Building BRICS: An Assessment of the New Development Bank
July 1944, Bretton Woods, USA.
The 44 “Allied” nations get together to establish a new global financial order — one that will enmesh the post-World War II consensus. The World Bank (WB) and the International Monetary Fund (IMF) come into existence. The World Bank’s main role is to provide loans and financial assistance to developing countries with a strong anti-poverty agenda. The IMFs main role is to promote international monetary co-operation, ensure exchange rate and trade stability and “bail-out” members facing balance-of-payments difficulties or financial crises. Though the Bretton Woods system effectively came to an end on 15th Aug 1971, when Richard Nixon abolished the US Dollar’s international convertibility to gold at a fixed rate, the two Bretton Woods institutions continue to dominate the global financial system. The fall of the Soviet Union made US the sole superpower— and capitalism and democracy the dominant economic and political ideologies. The World Bank and the IMF have been the key instruments in promoting these ideologies in other parts of the world. Statistics tell us that the World Bank is currently involved in 12,134 projects in 173 countries. The IMF, currently composed of 188 member nations, has lent billions of dollars to economies in crisis, most recently in the Eurozone region. Both the IMF and the World Bank, and the economic agendas they advance, are unparalleled and unchallenged in terms of their scope and scale. Up until now.
July 2014, Fortaleza, Brazil, 70 years on…
The five BRICS countries (Brazil, Russia, India, China and South Africa) sign an agreement to create the “New Development Bank” (NDB). Headquartered in Shanghai, the bank has a starting capital of US$ 50 billion (to be later increased to US$ 100 billion), with equal contributions by the five countries. The primary goal is to fund infrastructure and development projects in the BRICS and other developing countries, a role similar to that of the World Bank. Additionally, another US$ 100 billion are to be invested in a “Contingency Reserve Arrangement” (CRA), with a contribution of US$ 41 billion from China, US$ 18 billion each from India, Russia and Brazil, and US$ 5 billion from South Africa. The CRA is meant to provide emergency funds to member countries facing balance of payments crises and currency depreciation problems, a role similar to that of the IMF.
Pundits read significance in the BRICS Bank’s neutral title – “New Development Bank.” Superficially, it may be said that the decision to name the bank the “New Development Bank” rather than the “BRICS Bank” was warranted as there is a provision to let other countries sign up once operations begin, taking the membership beyond the BRICS nations (Argentina, Indonesia and Mexico are tentatively queued up for a start). More importantly, the title, as well as the rhetoric coming from the BRICS leaders, suggests their intention to establish a New Financial Order: one that is not dominated by Western economic institutions and interests. Prior to his departure to Brazil for the 6th BRICS summit, Narendra Modi expressed his optimism about the BRICS bank: “We meet at a time of political turmoil, conflict and humanitarian crisis in several parts of the world, and persisting weakness and risks in the global economy… I look forward to the successful conclusion of major BRICS initiatives, like the New Development Bank and the Contingent Reserve Arrangement, which have seen significant progress since their launch in New Delhi in 2012. These initiatives will support growth and stability in BRICS and also benefit other developing countries”. Prime Minister Modi as well as the leaders of other BRICS nations view the NDB and CRA as playing a key role in solving global problems in a changing economic scenario.
Developing countries have long sought reforms in the World Bank and IMF, which they criticize for trying to manipulate their economies by attaching stringent conditions to loans. Moreover, while the GDP of developing countries and their contribution to global trade has grown, they have not received a commensurate stake in these global financial institutions. For instance, voting rights in the IMF are determined by the financial contributions of nations to the IMF. Each nation’s financial contribution to the IMF is determined by a quota, a numerical figure that must be approved by 85% of the IMF, including the nation in question. The quota is calculated on the basis of a weighted average taking into account economic indicators such as the country’s GDP, its foreign exchange reserves and current receipts and payments.
