The world’s nouveau riche nations intend to buy themselves a space at the global development table.
On March 28 the leaders of the Brics countries – comprising Brazil, Russia, India, China and South Africa – announced a plan to create their own development bank at their fifth annual meeting in Durban, South Africa.
The new, yet-to-be-named institution will be a bank for emerging markets by emerging markets, and its aim will be to do a better job than existing supranational lenders when it comes to distributing funding.
Given that the five participating nations boast a combined gross domestic product (GDP) of nearly US$15 trillion, or 25% of the world’s GDP, they can afford to create such an institution. And there’s certainly demand.
“There is a lot of need for [more funding among] developing and emerging economies,” Carlos Márcio Cozendey, Brazil’s secretary of international affairs at the Ministry of Finance, tells Asiamoney. “Of course, they have access to markets and their own resources, and multilateral institutions such as the World Bank and regional ones like the African Development Bank [AfDB], CAF [Corporación Andina de Fomento] development bank in Latin America and the Asian Development Bank...but they’re not able to supply all the needs that those countries have.
“The idea is to have a lean institution – not something like the World Bank that also has the purposes of research and policy advice and other things. Rather, an institution that would be concentrated on infrastructure and sustainable development projects.”
The new Brics bank’s ostensible purpose is to help meet a US$2 trillion-plus need for infrastructure among emerging markets, of which only US$800 billion-US$900 billion is being met, according to the World Bank.
But politics, not altruism, is a key reason for its creation. The five nations hope that a successful development bank will give them a stronger voice on the global stage.
The Brics countries have, to varying degrees, all sought greater influence in their respective regions, but earning it has been difficult. The leadership of the most prominent existing supranationals is skewed towards the developed world: the US heads up the World Bank’s lending efforts, Japan leads the Asian Development Bank (ADB), a Western European individual traditionally runs the European Bank of Reconstruction and Development and France’s Christine Lagarde leads the International Monetary Fund (IMF).
For the world’s largest emerging economies to build their own institution would offer a clear statement to the Western world about their increasing confidence and financial prowess. It underlines a simple message to smaller emerging markets: you don’t need to look solely to the West for support.
But building a successful new supranational will not be easy. The backing countries are neophytes at leading multinational organisations of this magnitude, and there are major geographic, political and cultural distances between them. The Brics will have to agree where the bank will be headquartered, how the investments are to be divided and which nation will lead the charge.
“The challenge is monumental, and there is pressure because this is history in the making – when you see the creation of the IMF and the World Bank, the makeup is so important. It’s the early decisions and developments that become your legacy,” says Abdullah Verachia, co-founder and partner at South African emerging-market consultancy firm Frontier Advisory, who was present at the Durban talks. “The countries are absolutely motivated to launch this bank, but the devil is in the detail and the responsibility rests on their collaboration.”
The supranational will only live up to its potential if each founding country can set aside its own interests. It’s a task that China, the world’s second-largest economy and likely initiator of the Brics bank idea, may find particularly difficult.
Pulling their weight
It’s not difficult to see why the five Brics nations feel underrepresented on the world stage.
They account for more than 40% of the world’s population, and 25% of its GDP. By 2020, the combined economic output of Brazil, China and India is expected to surpass the aggregate production of the US, Germany, France, the UK, Italy and Canada, according to the United Nations Development Programme’s 2013 Human Development Report. All of the countries except South Africa are in the world’s top 10 economies by size.
The Brics’ rising economic strength has increased their influence in other countries. External investment from the five nations rose from US$7 billion in 2000 to US$126 billion in 2012, led by China and Russia. This was a rise from 1% of the world’s investment flows to 9%.
Yet while the five countries boast the financial heft to support a development bank, they have yet to demonstrate the sort of cooperation needed to do so. Since the first official Bric summit in Yekaterinburg, Russia in 2009, the group has announced hardly any concrete developments.
Cooperation will not be made any easier by the nations’ profoundly different political cultures. China has a single-party communist government, Russia and South Africa one-party winner political systems, while India and Brazil boast vibrant but somewhat chaotic democracies. This affects each country’s priorities and attitudes towards global issues.
“There were a lot of us at Durban who were amazed an agreement was actually reached to create a bank,” says Anthony Thunström, chief operating officer of KPMG’s global Africa practice.
Given these differences, the rhetoric surrounding the idea of a Brics bank was deliberately abstract when the idea was first raised at the fourth Brics summit in Delhi in 2012. However, the nations evidently feel that these are surmountable obstacles, given the leaders’ more decisive language in Durban.
“Everyone was quick to point out the million and one reasons why this is very challenging. But the Brics assessed the feasibility, felt positively about it and reached an agreement,” says Thuström. “The conversation very speedily moved from ‘This is unlikely to happen’ to ‘Wow, it’s going to happen’.”
