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Economy

Asia infrastructure needs reform not more development banks

Amid talk of the "Asian century," one of the most important questions is how best to finance the continent's tremendous infrastructure needs. Whether crumbling roads in the Philippines or power blackouts in India, the region's physical infrastructure is increasingly inadequate, overburdened and poorly maintained -- where it exists at all. 

     In Southeast Asia alone, $60 billion is needed in annual investments over the decade to 2020 for road, rail, power, water and other critical infrastructure according to the Asian Development Bank. And that is in addition to national projects with "significant cross-border impacts such as airports, seaports and roads to borders," the Bank said. 

     As for India, the Council on Foreign Relations, an independent U.S. think tank, put it simply in its backgrounder "Governance in India: Infrastructure," saying "India's infrastructure sector has battled decades of dysfunction." It is no wonder, the report says, India's infrastructure financing gap has now reached $1 trillion. "Build toilets first, temples later," said Indian Prime Minister Narendra Modi, referring to his nation's overwhelming water supply and sanitation infrastructure needs.

     Granted, large parts of Asia have made significant progress in recent decades. Seventy-five years after the German invasion of Poland on Sept. 1, 1939 kicked off a second global war, the region and the world have been largely rebuilt. Sparkling cities and vast road networks have emerged in Asia, as have institutions that are now decades old. In July 1944, in Bretton Woods, New Hampshire, the foundation was laid for the post-war global financial infrastructure that includes the World Bank and the International Monetary Fund, both headquartered in Washington D.C.

     In 1966, the ADB was established in Manila, Philippines, under the watchful eyes of the U.S. and Japan, to speed up the region's economic development and reduce poverty. An alphabet soup of institutions linking Asia now includes the Association of Southeast Asian Nations, the South Asian Association for Regional Cooperation and the Asia-Pacific Economic Cooperation organization.

     Yet poverty and corruption still mar the region's economic landscape despite billions spent on infrastructure projects in recent decades to spur growth and lift the populace out of poverty.

     Is it time for a change? China certainly believes so. Beijing has hit a chord with its push for an Asian Infrastructure Investment Bank, arguing that the World Bank and ADB, among other Western-influenced international financial institutions, are not filling the region's infrastructure investment gap.  

     Formally launched with great fanfare by the Chinese government in Beijing in October -- without the support of the U.S., the European Union or Japan -- the AIIB will have an initial capital base of some $100 billion, nearly two-thirds as large as the ADB. All 10 ASEAN members are among the 20 or so nations that have signed on or indicated they will do so. Even Australia, a staunch U.S. ally, has said that it will join.

     Another new international financial institution, the New Development Bank, also called the BRICS Bank, named after its founding nations -- Brazil, Russia, India, China and South Africa -- will start with a capital base of $50 billion and also seek to provide incremental infrastructure financing.

Political entities

But are more multilateral development banks really what the world -- and Asia in particular -- needs most?

     The answer is no. But, if we want to understand the true raison d'etre and message of these emerging financial institutions, we should recognize what the AIIB, the ADB and the Bretton Woods institutions really are. All are political entities. Designed to do good, at least at the margins, these institutions also advance their founders' political and economic agenda, whether the founders are China, Japan, or the U.S. The AIIB and NDB will likely be no different.  

     Australia's announcement of its plan to join the AIIB also demonstrates how national economic interests may well prevail over environmental, human rights and other concerns as countries decide whether to join such institutions. China is now Australia's largest two-way trading partner, according to the Australian Department of Foreign Affairs and Trade. This November, Australia and China agreed to a landmark trade agreement.

     New and existing multilateral development banks and aid agencies might well help finance individual projects and do some incremental short-term good. But Asia's own experiences -- including China's own development successes -- make clear that such institutions are neither a complete nor a long-term solution to addressing the region's large and growing infrastructure financing challenges. 

     Even as China moves to "put its money where its mouth is" and challenge long-established international financing institutions with institutions of its own, government funds will be insufficient to meet all financing needs.

     Now is the time for international financial institutions and the countries that back them also to do a "rethink." Asia's infrastructure financing gap would be better addressed by vital reforms focusing on the region's financial infrastructure and by taking steps to ensure that the large amount of money made in Asia is retained and invested there. The ADB, as an example, notes that the key to financing Southeast Asia's unmet infrastructure needs lies in unlocking the region's private savings' accounts and mobilizing the $700 billion held in foreign exchange reserves.

