Thursday, October 30, 2014

Banking on the BRICS

BERKELEY – For the leaders of the BRICS countries (Brazil, Russia, India, China, and South Africa), the announcement in July of their agreement to establish a “New Development Bank” (NDB) and a “Contingent Reserve Arrangement” (CRA) was a public-relations coup. The opportunity for a triumphal group photo was especially welcome for Brazilian President Dilma Rousseff, in light of her country’s ignominious World Cup defeat and slack economy, and for Russia’s President Vladimir Putin, given the international reaction against his government’s support of the rebels in Ukraine.

The agreement was also an opportunity for the five countries to reiterate their dissatisfaction with the World Bank, the International Monetary Fund, and the role of the dollar in the global monetary system. The BRICS possess just 11% of the votes in the IMF, despite accounting for more than 20% of global economic activity. The US Congress refuses to ratify the agreement reached in 2010 to correct this skewed state of affairs. And the United States has displayed no willingness to renounce its anachronistic privilege of nominating the World Bank’s president.

Meanwhile, the share of the dollar in global foreign-exchange reserves remains more than 60%, while 85% of global foreign-exchange transactions involve dollars. Given the reluctance of underrepresented countries to sign up for the IMF’s precautionary credit lines, central banks desperate for dollars can obtain them only from the Federal Reserve. The Fed was reasonably forthcoming in providing dollar swaps in the last crisis in 2008; but there is no guarantee that it will behave similarly in the future.

Thus, the BRICS’ dissatisfaction with the status quo is understandable. The question is whether their NDB and CRA will make a difference.

The logic for the NDB is compelling. The BRICS, and developing countries generally, have immense infrastructure needs. China may not have an infrastructure deficit, but it has something else: large construction companies that welcome the opportunity to undertake additional projects abroad. Hence the incentives of the NDB’s prospective creditors and borrowers are happily aligned.

Moreover, there already is a proliferation of regional development banks, from the Inter-American Development Bank and the Asian Development Bank to the more modestly capitalized African Development Bank. These institutions cooperate with the World Bank. Their existence creates no major problems for the Bretton Woods institutions.

There is no reason why the NDB should create problems, either. With initial capital of just $100 billion, it is too small to make a major contribution to global infrastructure needs. But inadequate capitalization can be corrected over time.

The CRA – intended to lessen the BRICS’ dependence on the Fed and the dollar – is another story. The five participants agreed to earmark $100 billion of their foreign-exchange reserves for swap lines on which all members are entitled to draw.

But here the interests of prospective borrowers and lenders are not obviously compatible. The next BRICS country experiencing a crisis will want to draw on the CRA. But the other members will hesitate to lend more than token amounts, especially if there are repayment doubts. In contrast to development finance, the incentives of potential lenders and borrowers are not aligned.

Permitting the lenders to impose policy conditions on borrowers, and to monitor their compliance, can redress this problem. But imposing conditionality on sovereign states is a delicate matter – especially when the countries involved are as large, proud, and diverse as the BRICS. It is difficult to imagine Brazil, for example, accepting policy conditions laid down by China.

Other attempts to establish networks of swap lines and credits, such as the Chiang Mai Initiative, which was negotiated in the wake of the Asian crisis, have been bedeviled by the same problem. The Chiang Mai network is even larger than the CRA. But, given the divergent interests of lenders and borrowers, it has never been used – not even in 2008, at the height of the global financial crisis.

The architects of the Chiang Mai Initiative attempted to finesse the problem by requiring countries that draw more than 30% of their swaps to negotiate a program with the IMF. Ironically, the “Treaty for the Establishment of a BRICS Contingent Reserve Arrangement” contains exactly the same provision. So much, then, for the CRA as an alternative to the IMF. And, if inclusion of that provision was not revealing enough, then there is the fact that the BRICS’ commitments to the CRA are expressed in US dollars.

