Laying the BRICS for a New Global Financial Architecture?

While very little is still known about the modus operandi of the New Development Bank formed by the BRICS nations, Anushka Wijesinha and Raveen Ekanayake argue that the new initiative marks a significant step for emerging economies in moving beyond the Bretton Woods institutions.


As the FIFA World Cup in Brazil came to a close in Rio De Janeiro, the spotlight shifted to another Brazilian city, Fortaleza, this week as leaders of five nations gathered to make a new breakthrough in global economic governance. Two and a half decades since a Goldman Sachs investment banker coined the first acronym for an emerging markets basket – BRICs (Brazil, Russia, India, China), and 3.5 years since it added its newest member – South Africa, this grouping of emerging economic giants have just inked a deal to create the world’s newest development bank, the ‘BRICS Bank’. The bank (and a reserve fund), which is to be based in Shanghai and headed in its first term by a nominee of India, is being seen as a counterweight to financial institutions headquartered politically and physically in the West, like the World Bank and IMF. The agreement could see a new relationship emerging between the BRICS and other developing countries in financing infrastructure projects, away from the dependence on traditional ‘Bretton Woods’ lenders. Whilst a lot has been covered on the deal to set up the bank, this article aims to go beyond and explore some of the other compulsions and trends that might shape the bank’s form and function.


A 5 Year Journey


It has been 5 years since the inaugural BRIC summit took place in Yekaterinburg, Russia in June 2009, when the leaders of the first four nations decided to moved beyond a catchy acronym and become an international economic platform. At subsequent summits, some progress was made on new avenues of economic cooperation, but the idea for a BRICS Bank was first conceived in Delhi in 2012 and further mooted in 2013. In fact, the 2013 summit was supposed to clinch the deal but that did not materialize. Back in March 2012, in New Delhi, BRICS leaders inked a deal to provide credit to each other in local currencies, to facilitate economic growth during times of crisis. The aim of the currency swap deal is to promote trade and investment in local currencies as well as to cut transaction costs. It is also viewed as a step towards replacing the dollar as a reserve currency in trade between BRICS. In March 2013, the central banks of both Brazil and China took a bold step entering into a US$30 billion currency swap agreement. The new bank is, then, a strong next step in this ongoing process.


BRICS Bank Structure


Little is known about the structure of the new Bank. What is known, however, is what the funding for it will look like. The BRICS bank will compose of US$ 10 billion of paid up capital – with US$ 2 billion from each member over seven years, and an additional US$ 40 billion to be “paid upon request”. Even that had been contentious. While it was agreed that the bank will initially have a capital of US$ 50 billion, India was keen that each country would contribute an equal US$ 10 billion share and thus have equal shareholding.


“The overall agreement is considered an early victory for Modi – a successful multilateral engagement early on in his tenure”


China, however, was reportedly vying to offer the majority of funds, and that raised a concern among the rest of the group who felt it would give China greater power. The new Indian Prime Minister, Narendra Modi, had been particularly keen to ensure that unlike the Bretton Woods IFIs – where economic might determines voting power – the new bank should have equal shareholding and give equal voice to all members. The overall agreement is considered an early victory for Modi – a successful multilateral engagement early on in his tenure.


Emergency Lending sans-IMF


In addition to the BRICS Bank, the five nations also agreed to set up a US$ 100 billion dollar currency reserve pool called the Contingent Reserve Arrangement (CRA), which will act as an alternative to the IMF in providing emergency cash during times of economic stress, short-term currency crises, or balance of payments problems. To this, China is set to contribute US$ 41 billion, Brazil, Russia and India will each contribute US$18 billion, and South Africa $5 billion.


The CRA might certainly be more flexible and attach fewer conditions than the IMF. But the IMF is no longer approaching emergency lending in the way it used to. This was clear especially in the aftermath of the global recession, when IMF’s usually-rigid conditionalities were ditched in favour of more pragmatic and palatable reform frameworks in the interest of expediency. This was true even in Sri Lanka’s own Stand-by Arrangement with the IMF in 2009. Yet, there were still politics at play as the government’s request in February 2009 was dragged until July 2009, supposedly due to opposition from the IMF’s key shareholder, the US, on issues surrounding the end of the war. It is unclear to what extent the CRA would be different, in offering easier and quicker responses. Some experts have suggested that the CRA would be modeled along the Chiang Mai initiative of ASEAN, established in May 2000. But the China Mai Initiative is very closely linked to the IMF – only 40% of a member’s borrowing quota can be accessed without the member agreeing to an IMF policy program.


Reforming Global Economic Governance


The tussle by the BRICS for a greater voice in global economic governance is not new and it is no secret that many emerging nations are keen to move beyond the era of WB and IMF preeminence in the international financial architecture. As an article on our blog highlighted in 2010, emerging economies have been agitating for some time to secure more voting power and greater participation in decision making, relative to their weight in the global economy.


