group” plan launched in 2013.

In addition, the WBG’s strategy to use public funds only as a last resort will require active cooperation with other MDBs and bilateral donors to avoid WBG operations being undercut. International financial institutions often compete to finance projects, especially those that could be financed commercially and that present an equivocal case in term of additionality.

Institutional Reforms

“3.0,” the IFC’s long-term strategy was endorsed in December 2016 and followed by an institutional reorganization. The new direction aims to adjust IFC’s business model to increase its capacity to leverage commercial capital in frontier economies.

Innovative Instruments

The WBG is expanding its suite of tools to de-risk markets and projects. In April 2017, the WBG established a $2.5bn Private Sector Window (PSW) with the International Development Association (IDA) – its concessional arm.

The PSW is composed of four facilities that provide and support project-based guarantees, currency risk-sharing, and blended finance, with a focus on infrastructures in frontier economies. This new window will allow IDA to support the operations of the IFC and the guarantee arm of the WBG by limiting their exposure and carrying part of the risks on its balance sheet. A pipeline of projects is currently under development.

The WBG is also working on other tools, such as indices and bonds, to support the development of infrastructure as an asset class.

Financing Capacity

The WBG repositioning, and the associated focus on frontier economies, will require stronger financial capacity. Extensive efficiency and leveraging measures have recently been implemented across the WBG.

Nonetheless, at the Annual Meetings in October 2017 the WBG will introduce a new package of proposals that is likely to include a strengthening of the equity base of the International Bank for Reconstruction and Development (IBRD) – its non-concessional public sector arm – and the IFC. However, there is very limited appetite among member countries for a general or selective capital increase, especially within the United States government.

 

This is an electronic, unedited version of an article published in the Oxford Analytica Daily Brief

China and the AIIB on the Belt and Road: Power Sans Control

As the Asian Infrastructure Investment Bank matures, it emancipates from its Chinese parent. But the multilateral development bank remains a key instrument of China’s foreign and development policy.

Eighteen months after starting operations, the Asian Infrastructure Investment Bank (AIIB) is still in infancy. But the newest multilateral development bank has already declared independence from its Chinese parent. Last week, at the AIIB’s second Annual Meetings, President Jin Liqun drove a wedge between his institution and China’s flagship foreign policy and development initiative. “There has been some confusion,” he said, about the relationship between AIIB and the Belt and Road Initiative (BRI – formerly known as ‘One Belt, One Road’). “We operate by our standards, by our governance. The Belt and Road is a marvelous program … but we have our standards”.

On the face of it, this statement is surprising. Both proposed by China in 2013, the AIIB and the BRI have in common not only a progenitor and a birthyear. They also share a same purpose: to improve infrastructure connectivity in Asia. In fact, the raison d’être of the AIIB is to implement the BRI’s hard infrastructure agenda.

By design, the BRI overwhelmingly relies on bilateral channels for its implementation. A large share of the financing for infrastructure projects indeed transits via China’s so-called ‘policy banks’ and ad hoc funds. Last month, at the first BRI summit, President Xi Jinping announced an additional $70 billion for the BRI infrastructure component to be delivered via such institutions, namely the China Development Bank, the EXIM Bank, and the Silk Road Fund. Although significant, China’s commitments pales in comparison to BRI’s total cost, estimated in the trillion of dollars. Well-aware of this shortfall and of the financial risks involved, the Chinese leadership has made mobilizing external resources a priority from the outset. The establishment of the AIIB, which leverages capital from its member countries to finance infrastructure projects, intervened in this context.

Four years later, the reality of the AIIB as a Chinese-made vehicle built to work in tandem with China’s bilateral institutions to implement China’s foreign policy and development initiative is in question. From a Chinese object, the AIIB has evolved to acquire a life of its own as a multilateral institution. This emancipation of the AIIB has consequences for its operations, and potentially for its mandate.

Into Bretton Woods

The choices on staffing, policies, and strategies that the AIIB made to date reveal an institution created much less in China’s image than in that of the traditional multilateral development banks.