To ease worries about cooperation, the five countries announced at Durban a US$100 billion relief fund to safeguard against future economic crises. This fund will support any Brics nation in the event of economic disaster, expressly countering the IMF’s traditional role. It is designed to underline the countries’ seriousness about capital collaboration and mark the first step towards building the development bank.
Bric by Bric
Details on the upcoming bank are still emerging, but sources close to the decision-making have outlined key ideas that will lay its foundation.
The Brics countries intend to commit US$10 billion apiece to finance the launch. It looks a small sum given the size of some of their economies, and is a fraction of the World Bank’s US$136.3 billion outstanding loan portfolio as of the 2012 fiscal year. But it’s a start.
A representative from Russia’s Ministry of Finance tells Asiamoney that Brics leaders who met in Washington during the week of April 22 decided to create delegations – comprising senior finance ministry and central bank members – to hammer out the specifics of the new institution.
Proposals on the bank’s operational activity must be decided before the G20 leaders meeting in St. Petersburg on September 5, where the Brics hope to make the first announcements about the new supranational. The countries also hope to have decided on the bank’s headquarters, plans for its leadership structure, a voting model and the focus areas for investments – each a topic that onlookers are keen to hear about given that they are potentially contentious.
After the meeting the countries will begin the second stage of planning, including creating the necessary documents and intergovernmental agreements. Brazil’s Cozendey says that the goal is to get the countries’ legislators to approve the capital commitment for the bank and work from there.
This group would pick projects on a case-by-case basis, taking both the borrower and the poverty of the home country into account. It’s a model that appears to follow that of the ADB and other supranationals.
Infrastructure projects were intended to be the original focus of the Brics bank. However, in Durban the leaders of the five nations extended discussions to include mineral beneficiation and green energy projects.
The aim is to launch the bank at the sixth Brics summit in Brazil in March 2014. Its first investments are likely to take another year.
Politics at play
The plans look logical, but several issues remain. For a start, each founding nation will want a turn at steering the bank, believing it is uniquely positioned.
China, for example, has the most money and the most experience investing into global development projects. South Africa, which gained acclaim for its successful Durban summit, could argue that it should play a central role because Africa most desperately needs infrastructure financing.
“The Brics countries are competitors for FDI and influence. There will be problems that they won’t see eye-to-eye on and they won’t be able to avoid side-stepping key issues if they all have to collaborate on the direction of a multibillion dollar bank,” says Verachia. “Will this be a problem? I think it can be, and thus the allocation of power and responsibility is so important.”
Participants at Durban say for now South Africa looks the likeliest candidate for the bank’s headquarters. Geographically it’s the most centrally located among the Brics members, and its financial markets are among the most transparent and sophisticated of the group.
The identity of the first president is also uncertain. The role may rotate in conjunction with the Brics presidency, which changes after the annual summit. The country that holds the presidency after each summit – now Jacob Zuma, president of South Africa – could appoint a new president for the bank from their finance cabinet for a year-long tenure, while the other nations hold equal voting power in vice-presidency roles.
While this solution would be equitable, the Brics leaders must ask themselves if one year is long enough to make a difference. The World Bank, ADB and AfDB’s presidencies are five-year terms to ensure continuity. While the Brics countries will battle to name a single leader for a long term, there is value in maintaining a leadership administration for long enough to enact change. A minimum three-year presidency would help.
The biggest uncertainty hanging over the Brics bank is the commitment of its founding nations to the concept. Sceptics feel the primary purpose is to pressurise existing supranationals to reform in favour of capital-rich emerging nations. If that happens, the need for a Brics bank could dissipate.
“I am not sure when this proposal to create a new Brics bank is likely to take place, or even if it ever will. I am also unsure as to whether we really need another development bank,” says Jay Menon, lead economist, trade and regional cooperation, at the ADB. “What is more important, and I think this is what is driving this proposal, is reform of existing global multilateral institutions.
“The current architecture of the World Bank and IMF is somewhat outdated, and no longer reflects current geopolitical circumstances. If such reform, which is long overdue, can take place, I think much of the motivation and momentum underlying the current proposal will diminish.”
Credibility issues
The best way for the Brics nations to rebut cynicism about their sincerity would be to upgrade their commitment to the bank.
The Brics bank’s proposed US$50 billion in starting capital is a blip in emerging-market needs. By comparison, the World Bank claims approximately US$205 billion of subscribed capital from its 188 members while the ADB has US$165 billion of general capital.
“Unless the bank is of a reasonable size, people won't take it seriously,” says Peter McCawley, visiting fellow at the Australian National University and former chair of the ADB's Asian Development Fund X negotiations. “There are thousands of small banks around the world and if the Brics bank is just another one, it won't get very far. It might have a small amount of political importance apart from the loans, but at the end of the day, only a small amount. If it wants to be taken seriously, it needs to be reasonably large.”