“The tussle by the BRICS for a greater voice in global economic governance is not new”


Despite their ever-growing dominance in the world economy, the BRIC countries together enjoy less than 10% of the IMF’s total votes, while the USA alone enjoys around 15%. The G8, on the other hand, which consists of the world’s 8 most-developed economies plus Russia, enjoys nearly 50% of the total votes. A draft deal was reached several years ago to restructure the governing boards and related voting power – called ‘share of voice’ – in the World Bank and IMF to increase the influence of China and other emerging nations. However, the deal requires approval by US lawmakers, and the US Congress has stalled on passing the required enabling legislation.


At the annual meeting of the IMF’s International Monetary and Financial Committee (IMFC) in Washington in April 2014, developing countries’ frustration around this reached a tipping point. They released a communiquéstating “we are deeply disappointed with the continued delay in progressing the IMF quota and governance reforms”. Following this week’s Summit, the Brazilian President reiterated this view, remarking that “The IMF urgently needs to review its distribution of voting power in order to reflect the unquestionable weight of emerging countries”.


Modus Operandi of Lending Unclear


Very little is still known about how the new bank will conduct its lending. Will it immediately be open for loan requests from developing countries, or will it initially only be for the BRIC countries? Will there be specific types of projects that the bank focuses on, or will it accommodate any type of infrastructure financing needs? To what extent will the terms, durations, and conditions of the loans be more favourable than what is on offer from traditional multilaterals?


On the latter, it seems intuitive that the BRICS Bank will make a decisive break from the practices of established institutions. The bank is likely to make it easier and quicker for developing countries to access to large-scale financing for their infrastructure projects. But in the desire to be more flexible and expedient, will environmental, social, and governance considerations suffer? Moreover, how will the new bank build up the institutional capacity to fund and manage large-scale projects? Institutions like the World Bank and ADB come with years of experience in development projects – how to structure them, how to account for social and environmental concerns, how to ensure sustainability, how to ensure good governance and transparency in procurement.


“The bank is likely to make it easier and quicker for developing countries to access to large-scale financing for their infrastructure projects”


They have access to in-house and international experts with specific skills across technical and financial aspects of projects, and it will take years for the BRICS Bank to build up similar capability. Generous funding, alone, will not ensure successful projects. Or, it may be that the bank simply provides the financing in an arms-length manner, in the form of budgetary support to the countries, letting the respective country governments take it from there. There would be very different implications in each case.


China may be the biggest winner. It could use the BRICS Bank to lend to countries, instead of direct lending, in order to veil its predominance in a country (considering recent backlashes to its presence in Africa), give more legitimacy to its investments, and burnish China’s image as a responsible yet pro-reform global player.


BRICS Showing Growth Cracks?


When Jim O’Neill first coined the acronym BRIC back in 2001, the world economy was in much better shape than it is now. At the time, in current US$ terms, these four emerging economies accounted for 8% of global output (23.1% in PPP terms), and were growing rapidly. Given each country’s growth trajectory, it was envisaged that they would surpass the six largest western economies in terms of economic might by 2041, to become the pillars of the 21st-century economy. But many of them are projected to grow much more slowly than their 2000-2009 average growth rates (see Fig. 1), mainly brought on by the lingering effects of the global recession.


“growth in the five countries is projected to be half the pace seen seven years ago”


China is in the midst of a growth tempering, brought on by a tricky re-balancing of the economy. India is perilously close to being trapped in stagflation, and the new government is under pressure to kick-start growth. The once high-flying Brazil is expected to grow no faster than the US in 2014. Russia too seems to be slowing down. According to a survey of economists by Bloomberg, growth in the five countries is projected to be half the pace seen seven years ago. With economic vitality waning in Brazil and India, focus is likely to be mainly on generating domestic growth. Meanwhile, Brazil will be preoccupied with elections this year, and India with a new post-election reform agenda.


A New Player, but a Strategic Game


With a reported US$ 2.5 trillion a year funding shortfall facing developing countries, the BRICS Bank can only go so far in bridging this, and it will take decades to build up. According to a UNCTAD study, the new bank could lend US$ 3.4 billion per year in a decade – less than 6% of what the World Bank expects to disburse in 2014. It is also significantly less than the lending by BRICS’ own development banks – 4% of what the BNDES of Brazil, and less than 2% of CDB of China, doled out in 2013.


But to cite these challenges to foretell that the BRICS Bank, and indeed the grouping itself, have poor prospects is to miss the larger, more strategic point.


“They want to move beyond symbolism to real economic and political clout. To what extent this will happen is still uncertain”


The BRICS Bank has emerged not simply to share finances, but rather to counterbalance the hegemony of the traditional forces that have shaped the global economic governance arena for decades. They want to move beyond symbolism to real economic and political clout. To what extent this will happen is still uncertain. But the BRICS Bank and the CRA are certainly laying the foundations for a gradual change in the global financial architecture. It will have interesting ramifications for countries like Sri Lanka, which have large infrastructure financing needs, need to rely more on affordable commercial borrowing given the transition to middle-income status, and appear keen to explore newer and different sources of development finance.