Of course, the divergence of the AIIB from the Chinese model can be explained by its very nature. As a multilateral bank that borrows on international markets to finance its operations, the AIIB must abide by the standards and norms established by its Bretton Woods peers. However, another, unforeseen factor contributed to shaping the AIIB into an institution that is conceivably much different than the one China originally envisioned.

With 80 member countries so far, the AIIB’s attraction is as undisputed as it was unexpected. Paradoxically, this international success has come at a cost for China, which has been compelled to forge compromises on the AIIB’s governance and operational policies. For instance, the AIIB’s environmental and social framework and its new energy strategy bear the mark of the AIIB’s European members. They mirror the standards and rules adopted by the World Bank and the Asian Development Bank.  As more countries join in, China might also feel pressed to reduce its voting share, in effect relinquishing its veto power.

Power Sans Control

Even as China’s control over the AIIB is eroding, the multilateral development bank remains instrumental in the success of BRI – giving the Xi administration no reason to resist this evolution.

To be sure, the current balance of power within the AIIB still enables China to harness the financial firepower of the bank, whose formal mandate aligns with the BRI goals. Since it started operations, the AIIB has approved 16 projects for $2.5bn, most of which fall under the BRI umbrella. At capacity, the AIIB will have a portfolio exceeding $100 billion (and scalable to $250 billion), mostly focused on Asian infrastructures.

Furthermore, the multilateral setting enhances the inclusiveness and legitimacy of the AIIB, thereby allowing China to leverage the resources of participants that otherwise object to the BRI. India is a case in point. The country has long voiced its opposition to the BRI, citing the strategic implications of infrastructure development in the China-Pakistan Economic Corridor and in Pakistan-controlled Kashmir. At the same time, as a founding member and the host of the AIIB’s 2018 Annual Meetings, India has been an eager player in a collective institution that contributes to the BRI but steer clear of its most controversial activities. By statute, the AIIB cannot finance operations in disputed areas without the consent of all parties.

In this perspective, China’s dominance of the AIIB is at best expendable and at worst detrimental to the country’s foreign policy and development objectives under the BRI. At present, China can fully exploit the emerging division of labor between the AIIB and its bilateral institutions. Under this informal modus vivendi, multilateral capital would be applied to the infrastructure projects that present a sufficient case in terms of financial or economic viability, in line with the AIIB’s financial constraints. Chinese bilateral resources would be directed to the residual projects that find their core rationale in strategic objectives, such as dual-use infrastructures.

Out of Asia?

There remains however a distinct possibility that the AIIB will gradually spiral out of China’s orbit. Of the 23 countries that have joined the AIIB in 2017, 12 hail from outside the greater Asia region. As more non-regional, borrowing member countries join the AIIB, the multilateral development bank may shift the current focus on regional infrastructures to a more universal mandate, at the expense of the BRI. In such scenario, the AIIB and BRI would no longer align but merely intersect, leaving China to shoulder alone the burden of the Belt and Road.

Cooperation under the Belt and Road Initiative Will Increase

On May 14-15, China convened the first summit of the Belt and Road Initiative (BRI) – formerly known as One Belt, One Road. With this major diplomatic event, President Xi Jinping aimed to both showcase and buttress international support for his central foreign policy initiative, the success of which will hinge on the participation of other countries, regional organizations, and international financial institutions. Their contribution – or lack thereof – will affect the nature of BRI and determine the impact of the Chinese initiative on Asia’s infrastructure connectivity, economic system, and geopolitical order.

What next

BRI will remain a Chinese object, tied to China’s evolving economic and geopolitical ambitions. China will continue to provide the undisputed leadership and the bulk of the financing. But Xi Jinping will seek more followers, if not partners, to implement the initiative on which much of his domestic power depends. China will leverage their resources in projects, sectors, and regions where their positive-sum involvement will help China achieve its long-term goals under the BRI. In turn, China may make concessions on some contested issues, such as project standards and public debt sustainability.

