What to expect from the AIIB

Commonly perceived as a rival to Western-led multinational institutions the AIIB is actually designed to spearhead China's 'Belt and Road' initiative, a flagship strategy shaping China's own economic transformation including capital account liberalisation, free-trade zones and state-owned enterprise (SOE) reforms.

" This change will help transform China into a net exporter of capital."
Li-Gang Liu, Chief Economist, Greater China

As a net exporter for years, China was previously only a net earner of foreign exchange. As the major shareholder of the AIIB, China gains more confidence to deploy its huge reserves in the offshore market.

This change will help transform China into a net exporter of capital and in turn address the lingering issue of global imbalance.

NO RESTRICTIONS

China has demonstrated non-exclusivity in the AIIB establishment process. The bank's articles of agreement clearly state the AIIB will place no restrictions upon goods and services from any country.

While the US attempts to secure its geo-economic power in Asia through accelerating the formation of the Trans-Pacific Partnership (TPP), there is little reason for it to remain sceptical and critical to the rising voice of China in global economic affairs.

The AIIB will also benefit the regional debt capital market. It will raise funds primarily through bond issuance and the inter-bank market transactions. We estimate the AIIB may extend total loans of up to $US175 billion. If it follows the practice of the Asian Development Bank (ADB), its capital market activities could be $US10 billion a year.

The successful launch of the AOA is the first step for China to play a leadership role in a multilateral organisation. China has also gained significant credit in pushing through this international organisation in such a fast pace.

President Xi Jinping and Premier Li Keqiang proposed the idea in October 2013 and the MOU was signed by 22 Asian countries in only October 2014. Even that suggests the AIIB will likely be a very efficient organisation.

CHINA'S OWN REFORM STRATEGY DRIVES THE AIIB

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Given the close economic tie with China, prospective founding members can strengthen their investment link with China through the AIIB.

The total bilateral trade shared by these members was 50.4 per cent of China's total trade in 2014. Of the 56 AIIB members, 15 countries have established a Free Trade Agreement with China.

To them, China is their major trading partner and 30 of them have China's bilateral trade comprising more than 10 per cent of their total trade in 2014.

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The AIIB is a vehicle to complement China's 'Belt and Road' initiative and 'going out' policy of the SOEs.

Anecdotally, local governments have already started to formulate their local investment plans to match the initiative, aiming to utilise the transportation route for market access to Europe.

Fujian Free Trade Zone, for instance, is considered the starting point of the 21st Century Maritime Silk Road.

In April, China signed a package of deals worth $US46 billion to develop an economic corridor with Pakistan. Chinese companies will be involved in communications infrastructure and power generation projects.

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China has been a net earner of foreign exchange for years. But this situation will change. As President Xi Jinping noted in the Boao Forum in April, 'in the coming five years, China will import $US10 trillion of goods.

Investment abroad will exceed $US500 billion and more than 400 million outbound visits will be made by Chinese tourists.

MARKET OPPORTUNITIES

The AIIB will also benefit global financial markets, especially the regional debt capital market (DCM).

According to the AOA, the AIIB will raise funds primarily through the issuance of securities (i.e. bonds) in financial markets as well as through the inter-bank market transactions and other financial instruments, in addition to the initial capital of $US100 billion.

The leveraged structure could boost the total asset size to around $US175 billion.

The AIIB will likely attain the same AAA rating as with similar organisation like the ADB which is a regular participant in the debt capital market.

In 2014, the ADB raised $US14 billion of medium and long-term funds of average maturity of 4.3 years in 11 currencies including the RMB. Once the AIIB becomes more established, it will likely follow the practice of ADB.

With a total subscribed capital of about two-thirds of ADB, the AIIB may also add to the DCM market of $US10 billion a year, depending on the market conditions.

The institution will also be engaged in currency and interest rate swaps to hedge their financial risk exposure. The new organisation will be an alternative player in Asia's sovereign space.