However, practical experience has shown that the IMF does not determine these quotas purely on the basis of economic indicators. The quota determination is also shaped by political considerations of the member nations, particularly the G8 nations that have enjoyed relatively large voting rights in the IMF since it was founded. Thus, the BRICS nations contribute 21% to world GDP but have only 11% voting rights in the IMF. The Europeans contribute 24% to global GDP but have approximately 32% voting rights, while the US exclusively enjoys 16.75% voting powers, giving it immense influence in the IMF. While China and other BRICS nations have been willing to increase their financial contributions to the IMF and hence their voting rights, the US has been resistant to such efforts. In 2010, the G20 leaders agreed to increase the voting rights for the BRICS nations, but the US Congress has yet to give its approval. Given the large vote share the US enjoys, a US approval is mandatory to get the 85% supermajority needed to change the voting rights of the IMF. The proposed amendment will reduce the US voting rights to about 16.5%, still giving it immense influence. The reluctance of the US to agree to even a marginal reform is particularly cause for much angst with developing countries.
Also, as a perceived “division of spoils”, the two blocs have ensured that a US citizen has always headed the WB, and a European the IMF. Currently, the World Bank is led by Jim Yong Kim, a Korean-American citizen and the IMF is led by Christine Lagarde from France. This `pre-determined’ pattern of leadership has also led to resentment among countries from the developing world.
What really is “new” about BRICS and will it work?
1. Equal voting rights: In a stark departure from the WB and IMF philosophy, the voting power of each member is not determined by economic or demographic size, but each of the 5 nations is given an equal vote; and none have veto powers. The only caveat is that the BRICS nations together will have a minimum of 55% of the voting power, with the balance 45% being available for all other nations who may join on the basis of their financial contributions to the bank. Thus no one nation, or even two, may impose their limited agenda on the whole group. This emphasis on “equality” as a basic principle has been welcomed by countries in the developing world and will contribute to the expansion of the NDB. This could also enable impartial assistance to developing countries on the basis of their needs.
2. Modest in Size but Large in Influence: Here is a comparison of the relative size of the NDB vis-à-vis other financial institutions:
European Bank for Reconstruction & Development US$ 20 billion
Islamic Development Bank US$ 47 billion
NDB US$ 50 billion
African Development Bank US$ 103 billion
Inter-American Development Bank US$ 129 billion
Asian Development Bank US$ 163 billion
World Bank US$ 223 billion
European Investment Bank US$ 331 billion
(Source: The MarketRealist.com quoting Annual Reports)
Compared to the larger financial institutions, the NDB is only a minnow in size. And while some of the much larger institutions mentioned above have hardly made a dent in the global financial system, the waves the NDB has made in financial circles are already significant. This is due to the characteristics of the constituent nations. Composed of some of the fastest developing economies of the world, BRICS now comprise over one fifth of the world’s economy. Four of them (excluding South Africa) fall in the category of the top 10 countries with the largest foreign exchange reserves, and China tops the list with reserves of nearly $4 trillion. China and India are slated to become the leading providers of manufacturing and services by 2050, while Brazil, Russia and South Africa will be amongst the leading commodity providers. The BRICS’ growing economic strength is universally accepted. The geographical location of the NDB member nations is also a crucial factor in its expansion. Brazil and South Africa are in this group as representatives of their respective continents, as precursors to others from the region. Also, while the NDB has a starting capital of $50 billion, the leaders have promised to increase it to $100 billion over the course of a few years. Jolyon Howorth, Professor of European politics at Yale, is optimistic about NDB’s proposed capital expansion. “Reports suggest that in the middle term, we may see a capitalization of the NDB that would eventually be comparable to that of the World Bank,” he says.. “ The NDB may not reach this milestone anytime soon but it is definitely moving in this direction.”
Stephen Roach, Senior Fellow at the Jackson Institute for Global Affairs and an expert on US-China relations feels that the small size of the NDB does not necessarily prevent it from making a positive impact. “The Bretton Woods institutions have focused on providing macro-level financial assistance in the form of loans and investments tied to broad developmental goals,” he says.. “ On the other hand, I anticipate the NDB providing smaller loans towards specific projects, due to its relatively small size. These can be equally effective in poverty-reduction and development of the recipient nations.” China’s investments in Africa, geared towards very specific sectors without associating themselves with broad developmental agendas, are a case in point. They have been successful in achieving infrastructure development and improving healthcare systems in several African countries, even though China’s foreign aid in Africa is much lower than aid from the World Bank.
