New Development Bank and contingency reserve arrangement initiative

BRICS- was an acronym coined by Goldman Sachs economist Jim O'Neill in his publication,” Building Better Global Economic Brics ” representing five major emerging national economies: Brazil, Russia, India, China, and South Africa.

They are fast developing nations who have their own and varied interests in international trade and global matters. The grouping was originally known as "BRIC“, before the inclusion of South Africa in 2010.

In the recently concluded 6th annual BRICS summit in Fortaleza, Brazil leaders from BRICS agreed to establish a New Development Bank with an authorised capital of US 100 billion, followed by creation of a US$ 100 billion Contingency Reserve Arrangement to provide additional liquidity protection to member countries during balance of payments problems thereby warding off the criticism that BRICS was a mere acronym and was only a platform for meetings and discussions.

As of 2014, the five BRICS countries account for 40% of the world population, 20% world GDP and represent 18 %t of the world economy. BRICS also represent a grouping of members with divergent political system and inconsistent interests who have come together to carve a financial co-operation for development.

BRICS is the only world grouping that is not region, security or trade based who have now come forward to provide a launch pad for development Programs of developing nations and thus create a more multilateral world.

The above announcement involving two financial machinery is expected to have wide implications and ramifications on the world trade and finance.

Contributory Economic Scenarios that led to the announcement:

The new development comes amidst inequalities currently prevalent in the Bretton Woods world financial institutions like World Bank and IMF. World Bank is located in Washington and decisions are taken on 85% super majority vote. With USA having 16% vote, it has a virtual veto power.

Although BRICS control about a fifth of world economy and 40% of the world population they have only 11% of the votes with IMF. There is a longstanding dissatisfaction with Bretton Woods institutions on this score that voices they get at World Bank or IMF is not in commensuration with their economic growth. The quota reforms attempted by IMF to alleviate this dissatisfaction has hit roadblocks due to resistance from the current quota holders.

In addition to the mismatch between growth and voting rights, the stringent rules imposed by World Bank on infrastructure loans may also have gone into consideration in announcing the new initiative. World Bank‘s terms and conditions have been known to create structural mismatches between project funding, demand and supply.

Recently the World Bank moved away from funding coal plants in developing countries in favour of cleaner energy. But this does not take into account energy needs and energy access available in developing countries.

Mark Weisbrot, economist and co-director of the US Centre for Economic and Policy Research says “With a handful of rich alleys, the U.S. has controlled the most important economic decision-making institutions for 70 years including the IMF, World Bank and more recently G-7, 8 and 20; and they wrote the rules for the WTO. This (NDB by BRICS) is the first alternative where the rest of the world can have a voice”

Jim O’Neil of Goldman Sachs has said that if 2001/2002 financials and outlook were extrapolated over the next decade, China would be “as big as Germany” and Brazil and India “not far behind Italy” But the growth of BRICS as early as 2013 made the prediction modest as by then China has become the world’s second largest economy, Brazil is ahead of Italy and India one rank behind in terms of GDP. But in terms of Purchasing Power Parity, all BRICS countries are within the top 10.

Brazil now has more embassies in Africa than United Kingdom and China has replaced European Community as the Africa’s largest trading partner. Now South – South trade exceeds North- South trade by US$2.2 Trillion.

The failure of IMF to check currency speculation in Asian crisis in the early 2000 led to currency swap agreements between 10 Asian countries plus China, South Korea and Japan. IMF facility recipients also resent the tough reforms on which help is conditional.

And not all reforms suggested by IMF has been successful. A major problem with IMF/World Bank has been the political angle with which these institutions function. The IMF rush to commit US$18 billion to UKRAINE within days of the ouster of a legitimately elected Government has not gone unnoticed in world quarters.

In Fortaleza Vladimir Putin, Russia’s President extolled the role of NDB and CRA as a way to prevent “harassment” of countries whose foreign policy clashes with America’s or Europe.

According to Goldman Sachs analysis as revealed in “Dreaming with BRICS-: The Path to 2050”, by 2050, there will be radical change in the list of top 10 world largest economies. But in 2014 itself the list is radically changing.
By the end of 2013 China’s Yuan has replaced Euro as the second most used trade finance currency according to Society for Worldwide Interbank Financial Telecommunication. It is interesting to note that of the world’s six largest economies China’s Yuan is the only one that is not a reserve currency as the country’s closed capital account prevents it from becoming a reserve currency. Today more than 10,000 financial institutions are doing business in Yua.

The pool of off shore Yuan is US$143 billion .Alexey Maslov, head of the School of Asian Studies at the Higher School of Economics pointed out a number of facts that signify the changes in the world economy.

