Tuesday, 11 August 2015

Yuan Devaluation Signals Current Slump and Future Growth

On 11 August 2015, the People Bank of China weakened the yuan by almost 2 percent. The central bank’s move pushed the yuan´s “daily fix” to 6.2298 against the dollar, and that move was its biggest one-day change since China had loosened (somewhat) its dollar peg in June 2010. Financial market observers immediately jumped to two ´conclusions´:
·         While China´s central bank paid lip service to a more flexible exchange rate regime, it really signaled panic about China´s slowing growth;
·         The devaluation wasn´t a one-time shot but the likely entry to a prolonged period of engineering the yuan down to increase external competitiveness.
Consequently, all China-sensitive asset prices – such as oil, copper, shares of luxury brands and cars and emerging-market currencies – dived below their already depressed levels upon the devaluation news.
I will make the point that the market reaction and commentary is myopic: Even if the devaluation signals concerns about current growth, correcting the yuan´s accumulated overvaluation will be good for China´s growth, emerging countries´ growth as well as commodity and luxury exports.

Table 1: Yuan BIS Effective Exchange Rate, 01/2010 – 06/2015
2010 = 100

Some may still doubt that the yuan is overvalued. The evidence points to the contrary, though. According to the broad measure of BIS effective (trade weighted) exchange rate, the yuan has appreciated by some 30% over the past five years (Table 1). According to the Barclays behavioural equilibrium exchange rate model, the yuan remains the second-most overvalued currency in the world, by more than 20%[1]. The dollar’s recent ascent has pulled the yuan away from other currencies, leaving it increasingly overvalued, as the yen has stayed on a soft peg to the dollar. And even the Peterson Institute, traditionally the US Treasury´s ventriloquist to accuse China of unfair exchange-rate protection, has recently calmed down by gauging China´s so-called fundamental equilibrium exchange rate as ´correctly´ valued[2], at round 6 yuan per dollar. A further indication of yuan overvaluation is that the market and Chinese corporates had been expecting a yuan depreciation going forward: Onshore FX deposits surged in 2014, largely due to corporates holding more of their export proceeds in foreign currencies. Outflows recorded under the currency-and-deposits component of the balance of payments had also picked up, and forwards had been pricing in sizeable depreciation of the yuan versus the dollar.
Applying Dani Rodrik´s (2010) estimates[3] that a 10% nominal effective appreciation of the yuan would bring down China´s annual per capita growth by 0.86%, the 30% appreciation accumulated over the past five years may have chipped away some, 2.5% from China´s growth rate. This reduction in China’s growth has translated into a drop of GDP growth in poor countries (based on our former growth sensitivity estimates of 0.34 per cent)[4] by one percentage point of annual per capita income growth. The growth link between China and the emerging markets was even higher, with one percentage point of growth translating into 0.66% growth. These macroeconomic mechanics of growth can constitute a certain degree of growth optimism for China, the emerging countries, commodity prices, and world trade if China´s two percent devaluation in August is followed upon by the People´s Bank of China.

[2] William R. Cline (2014), Estimates of Fundamental Equilibrium Exchange Rates, November 2014, Policy Brief PB 14-25, November.
[3] Dani Rodrik (2010), ‘Making Room for China in the World Economy’, American Economic Review, Papers and Proceedings. Available at: http://pubs.aeaweb.org/doi/pdfplus/10.1257/ aer.100.2.89
[4] Garroway et al. (2012), ´The Renminbi and Poor Country Growth, The World Economy,
doi: 10.1111/j.1467-9701.2011.01408.x

Thursday, 30 July 2015

China Growth Proxies: Aussie, Copper and VW

China´s nominal GDP growth has declined from a post-crisis (2009) level of close to 20% yoy to the recent low of 5.8% yoy in early 2015, according to the last CICC Macro Thematic Report. The government targets almost 10% nominal GDP growth, with 7% real annual growth. By contrast, a soft purchasing manager index (PMI) and another equity sell-off have reinforced fears of Chinese growth slowing down. The flash Caixin/Markit PMI released last week showed China's factory activity contracted by the most in 15 months in July; however, the official PMI stood at 50.2 in July, on par with the previous month's reading, according to the median forecast of 20 economists in Reuters poll.

