Move Over, IMF: BRICS Bank Aims to Rewrite the Rules of Development
On July 15, the action in Fortaleza will shift from the football pitch to the political high table. The Brazilian seaside city that has hosted many of this year’s FIFA World Cup games is scheduled to hold the 2014 BRICS Summit, where leaders from Brazil, Russia, India, China, and South Africa will meet to establish ...
On July 15, the action in Fortaleza will shift from the football pitch to the political high table. The Brazilian seaside city that has hosted many of this year's FIFA World Cup games is scheduled to hold the 2014 BRICS Summit, where leaders from Brazil, Russia, India, China, and South Africa will meet to establish a long-awaited development bank that aims to balance the influence of the IMF and World Bank.
On July 15, the action in Fortaleza will shift from the football pitch to the political high table. The Brazilian seaside city that has hosted many of this year’s FIFA World Cup games is scheduled to hold the 2014 BRICS Summit, where leaders from Brazil, Russia, India, China, and South Africa will meet to establish a long-awaited development bank that aims to balance the influence of the IMF and World Bank.
Called "New Development Bank," the BRICS bank is expected to foster greater financial and development cooperation among emerging markets. The plans have yet to be finalized, but reports say each of the BRICS countries may contribute $10 billion in initial capital to the entity, which will have a maximum value of $100 billion. The bank will also establish a $100 billion reserve fund, with China contributing $41 billion, Brazil, Russia and India giving $18 billion each, and South Africa contributing $5 billion.
The term "BRIC" was coined in 2001, essentially as a marketing term for Goldman Sachs, and the group has long been derided for its lack of a coherent stance on major economic and political issues. But the establishment of the development bank, a historic challenge to the Western-dominated international system, shows the five emerging economies are taking their partnership seriously. The accomplishment appears that much more significant when viewed against the backdrop of the United States’ continued failure to endorse IMF reforms.
The BRICS — a group that represents more than 40 percent of the world’s population, about a quarter of global output, and nearly all of the world’s current growth — looks set to regain its geopolitical "mojo."
Putting Wealth to Work
The purpose behind creating the BRICS’s New Development Bank is twofold. First, the bank will benefit emerging markets by putting excess capital to work in financing large infrastructure projects. The BRICS countries have combined foreign-currency reserves of $4.4 trillion that will enable them to inject new vigor into long-term infrastructure financing in the developing world. Emerging markets also have a huge unmet demand for infrastructure investment: Addressing a BRICS summit in March 2013, South African President Jacob Zuma said the BRICS countries collectively need $4.5 trillion in infrastructure investment over the next five years.
Financing carried out through the BRICS bank will likely not only entail lower borrowing costs, but also fewer conditions than similar financing arrangements with the World Bank. The World Bank has historically focused more on poverty alleviation and clean energy projects than large-scale infrastructure development, and its loans often come with strict conditions for borrowers, including measures to enhance financial openness and improve human rights. Asian countries that have balked at this kind of interventionism may find BRICS bank loans appealing.
Second, the new entity will function as a currency reserve to aid countries in times of crisis and external shocks, especially against massive currency fluctuations caused by changes in monetary policy in advanced economies.
Since the financial crisis, the United States has embarked on a massive bond-buying program known as quantitative easing (QE) in an attempt to reinvigorate its domestic economy. By pushing U.S. interest rates to historic lows, this flood of easy money also spurred financial flows into emerging markets, which have offered investors higher returns. Foreign direct investment into BRICS nations reached $263 billion last year, accounting for 20 percent of global foreign direct investment, up from 6 percent in 2000, according to the United Nations Conference on Trade and Development.
But now that the U.S. Federal Reserve has begun scaling back or "tapering" its QE program, that flow of funds to emerging markets has begun to reverse — sparking concerns that an exodus of portfolio investment could destabilize emerging markets. That fear is especially acute in India, which has run continuous current account deficits over the years and experienced a currency crisis last year.
India’s central banker, Raghuram Rajan, has been at the forefront in cautioning about the negative spillover effects of a highly accommodative monetary regime in the West. Rajan’s call for greater monetary policy coordination has found little traction among central bankers in advanced economies. The Fed has rightly pointed out that its mandate is to worry about the U.S. economy, and not about the global impact of its domestic policy.