According to him more and more countries are gradually stopping the usage of dollar in international payments and choose Chinese Yuan. And this process began outside the BRICS and China plays a leading part in this process of less usage of dollar.

Through a gradual process, it now trades with a few dozens of countries in Chinese Yuan and their national currencies. Not only the BRICS but also a number of Latin American countries, Newzeland, Australia, South Korea are involved in the system. The proportion of China’s exports and imports settled in Yuan has increased six fold in three years to 12%.

The official reserves of global central banks have grown from US$2 trillion in 2000 to US$12 trillion in 2012 and there has been a significant shift away from US$ from 62% to 54%. The Canadian Dollar, Australian Dollar, Swiss Franc, Danish Kroner and Chinese renminbi are the currencies which are finding favour with emerging markets central bank as they have produced strong returns with healthy fundamentals.

The above scenarios make the proposed NDB and Contingency Reserve Arrangement significant.
Precedents:

The stringent conditions imposed by IMF had also had their echo in LATIN AMERICA. In the earlier 1960s the formation of Corporation Andina de Fomento (CAF) by Andean Nations was to bypass such rigid rules imposed by the World Bank on infrastructure loans.

In 2009 we saw the launching of “Bank of the South” (Bancosur) by seven Latin American countries to fund regional development and social protection. These indicate a latent remorse among developing nations about Bretton Wood Institutions and an urge to find a suitable alternative.

Now CAF funds more infrastructure than the World Bank and the Inter-American Development Bank in the region.

BRICS’ New Development Bank and Contingency Reserve Arrangement:

Against the above background of current economic scenario, The New Development Bank as proposed by BRICS will be on the following lines.

The Capital of the BRICS new financial Institution will be US$100 billion. But the initial subscribed capital will be US$ 50 billion with each signatory contributing US$10 billion with equal voting rights.

The Bank will function with headquarters in Shanghai and regional office in Johannesburg.
The membership in the bank will be open for all UN members meaning thereby the balance US$50 million will be utilized for outside subscription.

The capital base is aimed at financing infrastructure and “sustainable development “ projects in BRICS countries in the beginning but will be open for low and middle income countries who can buy shares and apply for loans.

To counter balance of payments problems “short term liquidity pressures” BRICS has created a US$100 million Contingency Reserve Arrangement, with following contributions. China 41%, Brazil, India and Russia 18% and 5% from South Africa.

BRICS launching of US$100 billion New Development Bank is quite an ambitious step but quietly acknowledges that it is not a replacement of IMF, World Bank or other regional development banks. The Fortaleza Declaration acknowledges that NDB will be a “supplement to the efforts of multilateral and regional institutions for global development.

World Bank has a subscribed capital of over US$ 223 billion in addition to barrowing US$ 30 billion annually through issue of Triple “A” rated bonds in the international market. Asian Development bank backed up by 67 member nations has a subscribed capital of US$162 billion. African Development Bank (53 African – 60% and 26 Non-African- 40%) has a subscribed capital of US$ 100.42 billion.

USA, Japan, Canada, Germany and France are all non-African subscribers of the capital. It took a considerable amount of time for all the banks to come to this level. All these banks also have Triple “A” credit rating.

Against the subscribed capital commitment of US $50 billion by each country, in the immediate term only a modest US$ 150 million has been promised by each of BRICS countries.

This is against their total commitment of US$ 200 billion- US$ 100 billion towards capital and US$ 100 billion towards Contingency Reserve Arrangement. Hence the commitment of the balance of US$1,850 million will be requiring good working on numbers by BRIC financial pundits as members other than China and Russia are having weak balance sheets, fiscal current accounts problems and sluggish domestic markets.

It is reported that a contraction of 0.6% in Brazil's economy between April and June, 2014 and a revision of the first quarter, has pushed the country into recession. China and Russia are the only countries with excess reserves.

According to the Geneva based World Economic Forum, BRICS countries’ Competitiveness is as follows. China, which has improved its position by one place to 28th spot, leads the BRICS grouping, among which India (71) has the least ranking by slipping 11 positions. Russia is ranked at 53rd position, followed by South Africa (56) and Brazil (57).

Viewed against these factors, the New Development Bank of the BRICS will take time to reach moderate levels of operation and cannot be termed as a really competitive institution to any of the current regional or global financial institutions in the near future. At best the competition can be only about efficiency of operation and prudent lending

China Factor: China had taken two important two steps affecting international finance. First, the currency swap initiative also known as Chiang Mai Initiative by which a network of bilateral currency swap agreements were initiated.

Secondly it has proposed to create an Asian Infrastructure Investment Bank with a registered capital of USD 100 billion to be headquartered in Singapore and has also invited India to join it for reasons of geography. China has ambition for a leading role in international finance.