Figure 1: China Growth, yoy, 2006-2015

What have the Australian dollar, copper futures and Volkswagen share prices in common? China. China´s linkage with the world economy is most directly read via demand-driven industrial commodities (copper, iron ore), market-determined China dependent currencies (such as the Australian dollar) and industrial goods that the Chinese like to and can increasingly afford (such as VW´s Audi cars). These asset prices can be taken as proxies for China´s growth.
China these days demands more industrial metals than the rest of the world combined. China´s industrialization and urbanization had created a super cycle in metal prices; with the new emphasis on consumption and services, this super cycle has probably ended. Still, short-term assessments about China´s growth prospects move copper futures and options contracts.
The Australian dollar (like the New Zealand dollar) is a flexible market determined currency, which has a high (ca 50%) beta to the renminbi (RMB). Several emerging-country currencies (which as a group had a 15-year low this week) will have even higher RMB betas; but their central banks intervene quite heavily on the FX markets.

Figure 2: Austral-Asian RMB Betas

Volkswagen depends on China for more than half its net profit and 71 percent of its free cash flow including income from joint ventures and royalties, according to auto industry analysts. Growing uncertainty over China has finally been weighing on Volkswagen shares. Half-year results show that weaker demand in the world’s biggest car market is already slowing the 89 bln euro giant.
If you believe (and many economists still do) that asset prices are leading indicators, a select narrow group of assets would provide information on China´s immediate growth prospects – the Australian dollar, copper futures, and, e.g., the VW share prices. If you think, instead, that China will defend its 7% growth target and soon start an upswing, you can consider the three assets as a great buying opportunity (and their prices as lagging indicators). Aussie, copper prices and VW shares are now caught in a nice solid downward channel.

Figure 3: Dr. Copper, 2011-2015

Figure 4: Australian/US Dollar, 2011-2015

Figure 5: Volkswagen Vz, 2015

Official Chinese macro data are routinely met with suspicion, especially by those foreign observers who think that government legitimacy is only supported by high growth and rising consumer wealth. Actually, sentiment about domestic economic conditions is nowhere in the world better than in China where 90% of the population consider the current economic condition as good, according to the Spring 2015 Global Attitudes survey released by the Pew Research Center. Although Pew Reseach doesn´t ask the Chinese about political (dis)satisfaction, the correlation between economic and political satisfaction is high; and political satisfaction nowhere higher than in Asia[1].
It would seem then that domestic assessments of China´s growth prospects are more upbeat than foreign (media, investors). To be sure, the foreign impact of China will morph as the People Bank of China is envisaging a wider trading band for the RMB, likely anticipating competitive depreciation as early as August. Historically, China has been very efficient to translate RMB depreciation into higher growth[2]

Time to go long Aussie, copper and VW?

[1] http://www.pewglobal.org/2015/07/23/global-publics-economic-conditions-are-bad/
[2] Rodrik, D (2008), “The Real Exchange Rate and Economic Growth”, Brookings Papers on Economic Activity, Vol. 2.

