Sunday, April 19, 2015

India and the AIIB

Last week the Chinese government announced that 57 countries, including India, have agreed to join the Asian Infrastructure Investment Bank (AIIB). The process of preparing the institution's shareholding pattern, governance framework and lending rules will soon start. So what should be India's strategy?

Foremost, India should realize that it is second only to China in all the parameters - GDP, population, actual infrastructure investments, financing needs and so on. But the politics and economics of joining AIIB pulls in different directions for India. 

Politically, it is undoubtedly in India's interest to not to be not part of the founding of an institution which now holds some global geo-political significance. India should aspire to a seat at the top of the table in an institution that has the potential to become one the leading multilateral financing institutions. But economically, India could well stay out of AIIB and not lose much. Its infrastructure investment needs are massive, nearly $ 1 trillion targeted for the 2012-17 period. The AIIB's contribution can, at best, be just a drop in the ocean. In fact, given its modest initial capital ($50 bn) and the perception discount (among investors and countries) associated with an institution that is clearly dominated by China, one could argue that economically the institution would benefit more from India's presence than India would. It is therefore safe to argue that the AIIB needs India atleast as much as India needs AIIB. India needs to leverage this to its advantage as it negotiates the Articles of Agreement (AoA) of the AIIB. It should not become just another invitee to a Chinese triumphal party.

Given the deep Chinese interest in displaying how the new institution will be fairer and more equitable than the Bretton Woods twins, India has the opportunity to play ball with China over negotiations on the AIIB's governance framework. Furthermore, given China's dominance in AIIB (its initiative, headquarters, leadership position etc), a framework which is fairer and more equitable than the Bretton Woods institutions would involve considerable sacrifices by China and gains for countries like India. 

Apart from the limited financing opportunities, what should be India's possible takeaways from an AIIB? 

1. India should push the AIIB away from multilateral sovereign lending and towards project finance lending. A country like India should have limited interest in sovereign loans and should be more concerned about using all potential sources to leverage international long-term capital to finance its, predominantly, privately financed infrastructure projects. For example, like with the case of World Bank and IFC, even a small AIB share in a project could serve as a credit enhancement and help crowd-in international capital at lower cost than otherwise. 

2. India should advocate issuance of bonds by the AIIB in not just dollar and renminbi (as is most likely, since China would not lose this opportunity to promote the renminbi as a reserve currency), but also rupees. This would help in the internationalization of the rupee as well as help Indian borrowers more cost-effectively hedge their losses and thereby lower the cost of their foreign capital. 

3. India should strive to use the AIIB as an instrument to promote the interests of its own infrastructure firms. It should not be a surprise if China uses the cover of AIIB lending to promote contracts for Chinese firms. There is a strong likelihood of this given the perception that China could use the AIIB to formalize the massive lending currently being undertaken by institutions like the China Development Bank, all of which are conditioned on awarding contracts to Chinese firms. In that case AIIB could become an extended arm of Chinese aid diplomacy. Instead, India should negotiate hard to ensure a level-playing field for Indian firms.

4. The bonds issued by the AIIB could be a potentially good source of risk diversification as well as earning higher returns for India's growing foreign exchange reserves, a large share of which are currently invested in low-yielding US Treasuries. In fact, India should use its reserves and unilaterally match any Chinese contribution either by subscribing to bonds or equity capital. 

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