If adequate dominance is not given to it in the NDB in commensuration with its size and growth, will it result in its neglect of the NDB by giving priority to the Asian Infrastructure Investment Bank? But NDB gives ample platform for Chinese to project a friendlier international image while launching their international economic policy.

As Pallavi Roy, a senior teaching fellow for Centre for International Studies and Diplomacy at the SOAS University of London suggests,” perhaps China would want to prove that it is a responsible rising power that can be can be a part of multilateral order”.

South Africa is also significant player in the African Development Bank being among the top 10 shareholders with 4.8% of shares. How they will balance their priorities remains to be seen. Similarly India holds 6.3% shares in Asian development Bank Vis a Vis Brazil in the BNDES which is one of the largest development bank in the world next only to Chinese Development Bank.

Infrastructure and Development Finance.

According to the World Economic Forum’s Green Investment Report- “To support a future global population of 9 billion people an estimated US$ 5 trillion per year needs to be invested in global infrastructure (~US$ 100 trillion over the next two decades,)

The World Bank estimates that South Asia alone would require US$2.5 trillion for infrastructure development over next ten years. Hence the question of NDB supplanting other financial institutions does not arise and there is enough space for NDB and other institutional finance to operate.

Organisational Structure: NDB will be headquartered in Shanghai – China with regional Centre at Johannesburg. If we look at the governing Structure of World Bank, previous World Bank presidents have been U.S.Citizens and IMF Managing Directors are Europeans.

ADB presidents have been Japanese. With rotation of Presidency, NDB attempts to do away with the current practice prevalent in the international development financial institutions. It has provided a rotational method of Presidency- an Indian for first six year’s a Board of Governors(Chair Russia) and a Board of Directors (Chair Brazil).

With equal paid up capital and equal voting share, an attempt to create an alternative model has been made.
With GDP growth centering around these countries , after a couple of decades with extension of membership ,mobilization of co-financing by Governments and private investments, NDB will be a force to reckon with.

But still many questions remain unanswered.

First, what will be currency of operation? Secondly, the role of Central Banks of BRICS to act as depository institutions of the NDB.

Thirdly the role of CHINA in the years to come. How will China maintain a balance between its own influences on the bank with that of other members’ impact? Chinese economy is larger than the economies of other BRICS combined.

This factor should not make China to become like another USA which pushes its way in the World Bank? The world expects a large hearted Chinese stewardship of NDB to become a successful venture. Fourthly what will be governing role of other outside Investors for US$ 50 billion? Fifthly what will be the administrative set up for the day to day operation of the NDB?

The location of the headquarters at Shanghai is not an attempt to suggest that NDB is a Chinese affair when we see the Presidents are by rotation and the Board of Governors and Board of directors at present are all non-Chinese. For example though ADB is continuously headed by Japanese, it is headquartered in Philippines.

Of course critics point out about divergent and conflicting interests between BRICS members. In a group there are bound to be differences.

There are difference in G7 also. It should also be noted that IBRD also was not a success all at once. It had to learn its lessons over the years to operate in a coherent way. But the binding factor with BRICS is they are developing countries with main focus on development and improving standards of life and at present this is their main concern.

But BRICS should also draw lessons from the failures of the following initiatives

Latin American Bancosur did not achieve the object because of a series of disagreements on various core issues like bank’s tax free status, concessional loans ,transparency rules ,environmental safeguards etc.,
Chiang Mai Initiative could not take off to expected levels due to lack of independent monitoring and surveillance mechanism and had to rely on IMF mechanism.

Brazil has actually shown how a single country can create a very effective development bank like BNDES. BRICS has the advantage of drawing Brazil’s rich experience of creating an effective development bank that actually promotes real development without all the strings of rigid conditions. Brazil has an important role to offer its rich experience to BRICS.

Nobel Prize in Economics, Professor Joseph Stiglitz, is impressed with the growth of BNDES and in his opinion, "Brazil has—the BNDES is a huge development bank, bigger than the World Bank.

People don’t realize this, but Brazil has actually shown how a single country can create a very effective development bank. So, there’s a learning going on.

And this notion of how you create an effective development bank, that actually promotes real development without all the conditionality and all the trappings around the old institutions, is going to be an important part of the contribution that Brazil is going to make."

What is important is how well BRICS countries will come together for an effective, transparent, hegemony free leadership that would pave way for a healthy engagement of the recipients and beneficiaries in risk management and coordination.

The combined efforts of two power blocs and three developing economies in the world is a great initiation by the BRICS countries for helping the countries in need. They must rise above regional and ideological difference and must create a mechanism for united action and strong decision making.

By Sundaraju Srinath

The writer is a Chartered Accountant