CHINA’S move to set up the Asian Infrastructure Investment Bank has received an overwhelming international response.

The purpose of the Asian Infrastructure Investment Bank (AIIB) is to provide financial assistance to infrastructure projects in Southeast, Central and Southern Asian regions.

The bank is expected to become officially functional by the end of this year.

It is also argued that existing financial institutions failed to provide adequate assistance during the last financial crisis.

So, what does the AIIB mean to China? Why does China want another institution and why is it willing to pay the enormous amount of $50bn to set up the bank? The answer is simple.

The Chinese want to promote their global image. China would also like to create a pool of likeminded communities that address their own economic problems and put forward assistance when and as required.

It is often argued that the exiting international financial institutions are controlled by the developed economies and their policies serve them exclusively. The IMF is a case in point. The seven largest high-income countries — Canada, Italy, France, Germany, Japan, UK and the US — control almost 45pc of the votes. Since the larger economies have a bigger share in the IMF, they tend to call the shots.

China would leverage the AIIB to further internationalise its currency

The Chinese economy is going through a critical phase where it needs to rebalance itself. The key challenges are to shift: from external demand to domestic demand; from government investment to private investment; and from traditional modes of production to more advanced means of production.

Traditionally, the Chinese economy has been driven by gross fixed capital formation. Annually, the country spends over 40pc of its GDP on infrastructure development. And this has been the key driver of Chinese economic growth.

China is also eager to maintain the pace of its economic growth to eliminate the fear of the middle- income trap. However, many experts disagree. It is argued that the size of the Chinese economy is very big and it depends on huge domestic consumption.

The external balance is another issue. China has carried huge trade surpluses over the years. In 2014, the trade surplus was over $382.4bn. With the creation of AIIB, China will be able to reduce its excessive external balance via outbound investment.

The overcapacity of construction materials is a further issue that China aspires to tackle through the establishment of the AIIB. Overcapacity in the iron and steel industry is probably ‘beyond imagination,’ Li Xinchuang, executive vice-secretary general of the China Iron and Steel Association, has said.

According to some rough estimates, China had nearly 300m tonnes of surplus steel output capacity in 2013. The amount was equivalent to nearly twice the annual output of entire Europe.

Besides these traditional industries, some emerging industries, like wind power equipment, poly- crystalline silicon and aluminium have the tendency to overproduce as well.

And while the Chinese currency is one the top five currencies, the renminbi is not an international reserve currency.

China would leverage the AIIB to further internationalise its currency. Consequently, the use of the renminbi will be the most viable option for investors.

The AIIB is not only significant to China. It will also provide new financial support to developing Asian countries and nurture the global economy.

The writer is a professor at Jinan University, Guangzhou, China

Published in Dawn, Economic & Business, April 27th, 2015

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