Monday, 22 June 2015

Addis and Multilateral Concessional Finance

The UN Conference on Financing for Development in Addis Abeba in July 2015 will pave the way for the implementation of the post-2015 development agenda. The GDI Briefing Paper series „Financing Global Development“ analyses key financial and non-financial means of implementation for the new Sustainable Development Goals (SDGs) and discusses building blocks of a new framework for development finance. Chris Garroway and Helmut Reisen will warn in their GDI Briefing Paper: Beware of "end poverty" euphoria and of trigger-happy reform of multilateral concessional finance.
The shrinking client base of concessional finance
The post-2015 agenda offers a transformative vision for ending extreme poverty by 2030 and shifting the world to a carbon-free growth path. Some of the institutions best equipped to finance this agenda, however, face pressure to downsize as borrower countries lose eligibility for concessional finance, as they surpass income per capita and creditworthiness eligibility criteria.
India, for example, is the largest World Bank borrower by volume, and recently became a middle-income country, with income per capita above the threshold for concessional finance eligibility. Other large, fast growing middle-income countries, including Vietnam and Nigeria, are already “blend” countries, receiving a mix of both highly concessional credits from the World Bank’s soft window, the International Development Association (IDA), as well as less concessional hard loans from the World Bank’s lending arm for credit-worthy countries.
The graduation from concessional finance of large middle-income countries raises a range of conceptual, political and operational issues for multilateral donors. On the conceptual side, the nature of global responsibility towards poor people living in non-poor countries – particularly those that have only just become non-poor – may conflict with political considerations against providing concessional finance to countries that have accumulated high reserves and are turning into emerging donor countries themselves. This raises questions about the future roles, mandates and instruments of IDA, but also African Development Bank (AfDB), Asian Development Bank (ADB) and their respective soft windows (which in the case of ADB is already in the process of being dissolved and merged with ADB's "ordinary capital resources"), as well as the International Monetary Fund (IMF) concessional instruments.
Prudence suggests approaching reform of the concessional windows with a precautionary, rather than deterministic, perspective to enable flexible institutional response. That perspective should not only consider future graduation prospects, but also prospects for reverse graduation, e.g., due to disasters, military conflict and governance failures.
Shareholders should not let multilateral soft windows blindly continue business as usual, but also must not allow them to ignore the option value of preserving their financial and institutional strength by “declaring success” and letting them shrink. 
The changing geography of poverty
The geographic distribution of people living in extreme poverty is changing due to the recent period of high growth. A number of the largest, faster growing countries continue to have sizable populations living in extreme poverty. In fact, three-quarters of the world’s extreme poor today live in countries classified as middle-income countries (MICs), which have limited access to soft finance. Only one-quarter of the world’s extreme poor live in the remaining 35 low-income countries (LICs).  Some believe that this will be a transitory phenomenon and that by 2025 poverty will become concentrated in fragile and conflict affected states. Others argue that a sizable share of world poverty could remain in stable MICs, or be concentrated in fragile MICs, e.g., such as Pakistan and Nigeria.
Many donors consider that middle-income country status itself is a reason to be reducing or even ending aid. The belief is that it is an affront to middle-income countries for donors to get too involved in their own internal policies, with the justification that distributional issues are fundamentally domestic in nature. A major political decision facing the international finance institution (IFI) shareholders is therefore whether the international aid community should target poor countries or poor people.
Medium-term poverty reduction scenarios published by the World Bank and others in recent years show that ending extreme poverty by 2030 is possible. The ambition required shouldn’t be underestimated, however. The release of the 2011 purchasing power parity (PPP) exchange rates estimated by the International Comparison Program also has prompted unsubstantiated claims that ending poverty may be easily accomplished, due to much lower price levels in developing countries than previously thought. This end-poverty euphoria and optimism is well intentioned, but misplaced. Jumping to conclusions about global poverty based on the new 2011 PPPs is unwarranted and potentially misleading. Leaving aside whether or not the new PPPs are appropriate for measuring poverty, using new PPPs will require re-calculating the poverty line itself to ensure it is the average of national poverty lines used in the poorest countries. The most thorough attempt to do this so far suggests a new global poverty line of $1.82 in 2011 PPPs, at which the world is still as poor as we thought, and ending poverty remains as ambitious (Prydz and Joliffe, 2015).
Regardless which PPPs are used, slow growth over the medium-term is the principal reason why ending poverty by 2030 remains highly ambitious. This is also why the high concentration of extreme poverty in middle-income countries is unlikely to be transitory. A study we conducted for BMZ (Garroway and Reisen, 2014) forecasts growth to 2025, measuring the impact on extreme poverty and on concessional finance graduation. Our main result: more than half a billion people will still live in extreme poverty in 2025, the majority in MICs ineligible for concessional finance.

