Crises create winners and losers. The Asian Infrastructure Investment Bank (AIIB), Asia’s newest multilateral development bank (MDB), has the opportunity to emerge as a winner from the pandemic, but only if it adapts without overstretching.
China proposed the AIIB in 2015 as an alternative to traditionally Western-dominated development banks, particularly the World Bank (WB) and the Asian Development Bank (ADB). It promised a streamlined approval process, a rejection of loan conditionality, and greater control for emerging economies, whose past efforts for an enhanced voice in organizations like the WB have been stymied by the dominant U.S. and European shareholders. U.S. protests that the AIIB would serve as a tool of Chinese foreign policy failed to prevent a number of key traditional U.S. allies from joining the Bank, including Australia, South Korea, the United Kingdom, and Germany.
Now, during the global Covid-19 pandemic, the AIIB is on its way to proving itself as a vital regional lender: it has acquired several new borrowers, expanded its lending instruments, and lent several billion dollars already in emergency funding. However, for the institution to establish itself as a major player in the crowded field of multilateral lending, it also needs to ensure this new lending does not increase the credit risk of its portfolio as debt distress heightens in the wake of the pandemic. It also needs to ensure its new lending activities do not outstrip its institutional capacity. Finally, the pandemic once again raises the question of whether the distance between the AIIB and China is large enough for the skeptics.
ADAPTATION OR MISSION CREEP?
Developing country governments worldwide are borrowing extraordinary amounts to finance public health initiatives and economic stimulus plans to contain the fallout of Covid-19 The AIIB is a newcomer to the development finance landscape—unlike its counterparts in the region with decades of experience, the ADB and the WB, the AIIB only began lending in 2016. Hence, as the AIIB’s president, Jin Liqun, described, Covid-19 “... is a litmus test of [the AIIB’s] ability to deal with a crisis and emergency. This is the time for us to demonstrate our adaptability, resilience, responsiveness, and readiness.” From one perspective, the AIIB appears to have risen to the challenge. It has committed $10 billion toward its response to the pandemic through its newly-established Covid-19 Crisis Recovery Facility—almost as much as the 61 loans it approved during its first four years combined—of which 5.8 billion has already been allocated. (All data are based on AIIB lending through July 31, 2020.) These loans have come under the regular lending terms of the AIIB, which is 75 basis points on top of the six-month LIBOR, which is currently hovering around 0.3 percent, and the pre- and post-pandemic AIIB loans have roughly the same average maturity, 23 and 26 years respectively. Despite some differences, we find AIIB’s fixed spread loans and the International Bank for Reconstruction and Development (IBRD)’s flexible loans to have comparable terms, including similar front-end and commitment fees, but the AIIB has more standard interest rates and maturity premium across different borrowers, compared to the IBRD where rates vary more across countries.
Just as important as the growth of its total lending, however, is the growth of its scope. First, the Facility has attracted three first-time borrowers: Vietnam, Maldives, and Mongolia (see Maps 1 and 2). Additionally, whereas almost all of its past loans have gone to traditional, large infrastructure projects (energy transmission, communications, etc.), Covid-19 has prompted the AIIB to invest for the first time in “soft” infrastructure like health programming. The institution has also for the first time begun lending for members’ liquidity needs, such as through $500 million credit lines to Turkey’s two national development banks and approving policy-based loans in conjunction with the ADB and the World Bank, providing flexible funding for national governments. While these new areas of operations demonstrate adaptation to the needs of the AIIB’s borrowers during the pandemic, they also represent a substantial departure from the institution’s original mission of filling Asia’s infrastructure gap.
Maps 1 and 2: AIIB Lending Before and After Covid-19 Left: AIIB lending up to March 2020. Right: AIIB lending towards Covid-19 relief since March 2020. The AIIB has approved some non-Covid-19 loans during this later period; these are not shown. Circle areas indicate total amount of AIIB funding. Source: Authors’ own compilation.