Impacts

The cooperation between China and multilateral development banks may increase the number of BRI infrastructure projects with competitive procurement;

  • Plans for BRI’s corridors may be altered to accommodate competing visions for Asia’s connectivity, such as Russia’s;
  • BRI’s geographic boundaries may be expanded to include Latin America and the rest of Africa;
  • At its Annual Meetings in June, the Asian Infrastructure Investment Bank may more formally align its mandate with BRI’s.

 Analysis

The first Belt and Road Forum for International Cooperation was attended by 110 delegations, 29 national leaders, and the heads of the United Nations, the International Monetary Fund, and the World Bank. Their presence demonstrated the international support for President Xi Jinping’s main foreign policy initiative.

Institutionalization

China capitalized on this support to anchor the BRI in an embryonic set of dedicated structures. At the summit, Xi Jinping announced the establishment of an advisory council and of a liaison office for the summit’s follow-up activities, along with new cooperative mechanisms such as the Facilitating Center for Building the Belt and Road.

Since the launch of the initiative in 2013, China has used BRI as a narrative to guide and justify various domestic and foreign activities. Similarly, Chinese provinces and countries along the Belt and Road have used the BRI brand to obtain the backing of the Chinese government for various infrastructure projects.

The new institutions presumably represent a first step from the idea to the reality of BRI as a transformative initiative. They have the potential to empower it with the capacity to be additional – ie. to enable activities that would not have otherwise taken place.

The nascent framework will remain under the authority of China, which is also due to host the next BRI summit in 2019.

Made in China

Overall, the summit reiterated the China-centric model of BRI, which remains a physical and relationship network with China as its sole node. For instance, bilateral agreements represented most of the 76 items in the list of deliverables prepared by the Chinese delegation. Similarly, only China committed new financial resources for BRI, the bulk of which is to be delivered via bilateral channels.

They include:

  • RMB 100 billion ($14.5 billion) for the Silk Road Fund, the $40bn China-owned investment fund established in 2014;
  • RMB 250 billion ($36.2 billion) for China Development Bank, for the creation of multi-currency lending schemes for infrastructures and industries and multi-currency credit lines for foreign financial institutions;
  • RMB 130 billion ($18.8 billion) for China Export-Import Bank.

In a bilateral setting China can leverage its full weight to achieve its economic and strategic goals under the BRI. In particular, tied bilateral financing allows China to maintain control over project preparation and implementation, thereby favouring Chinese companies or undertaking projects, such as dual-use ones, that do not provide sufficient commercial returns.

However, a China-centric model is not sustainable if BRI is to be successful, as China does not have the capacity to implement it alone. First, Chinese resources are significant but limited. For instance, foreign exchange reserves have dropped to $3 trillion, from a peak of about $4 trillion in 2013. Second, the risks involved in the construction and operation of infrastructure projects in unstable regions are considerable. Facing possible sovereign defaults in other high-risk countries, China will want to limit its exposure. These challenges explain, in part, why according to a recent study by the American Enterprise Institute, China’s combined investments in all BRI countries since 2014 is smaller and growing more slowly than Chinese investments in the United States alone over the same period.

China is therefore facing a dilemma: maintain the current model, at the risk of the failure of the initiative; or, in a process similar to the establishment of the Asian Infrastructure Investment Bank, multilateralize BRI to leverage the resources of partners at the expense of China’s control.

China’s declarations at the BRI summit reflect this balancing act.

Internationalization

The recent name change to BRI epitomized China’s recent efforts to shift BRI’s narrative from that of a Chinese policy to a more inclusive Chinese-led international initiative.

China used the summit to push for an internationalization of BRI. Xi Jinping reiterated his proposition that the cooperation and coordination take place within the framework of existing regional organizations such as the Shanghai Cooperation Organization.

The summit also marked an effort to enrol new partners, from non-BRI countries to the private sector, to implement the initiative. The joint communique mentioned the importance of non-discriminatory procurement procedures and that of private participation in infrastructures.

