Editor’s Note: This piece was
originally published on the Washington Post’s Monkey Cage
blog on July 17, 2014.
As World Cup fever recedes, this week in Fortaleza heads of state from Brazil, Russia, India, China, and South Africa (the so-called BRICS countries) agreed to establish a New Development Bank (NDB) at their summit meeting. They will have a president (an Indian for the first six years), a Board of Governors Chair (a Russian), a Board of Directors Chair (a Brazilian), and a headquarters (in Shanghai). What is the purpose of this BRICS bank? Why have these countries created it now? And, what implications does it have for the global development-finance landscape?
The “what” is relatively straightforward. The NDB has been given $50 billion in initial capital. As with similar initiatives in other regions (see below), the BRICS bank appears to work on an equal-share voting basis, with each of the five signatories contributing $10 billion. The capital base is to be used to finance infrastructure and “sustainable development” projects in the BRICS countries initially, but other low- and middle-income countries will be able buy in and apply for funding. BRICS countries have also created a $100 billion Contingency Reserve Arrangement (CRA), meant to provide additional liquidity protection to member countries during balance of payments problems. The CRA—unlike the pool of contributed capital to the BRICS bank, which is equally shared—is being funded 41 percent by China, 18 percent from Brazil, India, and Russia, and 5 percent from South Africa.
Next, the “why.” As we have discussed in our research, the rising economic strength of the BRICS countries has outpaced increases in their voice at the World Bank and the International Monetary Fund (IMF). South-South economic cooperation has expanded dramatically in recent years. Brazil now has more embassies in Africa than does the United Kingdom. China has become Africa’s most important trading partner. The value of South-South trade now exceeds North-South trade by some $2.2 trillion—over one-quarter of global trade. Low-income countries have also seen unprecedented growth in “South–South” foreign aid—with China, Brazil, and India all becoming larger donors. So, these BRICS institutions are partly just the result of a two-decades long process of greater economic engagement by and among developing nations.
In the meantime, long-standing dissatisfaction with Bretton-Woods institutions has also pushed BRICS towards a developing-country alternative to global development finance. We have seen this before. In the late 1960s, Andean nations created the Corporación Andina de Fomento (CAF), also known as the “Development Bank of Latin America,” as a way of bypassing the stringent rules imposed by the World Bank on infrastructure loans. In the early 2000s, partly as a reaction to a widely perceived failure of the IMF to stop currency speculation during the Asian Crisis, 10 ASEAN nations plus China, South Korea, Japan established a network of bilateral currency swap agreements that would become he Chiang Mai Initiative. In 2009 seven Latin American countries signed an agreement to establish the “Bank of the South” or BancoSur to fund regional development and social protection, and in which each member nation would have one vote. Both of these latter efforts were launched, in part, as a response to the Bretton-Woods enforcement of conditions on countries seeking emergency loans. So it is with the NDB and the CRA; said the official statement, “International governance structures designed within a different power configuration show increasingly evident signs of losing legitimacy and effectiveness.”
Although the BRICS comprise over one-fifth of the global economy, together they wield about 11 percent of the votes at the IMF. But reform to the governance of the Bretton-Woods institutions has encountered a number of roadblocks. In 2008 and again in 2010, quota reform at the IMF was intended to double total financial commitments from all member countries, while at the same time giving BRICS countries larger voting shares. Because this required additional contributions by member governments of richer countries, several balked for different reasons.
Smaller European countries, whose quota shares would be reduced by the changes, opposed quota reform on the grounds that their contributions to total official development assistance would be undermined if their voting strength were diminished at the IMF. In the United States—whose shares would not be reduced by quota reform—the Congress failed to approve increased capital contributions to the IMF. In the one recent effort to pass quota reform, Democrats in the House of Representatives tried to sneak an amendment into a loan guarantee for Ukraine that would have authorized the increased quota, but then withdrew the amendment, bowing to Republican opposition. Thus, the one time the Congress has considered IMF quota reform has been as a rider in an unrelated bill.
These developments show the political tightrope on which countries must walk when it comes to global development finance: while low- and middle-income countries have legitimate claims about their exclusion from the governance of the Bretton-Woods institutions, richer countries cannot cede too much influence over these institutions to developing nations and still justify large contributions—in particular, to the World Bank’s International Development Association every three years, and to the IMF as part of quota reforms—to their restless voters, especially during difficult economic times.
What are the implications of the BRICS institutions for international development finance? Developing nations hope that BRICS bank/CRA may eventually challenge World Bank-IMF hegemony over matters such as: funding for basic services, emergency assistance, policy lending, and funding to conflict-affected states. The World Bank’s own estimates point to a $1 trillion infrastructure investment “gap” in developing countries. Existing multilateral development banks are able to fill approximately 40 percent of that gap. So, the fact that a BRICS bank aims to make electricity, transport, telecommunications, and water/sewage a priority is important; the demand for infrastructure is expected to grow sharply as more countries transition out of low-income status. In terms of scale, it has been suggested that—after a couple of decades, should membership be expanded, and should co-financing by governments and private investors be mobilized—that BRICS Bank loans could dwarf World Bank loans. This type of success has been seen with the CAF, which now funds more infrastructure in Latin America than the World Bank and the Inter-American Development Bank combined.
Whether the BRICS institutions go the way of the more successful CAF on the one hand, or the way of the as yet unutilized Chiang-Mai Initiative orBancoSur on the other, will ultimately depend on two other factors: risk management and coordination.
Presumably a BRICS bank and reserve fund will need to ensure a high-quality loan portfolio that maximizes developmental impact, but keeps defaults to a minimum (for expanding the scale of lending operations, it would also be important to make profits on its loans). And so the problem of surveillance will have to be tackled. Unfortunately, the track record of regional initiatives on surveillance does not bode well. The Chiang Mai Initiative, for example, was simply unable to devise and implement a system of monitoring and surveillance, and eventually resigned itself to requiring countries using its credit lines to undergo surveillance by the IMF! The result: not a single Asian nation has used credit through the initiative.
Meanwhile, given the abundance of evidence that multilateral economic initiatives work best when their principal stakeholders are able to resolve coordination problems, the possibility of serious intra-BRICS disagreements could prevent these new institutions from operating at capacity. Hugo Chavez’s dream of BancoSur supplanting both the World Bank and IMF in Latin America foundered on a series of disagreements on issues such as: the bank’s tax-free status, the role of concessional finance, relationships with the private sector, transparency rules, and the need for environmental safeguards.
The structural disparity between China and the rest of the BRICS members (the Chinese economy being larger than the economies of all other BRICS combined) is at the heart of the matter for any BRICS institution. China’s dominant position makes coordination—in terms of operations and funding priorities—difficult to imagine. At one point, all other BRICS countries have expressed concern with Beijing’s economic policies and currency regime. Brazilian and Indian central bankers spoke out against the undervalued Yuan in 2009 and 2010, but to little effect. Ongoing trade disputes among developing countries also threaten unity. Last year WTO member states reached a deal on trade facilitation in Bali but India, among a group of developing nations, has threatened to withdraw support for the protocol over the issue of food security. A joint communiqué of BRICS trade ministers remains vague about whether BRICS countries commonly support the Bali agreement. These, along with a host of other intra-BRICS disputes, could limit the effectiveness of the NDB/CRA. For now, they seem to have been papered over amid the excitement surrounding the Fortaleza agreements. But they will, ultimately, determine whether the developing world has finally found a viable alternative to Bretton Woods.