A currency reserve for emerging markets is the best way to soften the blow. While the proposed reserve will not be large enough to rein in exchange rates in the long term, it could help cushion the short-term impact of capital outflows and exchange-rate volatility. China, for instance, has nearly $1.27 trillion sitting in low-yield U.S. Treasurys. In times of crisis, it could offer some of these reserves as short-term "dollar liquidity" to vulnerable members through the BRICS bank’s multilateral reserve framework.
India’s Modi Moment
The financial and trade connections between emerging economies have historically been weak. While this relationship changed dramatically in the last decade, the economic interactions between emerging markets are still only a fraction of those between emerging markets and the West. Bilateral trade between India and China, for example, grew from less than $3 billion in 2000 to $65 billion in 2013 — yet that number still seems minuscule compared with the $579 billion in goods and services that the United States and China exchanged in 2013.
But the BRICS bank could open up the possibility for new and virtuous cycles of trade and financial flows among emerging economies. And India is strategically positioned to play a role in the bank’s success.
For nearly a decade, countries like India have benefited from increasing global liquidity flows. The low interest rate regime during Alan Greenspan’s tenure at the U.S. Federal Reserve and the Fed’s monetary easing after the 2008 global financial crisis injected an enormous amount of liquidity into the global monetary system. This helped finance an investment boom in emerging markets like India that is quickly going bust as liquidity tightens in the United States. Meanwhile, a slowdown in China continues to weigh on commodity-driven economies such as Brazil and South Africa.
But consider this: Narendra Modi, India’s new prime minister, is attempting to transform India into a manufacturing powerhouse. If India succeeds in building out its industrial capacity, upgrading its infrastructure, and urbanizing its economy, it could trigger the next commodity boom that will benefit Brazil, Russia, and South Africa.
Such a transition in India would likely depend on a new "tide of liquidity" originating not only from the United States and other developed markets, but also China. Flush with capital, China is already emerging as the banker to the developing world. In 2010 alone, China’s state-owned banks extended a $3 billion loan to Reliance ADAG, an Indian power and telecommunications company, and a $1.2 billion loan to Brazilian iron-ore giant Vale.
The renminbi is the fastest-growing major currency in the world today and is the second-most commonly used currency in trade finance. Access to renminbi financing through the BRICS bank could spur greater capital flows and streamline trade between China and the rest of the BRICS, including India.
This possibility makes a compelling case for a new financial entity outside the control of the United States and Western Europe. The BRICS bank has a unique opportunity to strengthen the web of interdependence among the emerging markets. Moreover, a multilateral framework like the BRICS bank will allow borrowers to avoid direct credit arrangements with state-owned Chinese banks. Some borrowers have accused China of withholding loan disbursements at strategic junctures to influence other outcomes in the recipient country.
Brave New World
Despite this web of complementarities between the BRICS, obstacles remain that could pose a long-term challenge to the bank’s operations. For one, the BRICS grouping encompasses a dizzying array of values, political structures, and geopolitical interests.
One small example is the territorial disputes between India and China. What policy architecture will the new development bank adopt for projects in disputed areas? In 2009, India and China wrestled over a $2.9 billion loan from the Asian Development Bank (ADB) to fund India’s infrastructure, including a $60 million watershed development project in the "disputed" northern state of Arunachal Pradesh. At the ADB, the United States and Japan can play arbiter to such disputes. But this mechanism may be absent in the BRICS bank, where China will likely exercise greater leverage due to its economic strength.
Even so, the political significance of the New Development Bank should not be lost on anyone. The BRICS summit comes on the heels of significant geopolitical shifts in recent months. The Russian invasion of Crimea has reignited frictions between the West and Moscow, prompting a new Asian realignment between Russia and China. The $400 billion gas deal between the two countries is the first major global energy transaction that seeks to bypass the U.S. dollar.
Even as the BRICS forge stronger economic and investment ties, the grouping could also strengthen due to converging security interests. The three major stakeholders, Russia, India and China, already share common security and economic interests in a post-2014 Afghanistan, raising the possibility of a trilateral framework of cooperation in the strife-ridden country.
Buoyed by a rising tide of rapid economic growth, the BRICS have shifted the global economic balance toward the developing world in recent years. However, the international monetary system remains unipolar in character and dominated by the West. If the BRICS succeed in their upcoming negotiations, the New Development Bank could mark a significant step toward a multipolar financial order.
Shrey Verma and Ana Swanson are M.A. candidates at the Johns Hopkins School of Advanced International Studies in Washington, D.C. Follow them on Twitter at @shrey7 and @AnaSwanson.
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