Furthermore, China signed a memorandum of understanding with six traditional and non-traditional multilateral development banks. They pledged to collaborate on matters of common interest under the BRI, including via a new forum for financial cooperation. In parallel, the World Bank is establishing the Global Infrastructure Connectivity Alliance, a platform mandated by the G20 under Chinese presidency, whose mission will include mapping the BRI and sharing information on associated bankable projects.

China and the IMF will also set up a joint capacity development centre focused on the BRI countries. The involvement of international financial institutions will help improve the policy and regulatory environment and provide additional financing, thereby facilitating the implementation of BRI.

China’s effort to internationalize BRI is not open-ended, nor is it necessarily a step toward multilateralism.

New aspirations

China has also used the summit to expand the geographic and thematic realms of BRI. In the process, the BRI might grow to supersede, instead of merely complementing, existing mechanisms.

The summit further blurred the geographic boundaries of BRI. It opened the possibility of expanding BRI to the rest of Africa and to Latin America.

The summit also demonstrated the continued effort by China and bilateral partners to expand the use of the renminbi for trade settlements and for other cross-border financial transactions, at the expense of the dollar. The internationalization of the renminbi has the support of several BRI countries, including that of Russia following the imposition of international sanctions in 2014.

China reiterated the need for the development of hard infrastructure which had formed the core of the BRI. But at the summit it placed a greater emphasis on the soft infrastructure – customs clearance systems, quarantine processes, market access, trade barriers, and foreign investment procedures. This shift may signal a renewed effort by China to set the regional economic norms and standards, in part filling the vacuum created by the withdrawal of the United States from the Trans-Pacific Partnership.

 

This is an electronic, unedited version of an article published in the Oxford Analytica Daily Brief

The U.S. Development Policy Is at a Crossroads

The U.S. administration presented a budget request for FY2018 that contains measures that will have an impact U.S. development policy over the next four years. The recommended funding cuts in foreign assistance and the proposed elimination of agencies mark a break from the bi-partisan approach of the last decades and might signal a major shift in policy. A momentous change in the financing, institutions, and priorities of U.S. development assistance would have consequences for the development sector, U.S. foreign policy, and prosperity around the world.

What next

 The President’s “America First” budget reflects a bargaining position that will be examined and moderated by Congress later in the appropriation cycle. But it will pave the way for an evolution of the U.S. development policy according to two scenarios: in a “marginal reform” scenario, the bi-partisan approach will largely prevail and development agencies and programs will undergo limited adjustments in terms of budget, instruments and priorities; in a “major upheaval” scenario they will face large budget cuts, some might be phased-out and the rest repurposed.

Impacts

 The elimination of U.S. funding for bilateral and multilateral climate change programs will jeopardize the implementation of the 2015 Paris agreement;

  • Reduced U.S. assistance to low-income countries that the U.S. administration deems “non-strategic” might reverse development gains;
  • The removal of U.S. development agencies for exports and foreign investments would limit business opportunities for U.S. companies;
  • The use of development assistance for short-term foreign policy objectives and reversal from untied aid would weaken international cooperation on development;
  • S. opposition to the reforms of International Financial Institutions would accelerate the fragmentation of the Bretton Woods order.

Analysis

 In 2015, the U.S. provided $31bn in Official Development Assistance (ODA), which represents about 0.17% of GNI (for a United Nations target of 0.7%) and 0.8% of the federal budget. About 65% of U.S. ODA is untied, meaning that there is no condition that the funds be used to procure goods or services from the U.S.

More than 85% of U.S. ODA is provided bilaterally, via more than 20 agencies and bureaus. The rest consists of contributions to multilateral funds managed by development banks and UN organizations.

Graphic: U.S. Development Spending (Gross Disbursements, billion dollars); Source OECD

President’s Budget Request

On March 16, 2017, the White House initiated the budget process by presenting its blueprint for the fiscal year starting on October 1st. The document introduces some headline numbers for development spending and reveals some of the administration’s development priorities. But it does not provide a definitive outline of the forthcoming U.S. development policy.