Redefining eligibility criteria
At present, the multilateral soft-finance windows are all pegged to the IDA “operational cutoff”, which refers to eligibility ceiling defined by a specific level of GNI per capita (US$1,195 for FY13). This has been a malleable yardstick in the past; IDA eligibility was initially based on the “historical cutoff” (US$ 1,945 for FY13). High demand for limited IDA resources led shareholders to lower the cutoff in the early 1980s. Most observers agree that the cut-off itself is arbitrary and doesn’t reflect a salient distinction between countries at different levels of development.
There are possible avenues for redefining the present operational cutoff. IDA itself has suggested looking at other criteria beyond income per capita. Possible complements could be the UNDP Human Development Index, the UN Economic Vulnerability Index, or a similar index. Another approach would be to re-instate the original “historical” cutoff. The simple but elegant solution is not only justified by the historical precedent, but also finds support in the ultimate stated objective of concessional windows to provide a durable way out of dependence on external resources for development finance needs. Our BMZ study (Garroway and Reisen, 2014) point to the empirical fact that few countries with income per capita below $2000 have non-poor populations that can afford redistribution at the national level to cover the poverty gap. This capacity for redistribution – proposed by Ravallion (2010) – is measured by the marginal tax rate on the non-poor population necessary to close the poverty gap. It is an independent, highly relevant justification for raising the IDA operational cutoff back to its historical level.
Smoothening transition periods
The multilateral concessional windows can also soften the transition from soft financing by making “blend” status a more explicit step in graduation. Smoothing already happens in practice through the use of blended and hardened terms, but it is not part of an explicit phased and transparent approach. A widened transitional window for concessional resources could be made available to countries whose incomes fall between the current threshold and a higher threshold, perhaps the historical cutoff. Again this finds justification in the finding that roughly $2,000 per capita serves as dividing line between countries that can feasibly reduce poverty through redistribution and those that would face prohibitively high tax rates on the domestic non-poor.
IDA itself has proposed three criteria for access to transitional support: (a) GNI per capita below the historical threshold; (b) a significant poverty agenda, as measured by poverty levels and other social indicators; and (c) a significant prospective reduction in available financing after graduation. Such support could be made available for new graduates that meet these three criteria and would help smooth the transition of graduating countries. Given the eventual objectives of mobilizing domestic finance adequately, allocation under the transitional window might also be earmarked toward public spending for social inclusion and redistribution as well as improved fiscal federalism, i.e. through higher fiscal transfers from rich to poor states.
Strengthening sub-sovereign allocations
IFIs could also increase direct funding in grants or credits to local governments or even nongovernmental organizations in regions with per capita incomes below country-level eligibility thresholds, even if the country’s average income level is above the threshold. Apart from the rural-urban inequality in populous large emerging countries, such as Brazil, China, India or Indonesia, new threats like disaster-related impoverishment also have distinct within-country geography. Again, like the earmarking of transitional resources, the sub-sovereign allocations could also be aimed at cooperation on inclusive policy processes such as budget allocations, and sustainable urbanization to improve prospects for more inclusive development. Some MIC governments might interpret such cooperation as excessive interference into domestic political processes. But such concerns might be less for multilateral rather than bilateral donors. Within the multilaterals space this type of cooperation is well-suited for agencies where MICs have more voice in governance.
It also may be worthwhile to explore to what extent the European Union (EU) experience can inform multilateral concessional lending. EU Structural Funds and the Cohesion Fund are financial instruments of EU regional policy, intended to narrow disparities among regions and Member States. Since 2000, more than €500 billion in Structural Funds, mostly via the European Regional Development Fund, have been channeled to local projects in EU countries via national intermediary institutions.
Opening the soft windows for global public goods
Another major political decision relates to the role of multilateral concessional finance in provisioning global public goods, especially related to climate change adaptation and disaster management. An important side effect of mainstreaming climate change into development cooperation will be the need for multilateral donors to integrate vulnerability to environmental and global risks into their allocation criteria of concessional flows. An alternative to withdrawing concessional finance from MICs would be using the soft windows to co-finance regional and global public goods. The mandate of the soft windows could be adapted to focus explicitly on infrastructure with upfront cost but long-term developmental benefits as a way to help sustain global economic growth and human welfare. Tracer sectors could be climate change adaptation and disaster risk prevention and management.
Indeed eleven of the prospective 2025 IDA graduates we identified in our BMZ study already have greater than $US 100 million prospective annual disaster damage costs (Garroway and Reisen, 2014). Asian MICs, India and Bangladesh, top the list. Disaster risk management should be integrated with poverty eradication efforts; otherwise, ending poverty may not be within reach. The soft windows could thus contribute to the SDG-agenda while maintaining their anti-poverty mandate.
The option value of waiting on soft window reform
The option value of preserving the concessional windows is considerable in a world with global governance failures that prevent first-best policy solutions. The provision of global public goods requires the institutional infrastructure that these windows can deliver. Shrinking the soft finance windows prematurely would mean losing the considerable option value of waiting. It implies losing effective ļ¬nancial and technical services and know-how on a scale and with a quality that matter globally or regionally. It would also forego network externalities that represent a valuable global asset. Shrinking the multilateral soft windows would also imply – for better or for worse – that MICs would also need to speed up the establishment of new development banks, such as New Development (‘BRICS’) Bank and Asian Infrastructure Investment Bank, without benefiting from knowledge and ´certification value´ that existing concessional windows have acquired already (Reisen, 2015).