The NDB makes sense for the BRICS, and it has a future. But the CRA is empty symbolism, and that is how it will be remembered.

Hide Comments Hide Comments Read Comments (3)

Please login or register to post a comment

  1. Commentedj. von Hettlingen

    Barry Eichengreen, "Banking on the BRICS" is - theoretically - not a bad idea! The five member states – Brazil, Russia, India, China and South Africa – account for more than 40 percent of the world's population, almost 20 percent of the world's total GDP and 17 percent of global trade. Despite slower growth in recent months, they still make a notable contribution to the global economy.
    The New Development Bank (NDB) that BRICS created last month in Brazil couldn't have been more appropriate to mark the 70th anniversary of Bretton Woods Conference, which created institutions like the IMF and the World Bank. The NDB will be a new challenger to IMF and the World Bank and the ranks of other similar regionally focused agencies. Its main goal would be to mobilise resources for infrastructural and development projects in BRICS as well as other emerging economies and developing countries. The NDB would bring resources into this important area. Even the World Bank acknowledges that more is needed. There's a gap between what is available and what is needed. The gap is estimated at $1 trillion in low and middle-income countries, and the demand for infrastructure continues to grow as countries develop.
    That the BRICS nations - which often see each other more as rivals than friends - could agree on a development bank ought to be seen as a wake-up call for the US Congress. The BRICS leaders have complained about unfair treatment for years. American administrations pushed to give them greater voices and votes. But European countries haggled and the Congress couldn't pass legislation to modernise and reform the IMF, which would give emerging countries a greater say.
    Despite their political and economic differences, the one thing the BRICS countries do share is an anti-Western, anti-dollar sentiments. What they also agree upon is that rich countries have too much power in institutions like the IMF (whose head is appointed by Europeans) and the World Bank (which is always led by an American). Brics nations have criticised the World Bank and the IMF for not giving developing nations enough voting rights.
    Brazilian President Dilma Rousseff said the BRICS nations had the power to introduce positive changes - equality and fairness. Their message is that they want a new world order, by creating clubs of their own to counter the existing system.
    The Contingency Reserve Arrangement (CRA) - " an alternative to the IMF" - is an emergency reserve fund, which will help developing nations avoid short-term liquidity pressures, promote further BRICS cooperation, strengthen the global financial safety net and complement existing international arrangements. Mr Eichengreen says "it will be remembered" as "empty symbolism", perhaps it has less chance to sustain as an institution.

  2. Commentedhari naidu

    My suspicion is that PRCs SILK ROAD project will become the first testing ground of NDB project financing under its first Indian management. The idea behind Silk Road is not only infrastructure development across the (ancient Asian) region but, in the process, facilitating trade and development, as a primary BRIC objective.

    XI seems to visualize that the new Silk Road will ensure that mainland China is never isolated from its neighbor's.

    For India, infrastructure development has become a priority and a social necessity to link up or network its vast subcontinent and states, as a development project.

    The CRA is fundamentally an instrument for a rainy day, methinks.

  3. CommentedHenri Erti

    Any other time of the year the establishment of the BRICS Development Bank and Contingency Reserve Agreement would have dominated the news given the significant ramifications to the existing international economic order. However, the grotesque events in Ukraine and Gaza rightfully stole the headlines and hence downplayed the agreement made between the countries involved to challenge the status quo in global monetary affairs. Nevertheless, taking into consideration the emergence of trade regionalism and the shift in the economic balance of power from the West to the East, collaboration between Brazil, Russia, India, China and South-Africa should be in fact expected. Albeit the timing for empowering cooperation between BRICS is favorable -- and to some degree even acute due to the sluggish performance of the advanced economies-- rivaling the IMF and World Bank is based upon political grievances and perceived economic injustice. Therefore, as the Economist aptly reminded, designing sophisticated acronyms is easier than running the institution that carriers them.!/2014/07/brics-development-bank-challenges.html