The administration requested $25.6bn in base funding for the Department of State and the U.S. Agency for International Development (USAID), a 28.7% reduction from the previous year. It requested an additional $12bn (-37.4%) as part of the Overseas Contingency Operations, an extraordinary fund for emergency activities, mostly in Syria, Iraq, and Afghanistan.

The blueprint calls for the elimination of funding for the U.S. bilateral and multilateral climate change programs. It reduces funding for the UN and affiliated agencies and sets a 25% cap for U.S. contribution to total UN peacekeeping costs. It reduces funding for Multilateral Development Banks (MDBs) by $650m over three years compared to commitments by the previous administration.

The blueprint pledges to meet current bilateral and multilateral commitments for vaccination, HIV/AIDS, and malaria programs. It allows for “significant” funding for humanitarian assistance, including food aid, disaster, and refugee program funding.

The budget proposes to eliminate independent agencies, including the African Development Foundation, the U.S. Trade and Development Agency (USTDA), and the Overseas Private Investment Corporation (OPIC).

Other Developments

In January 2017, President Trump signed an Executive Order that, for the first time, named the USAID administrator as a regular member of the National Security Council’s deputies committee. With another, he reinstated and expanded the Mexico City Policy (the so-called “global gag rule”) that restricts organizations that condone abortion from receiving any U.S. health funding.

In March 2017, the administration also requested a review of all agencies and programs for the purpose of reorganizing the executive branch.

U.S. Congress

The consent of the Republican-controlled Congress will be necessary for the budgetary and institutional measures put forward by the administration to become effective. The authorization bills will establish, continue, or modify agencies and programs; the appropriation bills will provide funding for those that are authorized.

Congress is not likely to agree on the proposed cuts in development spending, as several prominent Republicans have already declared their firm opposition.

Policy Pathways

The government can act on three main levers to reorient the U.S. development policy: funding levels, aid allocation, and channels of delivery.

Development spending for FY2018 is likely to be reduced, though not by the extent proposed by the administration. The cuts will not be spread equally across agencies, programs and sectors.

The administration has proposed that U.S. foreign assistance be re-focused on international organizations that “advance U.S. foreign policy interests” and on countries of “greatest strategic importance”. Any significant shift in spending allocation would require approval from Congress, which segments the budget into country and program accounts. It would not take effect immediately, in part because some funds are disbursed as part of multiyear strategies that would be costly to terminate prematurely. The existing federal budget process would also not be suited to a development policy based on “deals,” whereby the amount of aid a recipient receive depends on its support for U.S. international policies.

The administration is likely to propose a reorganization of U.S. development institutions later this year. The President’s budget suggests that such a reform would not be driven by budgetary concerns only. OPIC, whose elimination is proposed, returns about $280m annually to the Treasury.

The administration’s current approach to development reflects the positions of some conservative lawmakers, for whom OPIC, USTDA, and Export-Import Bank distort markets. However, the elimination of the agencies that help American companies export and invest overseas would run counter to the administration’s trade policy.

On the contrary, the administration might seek to offset some of the impact of budget cuts by accelerating the shift from aid to development finance, whereby scarce public funds would be used to leverage commercial capital for development purposes. This strategy would elevate the agencies that support private sector investments such as OPIC and USTDA, while maintaining those that reward good governance and economic freedom, such as the Millennium Challenge Corporation (MCC). It would phase out the other grant-based agencies, such as USAID, or re-focus them on emergency response and humanitarian issues. This approach could be accompanied by measures to support U.S. companies, including a more systematic use of tied aid.

All development finance programs could also be consolidated in a new entity dedicated to the private sector. Alternatively, agencies and programs could also be merged in a single entity at the cabinet-level on the model of the UK’s Department for International Development.

Presidential initiatives

Congress has codified presidential initiatives such as Feed the Future and Power Africa, which leverage private investment with aid-based instruments across U.S. agencies. But their existence remains dependent on the U.S. agencies that implement them and on the White House staff that coordinate the overall approach.