Garroway C. and Reisen, H. 2014. The Future of Multilateral Concessional Finance. Deutsche Gesellschaft fuer Internationale Zusammenarbeit (GIZ) GmbH.
Jolliffe, D. and Prydz, E., 2015. "Global poverty goals and prices : how purchasing power parity matters," Policy Research Working Paper Series 7256, The World Bank.
Ravallion, M. 2010. "Do Poorer Countries Have Less Capacity for Redistribution?," Journal of Globalization and Development, De Gruyter, vol. 1(2), pages 1-31, December.
Reisen, H. 2015. “Will the AIIB and the NDB Help Reform Multilateral Development Banking?”, Global Policy Journal, Wiley.


Wednesday, 20 May 2015

Li goes LAC: China´s Latin Role

China´s Premier Li Keqiang has just started his tour through Latin America (shorthand LAC, to include the Carribean), with promise of US$ 50 billion in infrastructure investment. LAC pins high hopes on broader and stronger China engagement on the continent. After a great first decade this century, the region is not doing well, give and take some cross-country differences in economic performance. But while China´s Latin role is definitely rising, it is likely to remain relatively limited, I will argue here.
LAC is already highly exposed to China: The cooling of China’s economy, a major driver of global growth, has sparked a commodities glut that has left LAC exporters of soybeans, crude oil, iron ore and copper with lower prices and export receipts. LAC growth has become increasingly China-centric over the 2000s[1]. But beyond the simple mechanics of growth linkages, the impact of China´s ongoing rebalancing away from hard equipment investment could be as significant as the impact of its growth moderation for many economies in Latin America that are materially reliant on commodities exports for growth.
A growth model that is dependent on investment is also commodity-dependent (or at least biased towards the use of industrial and energy commodities such as copper, oil and iron ore), while a consumption-led growth model would be less commodity-intensive. The rating industry has taken note of LAC vulnerabilities caused by China growth dependence: “The LatAm sovereigns that are more exposed to a slowdown in China … are Chile (Aa3 stable), Venezuela (Caa3 stable), Peru (A3 stable), Uruguay (Baa2 stable) and Brazil (Baa2 negative)”.[2] In 2013, Chile´s exports to China for instance totaled 7.4% of its GDP, mostly copper. Between early 2012 and early 2015, the copper price dropped by half as China´s investment led growth started to slow. The corresponding income effect of lower terms of trade must have been very strong indeed. Chile´s annual income windfall over the past 40 years, almost two percent of GDP[3], has turned into heavy losses until recently when copper prices have started to climb back up. Brazil government finances, with its economy contracting by about 1% this year, felt forced to cut funding to national development bank BNDES, a traditional source of cheap financing for infrastructure projects.
With government finances running dry, LAC is therefore trying hard to woo Chinese investment. Deep Chinese pockets are projected to cut transport channels from the Atlantic to the Pacific oceans. Infrastructure investments, such as a rail link from Brazil to Peru´s Pacific Coast, are required to lower transportation cost in view of higher LAC-China trade ($240bn in 2014). A Nicaragua-crossing interoceanic canal is being estimated to trigger $50bn of Chinese investment to Central America. Trade links are also important beyond raw materials as LAC is interested in pushing manufactured and services (tourism) exports to China. China has now surpassed the US as Brazil´s biggest trade partner, and hopes are for diversification and value-added enhancement.
Meanwhile, China has to deploy excess savings and to employ excess Chinese infrastructure-building capacities.  That is why China is wooing mining concessions in LAC. In a broader global context, China has experienced a diplomatic transformation. Chinese diplomacy has evolved from “keeping a low profile” to “proactive and enterprising”. China’s “One Belt, One Road” (OBOR) strategy and her 21st Century Maritime Silk Road target developing countries. After Asia and Africa, it is now LAC´s turn.  Geopolitics comes in via intensified travel diplomacy (Xi Jinping 2014 in Argentina, Brazil, Cuba and Venezuela, now Li Keqiang in Brazil (again), and also Chile, Colombia and Peru; summitry (e.g., CELAC-China ministerial early 2015 in Beijing; BRICS summits) and cooperation plans such as the China-LAC cooperation plan 2015-19. China is opening scholarships and training opportunities (both 6000) to LAC. For some countries (Venezuela, Ecuador, Argentina), China has assumed lender-of-last-resort functions.