The expansion in AIIB lending also reveals some of the institution’s limitations. The AIIB still lags behind the ADB, which has committed $20 billion in Covid-19 relief funding (with roughly $10 billion already approved), as well as the WB, which has approved $14.9 billion across the AIIB’s regional members. Additionally, almost all of the AIIB’s Covid-19 relief projects have been co-financed with these other institutions, which have typically taken on the bulk of the project preparation and oversight work—perhaps showing the limits of the AIIB’s conscious effort to stay “lean” and cost-effective with a slim bureaucracy. This uptick in co-financing reverses the institution’s recent trend toward greater independence (see Figure 1). While co-financing with the more established MDBs offers advantages—learning from expertise, boosting credibility, pooling resources for larger projects—it also means that the institution does not have full independence since it typically chooses to abide by other institutions’ lending frameworks in place of its own, as in the case of policy-based pandemic lending in conjunction with the WB and the ADB.
Figure 1: Proportion of AIIB Funding for Co-financed Projects Source: Authors’ own compilation.
Another issue with AIIB lending during Covid-19 is the creditworthiness of its portfolio. On the one hand, governments in the throes of severe human and economic crises badly need funds to save lives and revive economies. On the other hand, domestic and global economic recessions may make these governments, many of them already facing severe debt burdens, even less able to pay off their debts. MDBs must therefore tread a thin line, providing capital to those in need without saddling them with debt they will be unable to pay off.
This dilemma of responsible lending, which all MDBs confront to some extent, is particularly salient in the case of the AIIB. Its connection to China exposes it to additional scrutiny given the criticisms China itself has already faced for “predatory” bilateral lending to countries at high risk of debt distress—including major AIIB borrowers like Pakistan ($1.3 billion) and Sri Lanka ($280 million). Additionally, the AIIB’s pre-pandemic portfolio was somewhat riskier than that of the ADB’s. According to our analysis, its sovereign borrowers prior to the pandemic had a significantly lower average credit rating from Standard and Poor’s (S&P), Moody’s, and Fitch (see Figure 2). The AIIB portfolio also had a lower average credit rating from all three agencies than did World Bank projects in the region, although the difference was less dramatic. Furthermore, three borrowers from the AIIB (Laos, Tajikistan, and Maldives) are rated by the IMF as being at high risk of debt distress. Again, while this is not unique to the AIIB—ADB has also lent substantially to countries under high debt distress (e.g., Samoa, Tonga, and Tuvalu)—the institution nonetheless needs to make sure to distance itself from assertions that it is piling on the debt distress, all the while managing the credit risk in its portfolio.
Figure 2: S&P’s Sovereign Credit Ratings for AIIB and ADB Loans (2016 and March 2020) Source: Authors’ own compilation.
To its credit, the AIIB has already taken one step in the direction of addressing these concerns: the establishment of a special Covid-19 relief fund of $30 million to buy down the interest rate of loans extended under the facility for low income members that are eligible to borrow from the WB’s International Development Association (IDA). However, the amount dedicated to it is tiny; it merely repurposes the existing special fund utilized for project loan preparation, and it has not yet been utilized for pandemic-related lending, with existing loans being made largely under pre-pandemic terms. Given economic repercussions of the pandemic promise to linger in some AIIB members, the institution needs to consider a more robust special fund for low-income countries.
Another route for ensuring the sustainability of its portfolio would be for the AIIB to follow its counterparts and include conditionality on certain loans, allowing it to mitigate the risk of its resources being misused and increasing their chances of being repaid. This would be especially important in more open-ended budget support lending, as in its recent credit lines to Turkey. Conditionality would, however, present significant downsides: for many potential borrowers, the AIIB’s lack of conditionality and streamlined lending constitute its largest appeal. Conditionality would require a larger bureaucracy, in charge of closely monitoring loan arrangements, a slower process, and accusations of political favoritism in the choice of the conditions.
The pandemic is also a reminder of the delicate balance the AIIB has to find with respect to its sponsor, China. It cannot afford to lose the support of its founding leader, but it needs to avoid even appearing as a tool for Chinese interests. Although this is by no means a unique dilemma for the institution—it points to a perennial issue for great powers and their leadership in multilateral institutions—it does come at a time when Chinese foreign policy faces increasing international challenges, ranging from dimming relations with the U.S., to its border conflict with India, to broad protests to its military build-up in the South China Sea, and human rights violations in Xinjiang. These might make other countries more prone to suspicion of Chinese intentions.