Multilateral Organizations

In FY2016, the U.S. contributed $2.3bn to MDBs and $1.1bn to the UN system, with an additional $2.5bn for peacekeeping operations. A significant reduction in U.S. voluntary funding for multilateral organizations would be mostly borne:

  • by the climate funds, such as the Green Climate Fund ($3bn previously committed, with $250m disbursed),
  • by the UN specialized agencies that grant membership to the Palestinian Authority; and
  • to a lesser extent, by MDBs’ concessional arms such as the International Development Association (IDA) ($3.9bn previously committed over three years).

The administration might oppose future capital increases in MDBs and the International Monetary Fund and hinder reforms that would increase the influence of emerging countries. It might also exercise its voting power in these organizations to pursue foreign policy objectives, beyond the prohibitions already mandated by Congress.

 

This is an electronic, unedited version of an article published in the Oxford Analytica Daily Brief

The Impact of AIIB and NDB on Infrastructure Financing 

The advent of the Asian Infrastructure Investment Bank (AIIB) and of the New Development Bank (NDB) (or “BRICS Bank”) changed the landscape of international development. The new institutions have the potential to finance a significant share of infrastructure projects in Emerging Market and Developing Economies (EMDEs). They also have the potential to hasten the power transition from the United States and the West to China and the Rest. Their first year of operations offers insights on the extent to which they will be able to realize this potential.

What next

In the next few years, the AIIB and the NDB will have a small but growing ‘quantitative’ impact on infrastructure financing in EMDEs as they expand their portfolios of energy, transportation, and urban development projects, mostly in cooperation with other Multilateral Development Banks (MDBs). In the longer term, the AIIB is likely to have a bigger ‘qualitative’ impact, financing larger, riskier projects and investing in entire infrastructure networks. However, the AIIB and the NDB will reach financing capacity very gradually and most likely not before the second part of the next decade.

Impacts

  • The AIIB and the NDB will support the BRICS’ economic and foreign policy initiatives, such as ‘One Belt, One Road (OBOR)’;
  • The AIIB will help China diversify and increase the value of its international assets, including those of the Silk Road Fund;
  • The AIIB will open business opportunities for all infrastructure firms and the NDB will for BRICS-based companies;
  • Long-term investors will be able to access a wider range of bonds; some may be rated below AAA but will be higher yield;
  • The AIIB and the NDB will help achieve the 2030 Agenda for Sustainable Development and support global economic growth.

 Analysis

After one year of operation, the AIIB and the NDB remain in transition. Their membership, staffing, and operational priorities are developing.

The AIIB is in effect acting as a trust fund of traditional MDBs; the NDB as a credit cooperative for the BRICS. But the AIIB is on track to become an avatar of traditional MDBs, albeit one focused on infrastructure. The NDB is attempting an ambitious strategic shift towards the African continent.

 Composition and Governance

 

Financing capacity

Both the AIIB and the NDB have authorised capital of 100 billion dollars. All the AIIB capital is to be subscribed, with 20 billion dollars to be paid-in. Only 50% of the NDB capital is to be subscribed initially, with 10 billion dollars to be paid-in.

The outstanding operations of the MDBs financed on their own resources are capped at 100% of the (unimpaired) subscribed capital and reserves. The AIIB may decide to increase this limit to 250% of this total (China has a veto power). The equity operations of the AIIB are capped at the total (unimpaired) paid-in capital and reserves.

At full capacity, the infrastructure portfolios of the AIIB and the NDB can therefore exceed 100 billion dollars and 50 billion dollars respectively. The AIIB can increase this to more than 250 billion and the NDB to more than 100 billion.

A significant share of these operations will be financed by new money. China’s financial commitment to the AIIB does not come at the expense of its bilateral programs for infrastructure development.

These volumes of financing remain small compared to total needs. In 2015, the WBG estimated that financing requirements for basic infrastructure in EMDEs were 819 billion dollars per year until 2020 — 304 billion dollars in South Asia and 87 billion in East Asia Pacific (excluding China). Nonetheless, the AIIB and the NDB have the potential to provide a large share of MDB financing for infrastructure development.