Despite big announcements and high hopes, however, China´s Latin role will is likely to remain limited compared to Asia and Africa. Here are some barriers to China´s engagement:
·         China is growing increasingly worried about the model of lending secured against commodities. Last year, Chinese loans to Latin America reached $22 billion, surpassing the combined lending of long-established institutions such as the World Bank and the Inter-American Development Bank, according to estimates from the Inter-American Dialogue. But default concerns have been creeping in. Venezuela, for instance, has borrowed more than $56bn from China, mostly from the China Development Bank, but a steep drop in crude prices has added to stress on its already ailing economy. Argentina´s government, facing severe dollar shortages and a protracted legal dispute with U.S. creditors, has repeatedly turned to Chinese credit to bolster depleted foreign currency reserves. Growing concerns over its financial exposure to socialist-leaning South American partners such as Venezuela and Argentina are pushing for diversification of Chinese finance in the region[4].
·         LAC is traditionally part of US sphere, and that will well limit China-LAC ties. A Chinese perspective The Diplomat, 31-03-2015: “Culturally, Latin America has been part of Western civilization. Geographically, it borders the U.S., thus the regional economies are closely tied to the United States’. Some Latin American countries rely on the U.S. for security or are deeply influenced by the U.S. Meanwhile, the U.S. considers Latin America as its “backyard” and has a great impact on, or even dominates, some Latin American countries’ domestic and foreign affairs. U.S. influence is wielded through the Organization of American States (OAS), the Inter-American Development Bank, bilateral economic cooperation and assistance, multinational corporations, military aid, and even military intervention. When it comes to Latin America and the Caribbean, U.S. tolerance for China to expand partnerships and economic interests within this region is one thing; the development of military and security ties is quite another. Conversely, China could set up security and military alliances with African states if necessary, as that continent is far less influenced by the U.S. and Europe.”[5] The recent warming of Cuba-US relations must be viewed as a US response to China´s advance in America´s traditional backyard, I think.
·         Finally, both Latin America and Africa are less important than Eurasia in China’s OBOR strategy. And the China-Latin America relationship is of less significance than China-Africa ties, considering the factors of geographical distance, the United States’ great influence, weak economic ties, cultural differences, and a lack of ground transportation. Additionally, the relationship between China and Africa has developed for more than half a century, while economic ties between China and Latin America have only taken off in the past two decades.
Put in perspective, while China´s Latin role is clearly on the rise –  very visibly this week – it is likely to remain relatively limited.

[1] For evidence, see Christopher Garroway & Burcu Hacibedel & Helmut Reisen & Edouard Turkisch, 2012. "The Renminbi and Poor‐country Growth," The World Economy, vol. 35(3), pages 273-294, 03.
[2] Moody´s Investor Service, 2015. “Latin America: Vulnerability to China Growth Slowdown Vary by Sector”, Special Comment, 4 February.
[3] Gustavo Adler & Nicolas Magoud, 2013. „Four decades of terms-of-trade booms”, Voxeu, 4 July.
[5] Xue Li and Xu Yanzhuo, 2015. „Why China Shouldn´t Get Too Invested in Latin America”, The Diplomat, 31 March.

Tuesday, 7 April 2015

AIIB to Dwarf ADB Loan Portfolio

After the UK decision to join AIIB in March 2015, an avalanche of Western and Asian countries recently filed application to join the AIIB. China´s magnetic attraction and the isolation of the US and Japan became palpable in fast motion. Representatives from 21 Asian countries had signed the Memorandum of Understanding on Establishing Asian Infrastructure Investment Bank (AIIB) on 24 October, 2014 in Beijing. By end March 2015, more than fifty countries –two third Asian, one third non-regional - had filed application to join as founding members of the Beijing-based Asian Infrastructure Investment Bank (AIIB). Its subscribed capital is US $ 50 billion, half of which is paid in by China.

Like the NDB (better known as ´BRICS Bank´ and, compared to AIIB, advancing in slow motion), the authorized capital for the AIIB is US $ 100 billion, the paid-up capital US $ 10 billion. The NDB has been established with a global remit to lend to developing countries. The AIIB is focused on Asia.  Both new institutions are intended to concentrate on funding infrastructure projects. One of the major barriers to economic development in low and middle income developing countries is the lack of critical infrastructure such as ports, railways, roads and power.

