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To challenge the World Bank and the IMF, China will have to imitate them
Jan 31st 2015 | SHANGHAI
XI JINPING, China s president, was chummy in public when he met Nicol s Maduro
in Beijing in early January (pictured), praising his Venezuelan counterpart as
a good friend of the Chinese people . Behind closed doors, negotiations must
have been far more tense. Chinese banks have lent $50 billion to Venezuela
since 2007. With its economy in a deep recession, Venezuela s ability to repay
these debts is in grave doubt. Investors trading Venezuelan bonds would see
default as a virtual inevitability but for China s involvement. Having already
lent so much to Venezuela, will it give Mr Maduro yet more to prevent his
country from going over the edge?
And Venezuela presents just the first such dilemma for China. The
second-biggest recipient of Chinese loans in South America is Argentina, which
is also suffering as commodity prices swoon. It has started drawing on Chinese
credit to stop its currency reserves from shrinking further. Then there is
Russia. Chinese banks have lent more than $30 billion to Russian oil companies.
As Russia s economy crumbles, the promise of yet more Chinese cash is one of
its few pillars of support.
China is seen as a possible saviour of all three countries their lender of last
resort, the one banker to keep the money flowing when others turn away. That is
testament to China s remarkable growth; as recently as 2010, it was still a net
recipient of foreign aid. But it also casts a pall over China s record in
international lending.
China has dramatically scaled up its global loan book over the past five years
by dealing with countries largely ignored by Western lenders, whether for
political reasons (Russia) or economic (Argentina). Moreover, these loans have
come without the kinds of policy conditions normally imposed by the
International Monetary Fund. Instead of insisting on fiscal rectitude, China
has more often demanded that borrowers award contracts to Chinese construction
companies. Since 2008 China has also agreed some $500 billion in currency swaps
with nearly 30 countries, from Canada to Pakistan, which gives the
counterparties access to yuan when trouble is brewing.
At the same time, China is setting up development banks intended to challenge
the dominance of the World Bank and the IMF. Its actions stem in part from
frustration at how little say it and other developing countries still have in
their running. An agreement struck in 2010 to boost the voting power of
emerging markets would still leave America with a veto over big decisions, yet
Congress has repeatedly failed to ratify even that unsatisfactory deal (see
article). With China on track to surpass America as the world s biggest economy
within a decade, the anachronistic state of global economic governance is
growing ever more glaring.
Fast-developing
China is not waiting. In July it partnered with Brazil, Russia, India and South
Africa to form the New Development Bank, a World Bank knock-off with $50
billion in capital. The five also plan to pool $100 billion of foreign-exchange
reserves for any of them to tap in a crisis. In October China led the creation
of the $100 billion Asian Infrastructure Investment Bank (AIIB), a rival to the
Asian Development Bank, which is dominated by Japan. A month later it announced
a $40 billion Silk Road Fund, to be managed by another development bank backed
by China. With or without the delayed reforms, the circumstances of the World
Bank and the IMF will change, since China has charted a course to become an
alternative banker to the world.
The question is what kind of banker China will be. To be sure, it is easy to
get ahead of reality. The swaps offered by China are symbolically important,
but are more like straws than lifelines for countries gasping for liquidity,
says Eswar Prasad of Cornell University. And the guiding principle of China s
activity as lender of last resort is mercantilism. It wants to safeguard its
investments in Argentina, Venezuela and Russia. Business is business, says Yu
Yongding, a former adviser to China s central bank.
It is not quite that simple, though. One essential part of China s plan is to
internationalise its currency. Yuan are not as useful as the dollars the
Federal Reserve offers through currency swaps, but providing loans in a squeeze
is a good way for a central bank to acquire global clout. The Bank of England s
role as a lender of last resort in the Overend Gurney panic of 1866 helped
establish sterling as an international currency. By the same token, the Fed s
swaps with foreign banks after the financial crisis bolstered the dollar.
But China s support for Argentina, Venezuela and Russia is also risky. There is
an element of adverse selection: in the hunt for global commodities, China has
dealt with countries shunned by others. When trade deals morph into financial
support, it increases its exposure to losses.
A bigger concern is that China s ambitions for the yuan are prompting it to
lower its capital controls before its cloistered banking system is ready. Even
the IMF, long an advocate of faster financial reform in China, has urged it to
be more cautious. The total of unexplained capital outflows from China has
steadily increased in recent years, hitting $63 billion in the third quarter of
2014.
China does appear to be learning from its mistakes. China Development Bank s
foreign loan growth has slowed from nearly 50% a year in 2009-11 to just over
10% in 2013. Even before oil prices collapsed, says Erica Downs of Eurasia
Group, CDB had grown much warier about lending to Venezuela, tying its
financing to specific projects. In other words, it is becoming a little like
the World Bank.
What is more, China s decision to establish new multilateral development banks
is an implicit admission that its unilateral approach was not working. Jin
Liqun, the head of the AIIB, has travelled to capitals around the world to
promise that it will adhere to the highest standards of corporate governance.
Officials at the Asian Development Bank, the lender most directly challenged by
the AIIB, say they have been working closely with China to help it get off to a
good start. Chinese officials have even requested advice about the designs of
different development banks, hoping to learn from them. This suggests that
China is not looking to overthrow the existing order so much as to claw its way
into it.