The growing economic strength of the BRICS nations is universally accepted and their voices and demands in the global arena are growing louder. The NDB provides the platform for these voices to translate into action. Although its starting capital is low compared to other such institutions, there is much optimism that the bank will still be able to make a significant impact and its success will contribute to its future growth as an institution.
3. Overcoming the Dollar: In June 2012, China and Brazil announced a currency swap deal to enable payment in local currencies to finance trade up to US$ 30 billion. Similar deals have been struck by China with Japan, Australia, the UAE, Turkey and very recently with Argentina. Together with Brazil, these countries have bilateral trade with China well in excess of US$ 500 billion. On similar lines, VTB, one of Russia’s largest banks, and the Bank of China signed a treaty in May 2014 to pay each other in domestic currencies for “investment banking, interbank lending, trade finance and capital market transactions,” according to a VTB official statement. China’s steps to increase trade in local currencies suggest that the NDB could act as a facilitator between member nations for trade denominated in local currencies. In the modern global financial system, a Balance Of Payments crisis is essentially a shortage of US Dollars to settle overseas obligations. If a member country can pay for a large proportion of its imports in local currency, it can ease the pressure on its BOP position dramatically. Between them the BRICS nations have bilateral trade worth hundreds of billions of dollars, if not more. The NDB can provide a system of guarantees and other insurance products to ensure that the trade is safely concluded in local currencies.
Are the Cracks Showing Up Already?
1. Inter-country discrepancies and Dragon Fire: What is common to the BRICS countries is that they are all emerging economies. However, these countries differ in terms of their political systems, their economic models and their exact level of development. While India, South Africa and Russia are leaning towards market economies, Brazil and China have strong leftist tendencies, with the state playing a key role in the economy. With its communist government and relatively larger economy, China is already at odds with the other member countries. Several countries, including India and Brazil, have spoken out against the undervalued yuan. China is also involved in several political and territorial disputes with India and Russia. The conflicts between China and the other countries would not have been so worrying if it were not for China’s dominant position in the NDB. As of now, China has contributed the maximum amount (USD 41 billion) to the Contingency Reserve Arrangement. The headquarters of the NDB are in Shanghai, giving China immense influence over the organization. Contrast China with South Africa, whose level of development is much lower compared to the other countries. The country tried to bargain with China to make Johannesburg the headquarters and pay less than USD 10 billion, but finally the other countries prevailed. The inter-country conflicts, along with China’s increasing dominance, could pose a potential threat to the effectiveness of the NDB.
David Bach, Senior Associate Dean for Executive MBA and Global Programs at the Yale School of Management, points out, “If the NDB is looking to increase its capital beyond $50 billion to rival the capital of the World Bank, much of that will have to come from China and perhaps Russia as the other countries do not have the foreign exchange reserves to make such large contributions. The moment China contributes more than the other nations, there is internal pressure in the NDB to increase China’s voting share.” So could the NDB, founded primarily to temper US and Western hegemony, give rise to a new kind of hegemony in the developing world: that of the dragon? Roach does not think so. “Sparks between such diverse countries are inevitable and the economic dominance of China over the others is a reality in today’s world. At the same time, the combined economic clout of the five nations, and equal voting rights among the BRICS nations are definite positives. Unless the frictions between China and other countries intensify rapidly, I do not see this as curtailing the NDB.” It is also important to note that although the NDB is physically located in China, it has an Indian president, a Russian chairman of the Board of Governors, a Brazilian chairman of the Board of Directors and a regional center in South Africa. According to Howorth, “tThis process of parallel bargaining and negotiation can help ensure that all countries meet their financial commitments despite varying levels of development.”
