Author: Andrew Elek, ANU

China’s president, Xi Jinping, announced the creation of an Asian Infrastructure Investment Bank (AIIB) just before the October 2013 APEC meeting in Bali. If the new bank is managed professionally to finance commercially viable investments in economic infrastructure, it can begin to correct a very significant failure of global financial markets.

At present, despite very low interest rates, as Mahendra Siregar says, huge gaps in infrastructure coexist with a comparably massive accumulation of savings and under-used global economic capacity. There is vast unmet demand for productive economic infrastructure, especially in the emerging economies of Asia. In 2011, the OECD estimated that global infrastructure requirements over the next two decades will cost around US$50 trillion. The Asian Development Bank (ADB) estimates that developing Asian economies need to invest US$8 trillion from 2010 to 2020, just to keep pace with expected infrastructure needs. The supply of savings, much of which is generated in Asia, is more than adequate to begin to fill some of the demand for infrastructure.

Yet it will not be easy to steer more savings towards infrastructure, either globally or in Asia. The investments needed are typically for public goods, which are large-scale, long term and illiquid, and present challenging cost-recovery problems. The constraints on investment, especially attracting private investment in infrastructure, include problems of project selection and preparation, implementation risks, the need to translate sound economic rates of return into financial returns, and intermediation challenges.

These formidable problems can be overcome if political leaders and international financial institutions are determined to do so, and APEC leaders are now committed to improving connectivity in the Asia Pacific. China certainly needs far better links to its neighbours: the supply of cheap factory labour from the countryside is drying up and labour costs are rising rapidly, creating an urgent need to re-orient supply chains. The opening of Myanmar makes it possible to meet this need and allow more economies at various stages of development to participate in international production networks in line with their evolving comparative advantage.

There is room for a new development bank, specialised in financing large-scale economic infrastructure on commercial terms, working alongside existing multilateral development banks, including the World Bank and the ADB. These well-established institutions have the expertise to lend a lot more for infrastructure, but have moved in a different direction. Net lending by multilateral development banks on commercial terms has been negative in five of the last ten years, including 2011 and 2012. The World Bank and the ADB are now focusing on concessional lending and knowledge sharing with low-income countries, leaving an important niche to be filled by a new financial institution.

Following China’s decision to set up the AIIB, consultations are likely to take place around the Asia Pacific, encouraging governments as well as private investors to become foundation shareholders. Potential investors in the AIIB will want to be assured that the management of the new bank will be of high quality, preferably selected on a competitive basis, and will be overseen by independent, commercially experienced directors. Sound procedures for project selection, designing financing plans and tendering for project implementation can be based on those developed by existing multilateral development banks.

It should also be possible to clarify that the AIIB will operate on commercial principles. Subsidising the capital costs of some infrastructure can be justified by externalities that are created, but these subsidies should be injected by the governments of the economies which expect to reap the benefits, not by the new bank. The world does not need yet another window for overseas development assistance.

If it is carefully set up and well managed, the AIIB should be able to attract shareholding from Asia Pacific governments committed to their new APEC Framework on Connectivity, as well as from some private sources. If APEC governments on both sides of the Pacific participate in the new infrastructure development bank, the AIIB could be transformed into an Asia Pacific Infrastructure Investment Bank, which could invest in projects to upgrade connectivity among all Asia Pacific economies.

The composition of foundation shareholders and the official launch of operations could be announced at the 2014 meeting of APEC leaders in China. Early initiatives could be to finance a high-quality APEC Master Plan on Connectivity and improved trade logistics in the region — for example by lending to improve some of the region’s ports and airports.

To have a significant impact on the need for economic infrastructure, the AIIB would have to expand as rapidly as it can acquire the necessary expertise. In time, its impact on the region could be greater than the ADB or the World Bank, depending on whether those institutions decide to rediscover their capacity to finance productive infrastructure on commercial terms. The AIIB will create new competition for the World Bank and the ADB, but the new bank will also have a strong incentive to cooperate with them. Tapping into the expertise of experienced development banks is the most efficient way, and perhaps the only way, to build the capacity of the new bank to assess and implement projects successfully.

Andrew Elek is Research Associate at the Crawford School of Public Policy, Australian National University. He was the inaugural Chair of APEC Senior Officials in 1989.

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The potential role of the Asian Infrastructure Investment Bank