By John Manning – john.manning@internationalbanker.com
In July, the BRICS countries – China, Russia, Brazil, India and South Africa – set up a new bank (the New Development Bank) with the purpose of providing loans to poor countries across the world. The NDB will initially have a capital base of $100 billion, funds that will be used for infrastructure projects, which are a major issue in all of the BRICS countries save China. However, many of China’s construction companies would be happy to take on big projects abroad. What’s more, in addition to the bank, the five BRICS members will also set aside $100 billion from their foreign-currency reserves for swap lines, which can be used by any other BRICS member under a Contingent Reserve Arrangement. The bank will be headquartered in Shanghai, and its first president will be from India.
There seems to be a widely shared belief among Western analysts that the NDB will be too small to present an actual challenge to the IMF and the World Bank, given its limited capital base compared to the $232 billion of the World Bank and even the $165 billion of the Asian Development Bank. However, its creation does signal a growing disgruntlement among developing nations with the largely US-dominated policies that are applied by both the IMF and the World Bank. The BRICS collectively account for 40 percent of the global population and 20 percent of the world’s economic output. At the same time, together they hold just 11 percent of voting rights at the IMF, and the US Congress refuses to approve a change in the status quo. What’s more, the World Bank is traditionally headed by an American, something that persisted even after the last incumbent stepped down in 2012, when Africa and Latin America both presented strong candidates for the job. Instead, the helm went to American Jim Yong Kim. Given this situation, it is hardly surprising that the biggest developing economies in the world finally decided to do something about this distribution of power at the two international financial institutions.
Another major feature of the new bank is that it will allow the BRICS to reduce their overwhelming dependence on the US dollar. As UC Berkeley professor Barry Eichengreen points out, worldwide some 60 percent of foreign-currency reserves and 85 percent of foreign-exchange transactions are in US dollars. This makes countries unwilling to accept the prescriptions of the IMF to remain dependent on the readiness of the Federal Reserve to provide dollars to their central banks. This dependence is one more thing that the BRICS want to do away with or at least reduce, hence the establishment of the Contingent Reserve Arrangement. What’s more, they all want to reduce their dependence on the US dollar as a whole, a drive that fits in nicely with China’s strategy of making the yuan a global currency.
But one problem with the NDB is exactly this—one country, China, is taking advantage of the bank to advance its own economic interests, claims political analyst Dingding Chen. China is by far the biggest economy among the five and has made the largest contribution to the initiative in money terms. Chen cautions against such behavior, advising the BRICS largest member to promote equality, demonstrating that the bank can be used by all developing countries alike regardless of possible diverging interests. Chen notes that in this respect it is the right move to give every BRICS member a leading seat at the bank: while the president will be Indian, the chairman of the Board of Governors will be Russian, and the chairman of the Board of Directors will be Brazilian. The first regional office of the bank will be in South Africa. In other words, the bank’s founders have taken care to make sure that no one is left dissatisfied, at least not at first.
The news about the establishment of the bank is, of course, nothing but good for developing countries in need of financing. The World Bank and the IMF, particularly the latter, tend to attach often unacceptably harsh conditions to the funding they provide. The IMF does not ask for collateral when it lends money to troubled countries; instead it prescribes economic policies that the country must follow. The question about whether the NDB will also want to have a say in a country’s policies in exchange for funding is still open and very topical, given that the clients of the bank will be poor countries, where the risk of being unable to repay the loan is inherent. So it is possible that the BRICS will attach some conditions to the financing their bank provides. This, however, should not be seen as too big of a problem, according to some experts, given the main benefit of the new bank—that it provides a viable alternative to funding from the World Bank and the International Monetary Fund.
One additional benefit identified by Wall Street Journal author Richard Silk is that the creation of the bank may prompt reforms in the other two international funding institutions. For instance, Silk says, it may induce the IMF to finally make some changes to the voting rights of developing countries. The main beneficiaries of such a move would be China then India and Brazil, and the losers would be European countries, from which the votes are most likely to be taken.
At the same time, there is an inherent risk in the undertaking, which may threaten its success: all BRICS members have problems—some are serious, and some have problems between themselves, such as India and China with their territorial dispute. But more importantly, they each have to solve economic issues that could take the focus off the smooth running of the new bank and tempt them to use it for their individual purposes.
South Africa’s economy has been hit very hard by a five-month miners strike that left it on the brink of a recession, which the country barely avoided. Still, after slipping into red territory in the first quarter of the year, South Africa managed to scramble back on its feet, booking a GDP rise of 0.6 percent. Positive though this figure is, it’s far from sufficient for the smallest member of the BRICS.
Brazil is also struggling with a slowing economy. According to the latest analyst projections, its GDP is seen to expand by just 0.7 percent this year, down from previous estimates of 1 percent. What’s more, in the second quarter it contracted by 0.4 percent, according to analysts. With consumer confidence and industrial sentiment at historic lows, the current government and the one that comes after the October elections will have a lot of work to do to turn things around.
Perhaps Russia, however, is in the most serious predicament, with the EU and US piling up sanction upon sanction, and Minister of Economic Development Alexey Ulyukaev officially announcing that the country has entered a negative stage in its economic cycle. But Russia was quick to respond to the sanctions with some of its own, banning food imports from a range of Western European countries, among others, and diversifying its food sources in Latin America. Still, this would hardly be enough to sustain an economy that is expected by the Ministry of Economic Development to grow just 1 percent next year, down from a previous forecast of 2 percent.
China is also trying to recover from an economic slowdown that experts have said will last longer than previously thought and extend into 2015. In India, the government of Prime Minister Narendra Modi is giving all kinds of signals that they will turn things around, but only time will show how efficient their efforts will be. In short, all BRICS members have challenges at home and may at one point or another be tempted to use the New Development Bank to deal with them. Of course, this is pure speculation—the new bank is still very young, and it’s not even certain it will ever take off, since, apart from the World Bank and the IMF, there are a number of regional development banks that have been lending to troubled developing states for years.
The World Bank has already welcomed the new institution, saying it will be happy to work with any bank or organization aiming to improve the quality of life of people in developing countries. The IMF has not made an official statement about it. According to some, though, the NDB is, as The Economist puts it, “an acronym with capital”. The bank was set up with the view of supporting much-needed infrastructure programs across the developing world. But, The Economist notes, these needs are so enormous that even the tens of billions of dollars in disbursements from existing banks and funds cannot satisfy them, leaving them largely unmet. NDB’s capital is not sufficiently large to make a notable difference, but the enormity of the infrastructure needs could make the bank viable. Yet the biggest challenge for the five countries will be to overcome their internal differences and discrepancies, which will likely make it difficult to reach a consensus when it comes to using NDB funds. Still only time will tell whether the New Development Bank is an empty vessel or a functional lending institution capable of measuring up to the IMF and the World Bank.
Photo by: Presidential Press and Information Office