2. International Political Pressure Tactics: Despite their noble intentions, the member nations of the BRICS have to necessarily withstand pressure from vested interests in the Western Nations. In 2013, the US—lobbied by oil companies in Washington—applied immense pressure to stall a major natural gas deal between Russia and China. With respect to the NDB itself, negative cues have come from the IMF towards the participating countries. Brazil’s President Dilma Rousseff was obliged to state that her country’s participation in the BRICS Bank is not any indication of an intention to withdraw from the IMF, and that Brazil’s dealings with the IMF will continue as before. Thus for the NDB to work effectively, the member nations will not only have to put aside their political differences, but also show resolve and strength in face of political pressure on them. At the same time, it is against the interests of the US to exert continuous political pressure on the BRICS nations. “The train has already left the station,” says Roach. “The NDB has been established and the US can either accept and co-operate with it or resist it. But resisting the NDB runs the risk of casting America in an anti-development role, and will come to haunt America’s role in the global economy.” Since resisting the NDB is against the US’s own interests, it is quite likely that the NDB will be able to function in the long run without sustained political pressure.
3. No Pain? No Gain: Developing countries, particularly the BRICS countries, have routinely criticized the World Bank and IMF for being unrepresentative and attaching stringent conditions to their loans. The NDB promises to fulfill the gaps and shortcomings of these institutions through the Contingency Reserve Arrangement, an alternative to the IMF. But the question is: how? Bach firmly believes that conditionality is needed for nations to honor their commitments to repay the loan. “Any commercial bank will not lend to a business in a debt crisis unless it obtains a strong roadmap on how the business plans to use the funds to implement structural changes and prevent the crisis from happening again. When the IMF was initially set up, it found itself bailing out the same nations again and again until it established conditions and structural adjustment programs that addressed the underlying causes of economic instability in the recipient nations. Without concrete conditions and structural changes, the recipient nations not only risk backtracking on their commitments but could also re-enter a debt crisis,.” Bach said.
The CRA plans to bail-out nations in crisis through a system of Institutionalized Currency Swap Lines, allowing these nations to pay for imports in their own currencies rather than the US dollar. However, without strict conditions and stiff penalties on recipient nations, there is no assurance that the economic situation in these nations will improve. This could potentially discourage the lending nations from accepting the local currency of nations in crisis. History shows us that Institutionalized Currency Swap Lines outside of the IMF purview have seldom worked. This is the one reason that the Chiang Mai Initiative (2010) of the ASEAN nations plus China, Japan and South Korea, has never seen any meaningful draw-downs, despite as much as US$ 240 billion of currency swap lines available to member nations. As Bach further points out, “The absence of conditions in CRA loans means that it will only be able to lend to nations that have some amount of solvency.” Thus the CRA may not be able to reach the nations facing grave liquidity crises and most in need of funds. And if the CRA plans to impose stringent conditions on the currency swap lines, then how is it different from the IMF? Given the present status and clout of the NDB and the difficulties mentioned above, it does seem likely that only token amounts may be forthcoming to applicant countries under the CRA facility.
One possible solution is that the NDB will not really need to disburse huge funds under the CRA. The sheer fact of its existence as an alternative to the Bretton Woods system, and the growing clout of the nations behind it, may trigger meaningful global financial changes and a reform process in the IMF. Some of this reform is already visible. “Over the years, we have seen IMF conditionality evolve from a `one size fits all’ approach to a more customized approach. Also, the conditions and their implementation are much softer and accommodating of recipient nations,” says Bach. Bach feels that the presence of the NDB infuses competitiveness among financial institutions, which would ultimately lead to an improvement in the structures and mechanisms of financial assistance. “It is too early to say whether the NDB will succeed or fail. Its failure could carry valuable lessons for strategies of financial institutions while its success could lead to further reforms in the Bretton Woods institutions. Either way, it will be an interesting experiment to see unfold.”
Can the BRICS build on their strong foundation?
Nothing is more powerful than an idea whose time has come, and the NDB seems to be exactly that. Its constituents are nations whose time is coming. After all, the engines of future global economic growth are primarily the BRICS nations. And as they grow in stature, so will the NDB. That such a diverse group as the BRICS nations could even come together and reach this far, speaks volumes of their disenchantment with existing global institutions, and also of their resolve to take matters in their own hands. And ultimately it is this resolve that will enable them to tackle the obstacles that are bound to come their way, and make a success of this ambitious initiative.