Graphic: Financing Base and Total Lending Portfolio; Source: MDBs; All figures are in US$bn; *After OCR-ADF merger; ** As provided in Articles of Agreement

Ripple effect

Some of the impact of the new MDBs on infrastructure financing will be indirect. For instance, in 2016 Japan pledged to provide 200 billion dollars over five years via the ‘Expanded Partnership for Quality Infrastructure’, partly in response to the establishment of the AIIB.

Gradual deployment

The AIIB has committed 1.73 billion dollars for nine operations (nine more are under preparation); the NDB has committed 1.5 billion for seven operations (and intends to lend a further 2.5 billion this year). The pace of portfolio expansion will depend on three main factors:

  • Subscription payments, with the last installments due by 2020 (AIIB) and 2022 (NDB);
  • Recruitment process, with both institutions remaining understaffed (100 employees each; compared to more than 10,000 for the World Bank);
  • Capacity to generate projects, in particular with the provision of technical assistance, including via China’s 50 million dollar ‘Project Preparation fund’ for AIIB’s low-income members.

The AIIB and the NDB have relied on the support of other MDBs for project preparation. To date, 75% of the projects approved by the AIIB (and 100% of projects in the pipeline) are co-financed.

Operational scope and priorities

The geographic reach and sector coverage of the AIIB and the NDB are currently narrow but their scope is potentially very large.

Countries

The AIIB and the NDB can finance operations in all member countries regardless of their income levels. They can also invest in non-member countries (China at the AIIB and in most cases two founding members at the NDB can block such a decision).

But the MDBs’ 2016 documents, statements, and operations denote a focus on the sub-regions in which the main shareholders have the strongest interests. For the AIIB, they include countries along the OBOR axis. For the NDB, they include sub-Saharan Africa, where a first regional centre is being established.

Sectors

The AIIB’s and NDB’s Articles of Agreement provide for the financing of operations in ‘hard’ infrastructures as well as ‘productive sectors’ and ‘sustainable development’.

Their operational scope is currently more restricted, with an initial concentration on the energy sector. In 2016, energy operations represented 63% of the AIIB’s lending commitments and more than 55% of its project pipeline. The two other focus areas are transportation (25% commitments) and cities (12% commitments).

Energy strategy

The AIIB is preparing an energy strategy. The current draft builds on the international agenda. In particular, it mirrors the restrictions that the World Bank placed on operations in support of nuclear energy and, to some extent, of oil- and coal-fired plants.

The AIIB’s energy priorities are:

  • Rehabilitation and upgrade of existing generation stock and of power and gas networks;
  • ‘Low-risk’ greenfield power transmission and distribution projects;
  • Hydropower generation and non-conventional renewable energy (NCRE);
  • Gas-fired generation and related infrastructure.

The strategy provides for a significant share of operations, mostly demand-side energy efficiency and NCRE projects, to be co-financed with other MDBs.

Financing channels, policies and instruments

The AIIB’s financing practices compare with those of other MDBs. The NDB’s reflect the bilateral practices of the BRICS.

The AIIB’s and the NDB’s preferred instruments are loans, guarantees, and equity.

Standards

Both rely on the policies of member countries for the management of environmental and social (E&S) risks. Although less stringent than other MDBs, this approach converges with the World Bank’s new E&S framework.

Their procurement policies diverge though. The NDB’s restrict the procurement of goods and services to member countries only. The AIIB’s places no geographical restriction — and as such is more open than other MDBs’.

Partnerships

The AIIB and the NDB have engaged in collaboration with traditional MDBs for staff exchange and project co-financing, including the World Bank and the Asian Development Bank.

The NDB is also developing co-financing frameworks with the BRICS’ national development banks and financial intermediaries such as Industrial Credit and Investment Corporation of India, China Construction Bank Corporation, and Standard Bank of South Africa.

 

This is an electronic, unedited version of an article published in the Oxford Analytica Daily Brief