China appears to be on course to reset the existing global economic order dominated by the West. The setting up of the Asian Infrastructure Investment Bank (AIIB), a multilateral financial institution, is a significant step in this direction, challenging the long-held dominance of the Bretton Woods system.
Formed largely with Chinese capital and initiative, AIIB aims to fund infrastructure projects across Asia. Indications are that this new multilateral bank could rival the World Bank and other long-standing international institutions established by the U.S. and its allies.
AIIB will have a subscribed capital of $50 billion, which will eventually rise to $100 billion. In comparison, the subscribed capital of the World Bank and the Asian Development Bank (ADB) are $223 billion and $165 billion respectively.
Dramatic turnaroundAIIB was formally inaugurated in Beijing on October 21, 2014 with 21 founding-members including China, India, Pakistan, Singapore and Vietnam. Many other countries had initially declined the Chinese invitation to join the new bank, with U.S. allies such as Australia and South Korea allegedly under pressure from the U.S. to keep away from the initiative.
A dramatic turnaround for the bank occurred in recent weeks, as the deadline to apply to become a founding member of AIIB, April 1, 2015, came close. The U.S. was dismayed when the U.K. announced its decision to sign up on March 12, 2015, but in the days that followed, many other countries including France, Germany, Italy and South Korea joined as well. Latest reports indicate that AIIB has now received applications from 47 countries to become founder-members. These include Israel and Taiwan. China will remain the biggest shareholder in the bank, while the shares of non-Asian countries will be restricted to 25 per cent of the total.
The U.S. and Japan continue to remain firm about not joining AIIB. The U.S. Secretary of the Treasury expressed concern about whether the new bank would be able to meet the “highest global standards” of governance or lending. However, it is notable that even close American allies queued up to join the China-backed bank despite stiff U.S. opposition. This is a clear acknowledgement of China’s growing economic influence in the world.
China’s riseChina’s large foreign exchange reserves, which stood at $3,880 billion in 2013, provide it the financial muscle to be on the driver’s seat in the global economy today. From 2001 onwards, China’s exports, especially of manufactured goods, have been growing at a much faster pace than its imports. As a result, China’s current account surplus — mainly, the surplus of the value of exports over imports of goods and services — has climbed sharply upwards. Its foreign currency receipts have soared too, due both to the large export earnings and the net inflow of foreign capital into the country.
China has invested a major part of its vast foreign exchange assets in U.S. treasury bonds, despite the very low returns they offer. For China, these investments in U.S. debt form part of a strategy to prevent the appreciation of its currency, Renminbi. Because of this, Chinese manufactured goods remain competitive in the export markets. For the U.S., China’s investments in its treasury bonds have been crucial to bridging its “twin deficits”, of the federal government and the current account. China’s continued purchase of dollar assets has also been vital to maintaining the hegemony of the U.S. dollar in the global economy.
So here is one of the anomalies of our contemporary world. China is a provider of cheap credit to the U.S., although China’s per capita income is only a fraction of that of the U.S. Chinese workers not only provide cheap goods but also transfer a part of their hard-earned savings to the Americans, so that the latter can continue purchasing their goods. No wonder, according to Hung Ho-Fung, a scholar on global political economy, China has been ‘America’s Head Servant’ ( New Left Review , November-December 2009).
Both China and the U.S. have been seeking ways to break away from their mutually dependent relationship, especially in the wake of the global financial crisis. China, on the one hand, is trying to shift from an export-led to a more domestic consumption-led strategy for future economic growth. On the other hand, China is also looking for ways to strategically deploy its large foreign exchange assets.
It is with the above objective that China has been pumping a part of its foreign exchange reserves into the building of new global institutions, including AIIB. Last year, China along with other BRICS countries, established the New Development Bank, with a subscribed capital of $50 billion, headquartered in Shanghai. China is drawing up plans for a $40 billion “new Silk Road’ project connecting Asia with Europe. Chinese currency is likely to be recognised as an official reserve currency by the International Monetary Fund (IMF) by the end of this year. This will be a step towards reducing the global dominance of the U.S. dollar.
The present international financial institutions were created under U.S. leadership at the end of World War II. The U.S., Europe and Japan continue to wield enormous influence in them despite the relative decline of their economies. For instance, the U.S. still has a veto power on major decisions made by the IMF and the World Bank. At the same time, these institutions have failed to give due recognition to the growing weight of China and other emerging economies.
China’s massive investment and diplomatic efforts in recent years have been directed at shaking up the global financial architecture that has the U.S. at its helm. No wonder, then, that the U.S. and even Japan view Chinese moves with anxiety.
India has done well to join AIIB and other Chinese initiatives. Given its huge infrastructure needs, India could be a major beneficiary of AIIB. At the same time, it would be premature for India to imagine it holds economic power similar to China’s. Unlike China, India’s manufacturing sector is weak, its export earnings poor, and its current account almost always in deficit. More of the foreign capital flows to India are short-term in nature and hence volatile. For all these reasons, India will be unable to leverage its foreign exchange reserves the way China is doing.
The Chinese have promised that theirs will be “peaceful rise” as a global power. But the world outside is still circumspect. Be that as it may, China’s offer to provide alternatives to a world economy long used to the dominance of the “Washington Institutions” is, in itself, good news.
(Jayan Jose Thomas is an Associate Professor of Economics at the Indian Institute of Technology, Delhi.)