Although AIIB and NDB were launched in 2014, the decisions to create them reflect the growing discontent for many years amongst developing nations that the governance structure of the IMF and World Bank has not evolved to reflect the increasing weight of emerging markets in global GDP. AIIB and NDB can be viewed as part of a concerted Chinese attempt to build a Sinocentric global financial system, as an alternative to US hegemony, as voice reform in the established IFIs has failed. At the APEC Leaders’ Summit in November 2014, China´s President Xi also announced the creation of a new Silk Road Fund to improve connectivity in Asia, for which China will provide USD 40 billion of capital funding. The BRICS also had suggested in July 2014 an IMF-style contingent reserve facility (“Contingent Reserve Arrangement”), for which the five countries agreed to earmark $100 billion of their foreign-exchange reserves for swap lines on which all members are entitled to draw. The China-Africa Development Fund and the China-CELAC infrastructure fund are further examples of recent attempts to develop a global Sino-centric finance infrastructure.

Table 1: Loan-Equity* Ratios at AAA-rated MDBs, latest


Source: Various press releases and annual reports (assessed on 30 March 2015 at the MDB websites).

*Equity is defined as the sum of paid-up capital and reserves.


The AIIB is likely to eventually dwarf the ADB in terms of loan portfolio (and annual lending). The level of leverage (loan to equity ratio, the reverse of usable capital to loan ratio)) depends on the risk bearing capacity of a multilateral development bank (MDB). MDBs forgo such leverage opportunity if they transfer amounts to trust funds (such as IDA), which do not use a capital base to mobilize resources from financial markets and pass the amounts received from donors to beneficiaries at a rate of 1:1. A very simplified MDB balance sheet has the loan stock on the asset side and paid-up capital plus borrowings on the liability side. A trust fund (or concessional window) with no borrowings can thus achieve a loan-equity ratio of one only. Borrowings at the level of equity enable a loan-equity ratio of two, borrowings double the size of equity push the loan-equity leverage ratio to three. AAA-rated MDBs in 2014 recorded a loan stock-usable capital ratio of between 2 and 4 (Table 1). Usable capital of one US dollar, defined as paid-up capital plus reserves, thus could underpin a loan stock portfolio of USD 2 to 4 at the four leading AAA-rated MDBs.

The AIIB can be expected to obtain AAA rating by the leading rating agencies. Apart from strong support by the major shareholder China, the recent joining by highly-rated non-regional countries (including G7 countries) will lay the foundations of high intrinsic financial strength. Compared to the AAA-rated African Development Bank (AfDB), the AIIB will likely be less burdened by credit-negative considerations than the AfDB, which is burdened by a challenging operating environment across Africa. The regional exposure to Asia and the sectoral exposure to infrastructure should confer the AIIB a loan portfolio with relatively strong credit quality.


Table 2: Paid-up Capital and Total Loan Stock, US$ billion

Paid-up Capital
Loan Portfolio
Loan-Capital Ratio

Source: Various press Releases (assessed on 30 March 2015 at the MDB websites).


Table 2 compares the paid-up capital of the ADB and the AIIB as well as actual and prospective loan portfolios. Recent data show paid-up capital to stand at US$ 5.9 billion for the ADB, backing a total loan portfolio (outstanding plus undisbursed) of US$ 75 billion. (The respective numbers for the IBRD are paid-up capital of US$ 14 billion that underlies a total loan stock of US$ 152 billion.) If AIIB succeeds in building reserves from retained earnings and other sources, it could eventually reach a similar loan-(paid-up) capital ratio as ADB (12.7) and IBRD (10.9). Applying the ADB leverage ratio to AIIB, their paid-up capital (US$ 10 billion) could end up underpinning a loan portfolio of US$ 127 billion (AIIB). Applying the smaller IBRD leverage, the AIIB loan portfolio would still reach US$ 109 billion eventually, absent (negative) substitution or (positive) agglomeration effects respectively. While it is much too early today to be confident whether the newcomer will reach the financial performance achieved by ADB and IBRD, the scenario laid out here might well suggest that AIIB will end up with a higher loan portfolio than at present ADB. Consequently, expect the China led development bank to have a leading impact on multilateral development lending in Asia, hence on global financial governance.