To date, there is no “smoking gun” indicating illegitimate Chinese manipulation of AIIB lending. The Bank’s governance is modeled on other International Financial Institutions (IFIs), and former World Bank officials helped shape the institution at its birth. Furthermore, its executive roles (that is, vice presidents and higher) are held primarily by non-Chinese, with the exception of its president. The fact that India is both one of China’s greatest regional rivals and the Bank’s largest beneficiary (having borrowed $4.4 billion to date) provides at least anecdotal evidence that the Bank’s operations are seen as independent of self-serving Chinese foreign policy objectives.
Still, China does have numerous formal and informal routes to exercise influence over the institution, from its veto power to its outsized presence in the institution’s bureaucracy (a substantial plurality of non-vice-president leadership-level positions are held by Chinese nationals) to the AIIB’s location in Beijing (given that U.S. informal influence in the WB and IMF have been found to be aided by institutions headquartered in Washington, D.C.).
During the crisis, China was the first country to receive an AIIB Covid-19 relief loan – a full month before other countries. This could be justified on the grounds that Wuhan was the original epicenter of the pandemic, but China also benefitted from a uniquely generous loan agreement. Chinese authorities can retroactively reimburse up to 65 percent of the $355 million loan for costs incurred as far as 12 months before the loan’s signing, which significantly predates the known outbreak of the virus. While several countries were also given retroactive reimbursement (which was absent from the institution’s pre-Covid-19 loans), only one other country (Uzbekistan) could reimburse further back than January of 2020—and none could reimburse more than 40 percent of their given loan (this is based on our examination of available project documents; adequate documentation is not available for all Covid-19 loans).
Nor was this China’s first loan from the institution: it received two previous loans totaling $750 million. This borrowing comes at a time when the United States and Japan have been discouraging the MDBs they lead, the WB and the ADB, from lending to China, arguing it is not in the same category as other developing economies these MDBs are intended to serve. Indeed, China has the largest GDP, one of the highest GDP per capita, and the highest credit rating of the AIIB’s sovereign borrowers. This helps reduce the risk profile of the institution’s portfolio, since China is, to date, the only borrower from the AIIB with a higher than BBB sovereign credit rating. But it also raises questions about whether China has privileged access in using the AIIB to secure loans on favorable terms (and, potentially, with less administrative overhead). Whether the Chinese government itself is attempting to use its influence in the AIIB to seek its own benefit or if instead the AIIB leadership is pro-actively attempting to curry favor with its founder may be beside the point: as far as the AIIB’s legitimacy is concerned, the perception of Chinese influence, favoritism, or self-interested advantage may be just as important as actual Chinese influence.
The devastation wrought by the coronavirus pandemic in Asia presents the AIIB with both opportunities and risks. The institution’s response may determine its emerging role in development finance, for good or ill. The AIIB has responded quickly and substantially to the pressing needs of its members by expanding the scope of its lending (in terms of volume, countries, sectors, and modalities) and by partnering with other international financial institutions.
But each of these actions comes with risks: contributing to unsustainable debt; the diluting of the AIIB’s original mandate to focus on physical infrastructure investment; the sovereign complexities of policy loans and dependence on established IFIs, the shortcomings of which justified the founding of the AIIB; and perceived favoritism toward Beijing. AIIB management has a fine line to walk in perilous circumstances. How it navigates the current crisis may well determine its role in the global political economy for years to come.
Ayse Kaya is an associate professor and chair for political science at Swarthmore College and a visiting scholar (2019-2020) of Perry World House at the University of Pennsylvania. Christopher Kilby is a professor of economics at Villanova University. Jonathan Kay is the James C. Gaither Junior Fellow of the South Asia Program and Tata Chair for Strategic Affairs at Carnegie Endowment for International Peace