     Asia has some of the largest ''BRICS'' economies, but steps must be taken to address the "little brics" -- bureaucracy, regulation, interventionism, corruption and sectarianism -- if private sector funds are to go toward infrastructure finance.

     At the moment, this money finds its way to more favorable business climates, primarily in North America and Western Europe. According to the 2014 United Nations Conference on Trade and Development's "World Investment Report," Asia's emerging economies accounted for 23.1% of the world's $1.41 trillion foreign direct investment outflows in 2013, up from 17.8% in 2010.   

     This capital flight has significant consequences for the region's domestic markets. A one percentage point increase in FDI outflows from a nation leads to a 29% decrease in domestic investment as a percentage of gross domestic product, according to IMF economist Ali J. Al-Sadig. Here are four related steps that will help attract, keep and harness Asia's private capital as an engine for the region's economic development and infrastructure investment:

Business friendly

First, Asian nations must do more to become "business friendly." The 2015 World Bank "Ease of Doing Business" survey, which ranks 189 economies on their environment for doing business, shows there is significant room for improvement. Singapore holds the number one spot, but is clearly an outlier. 

     Six of the remaining nine ASEAN nations -- Philippines (95), Brunei (101), Indonesia (114), Cambodia (135), Laos (148) and Myanmar (177) -- find themselves in the bottom half of the survey. South Asian nations do not fare much better. Sri Lanka tops that subregion with a subpar score of 99 and India is at 142. Decreasing the time it takes to start a business, enforcing contracts and passing legislation that protects investors are urgently needed to make these countries more attractive for investment.

     Second, the region needs to focus on strengthening domestic banks and other areas essential to its underlying financial infrastructure. A strong banking system typically precedes the development of capital markets. Independent ratings agencies are also essential to helping investors understand risks.

     Governments in Asia also need to push for strong and transparent legal frameworks that promote the rule of law and enforce tax systems and intra-regional investment laws. Private property ownership rights should be shored up, where necessary, to foster investor confidence. This will require leaders to roll up their sleeves and summon the political will to fight corruption, eliminate stifling bureaucracy and interventionism, and promote transparency in all sectors of society.

     Third, Asia must address illegal capital outflows. According to a recent Global Financial Integrity report, $991.2 billion flowed illicitly out of developing and emerging economies in 2012 -- more than the combined total of FDI and net official development assistance that these countries received that year. China alone accounted for a massive $249.57 billion. Such illegal capital outflows stem from crime, corruption, tax evasion and other illicit activity. 

     For the period 2003-2014, China also led the list, with estimated illicit outflows topping $1.25 trillion. India was ranked fourth, with estimated illicit outflows of nearly $440 billion. Such numbers underscore the much larger impact that nations can have on meeting infrastructure financing needs through a focus on the rule of law and an environment that fosters capital retention than through the establishment of additional multilateral development banks.

     Fourth, the region should try to "crowd-in" investors by identifying infrastructure projects that can be made attractive to private investors. International financial institutions can play an important role by sharing risk with investors. For example, Washington's Agency for International Development, known as USAID, is working through its Power Africa initiative to channel private capital into African energy production by identifying "bankable" projects, which it promotes to domestic and international investors. The same can be done in Asia.

     As Asia's economic growth continues to help drive the global economy, it is time to bid goodbye to old narratives and approaches that could lead to short-term development money flowing into the next wave of Asian dams, bridges and other infrastructure, without regard for long-term results, impact and outcomes. 

     This might seem like a tall order, but amid the rise of China -- if not yet of India -- the "Asian Century" will require more than development banks that risk entrenching the region's addiction to their lending. The AIIB and the NDB could well provide incremental infrastructure financing and might well do some incremental good, but Asia's cities and citizens deserve more and better.  

     The critical challenge is that these and other organizations should do no harm. That means doing nothing to further delay the important reforms that Asian nations need if they are serious about meeting the region's infrastructure needs.

Curtis S. Chin, a former U.S. ambassador to the Asian Development Bank (2007-2010), is a managing director with advisory firm RiverPeak Group; Jose B. Collazo is a Southeast Asia analyst and an associate at RiverPeak Group. 

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