The bank’s relatively low capital level is also the product of politics. The ability of each nation to inject money varies, which is why a relatively low US$10 billion apiece was agreed.
This sum is a starting point, but the Brics should agree to at least double the total pool by a specified date in the near future. Each nation could agree to add US$5 billion apiece each year for the coming three years, for example, while slowly opening the bank’s doors to new members, who can also join after contributing capital.
This could be an invitation for other emerging markets to participate, or for developed countries such as the US and UK to play a supporting role too.
Of course the Brics bank will also eventually follow the example of its supranational peers and issue debt. The ADB’s estimated borrowing requirement through 2015 is US$14 billion-US$16 billion annually. The World Bank has a US$30 billion funding requirement for 2013 and had US$145.3 billion of bonds outstanding by June 30, 2012. The AfDB plans to borrow US$5.6 billion from the capital markets in 2013.
This raises another problem. Supranationals need to be able to raise low-cost funding to lend on to needy projects or to support credit guarantees. This requires a high credit rating, and the ADB, World Bank and IMF all enjoy ‘AAA’ ratings, largely due to their sponsors.
“Because of our AAA rating, we are able to mobilise funds from the market on sub-Libor basis. We pass on these benefits to our borrowers. We lend to sovereign governments at the cost of our borrowing, which is sub-Libor, plus maximum of 40 basis points. Our lending rates for private entity is risk-weighted,” says Indu Bhushan, deputy director general of the ADB’s strategy and policy department.
But the sponsors of the Brics bank are not highly rated themselves. S&P rates Brazil, Russia and South Africa ‘BBB’, and India at only ‘BBB-’, a notch above junk level. China is rated ‘AA-’, but this is still three notches lower than its supranational peers.
The bank’s backers argue that the rating agencies will view the combined backing of several countries in a positive light. “We have not determined one specific rating that this bank would obtain but there is generally an idea that we would have a higher rating than the countries’ ratings, of which the highest now is China,” says Cozendey. “We believe this because the idea is to have a strong capital structure, a conservative leverage ratio and good projects.”
The mission isn’t impossible. The AfDB is also rated ‘AAA’ despite many members holdings ratings well below that. But it was able to achieve this rating because it counts a list of non-African members contributing to management and funding, including ‘AAA’-rated Germany, Norway, Switzerland and the UK.
Adding similar Western nations as supporting members (in exchange for small capital commitments) may achieve a similar role. But it will be hard for the Brics bank to attain an ‘AAA’ rating if the Brics keep the institution between themselves.
“To get an ‘AAA’ rating when all members are rated notches below that is going to be more difficult,” says the national head of a global ratings agency within one Brics country. “Not all development banks need to be ‘AAA’-rated because issuing debt less expensively depends on who is investing in these bonds. It could be central banks of Brics who are willing to guarantee the bonds.”
He adds that China is the most obvious supporting candidate, given its financial strength. “Maybe it can find opportunities in this.”
China in control
Giving China a larger role would be a quick means to offer the Brics bank more capital too.
The country can certainly afford it. China’s GDP in 2012 was US$8.25 trillion, more than the other Brics combined. Second-place Brazil’s GDP was US$2.43 trillion, India and Russia had approximately US$1.95 trillion apiece, while South Africa’s was just US$390 billion.
China is certainly willing to put more money into the pot. Sources say the country wanted the bank’s initial capital to be US$100 billion – and offered to front the cash for any country reluctant to contribute a full US$20 billion.
But Brazil, India and South Africa are believed to have opposed its suggestion, hoping instead to start small and introduce parity at the outset (see box on previous page).
Observers say their caution is well-placed.
“There’s a simple rule in many of the multilateral agencies: the more money you put in, the bigger your voice – money buys votes,” says McCawley. “That’s the truth of the matter. I’ve seen it again and again. And that will be a consideration for the Brics, too. The more money a country like China puts into this bank, the more influential it will be. It will largely buy its position in the bank.”
Others note that China wants to use the participation of the other Brics members in a new supranational as a stalking horse for its own international ambitions.
“China has motivations,” says one executive at a global development bank. “Sceptics see the Brics bank, if it happens, as a way for China to take a growing role in a multilateral, and disguising aid to the countries it has interests in by channelling it through a multilateral institution.”
Greater backing from China would certainly offer the institution more capital clout. But it would also undermine the equality of supporting nations. If Beijing wishes this new supranational to have true international respect, it will need to show that it can take a backseat as a gesture of cooperation. This will earn it the respect of sceptics.
“China has the power to be a very particular team player within the group,” says Verachia. “It has its own interests in mind but if you look at the developments that China was able to make last year, it contributed 50% of all infrastructure spending in Africa, worth US$46 billion. China has been a very active and knowledgeable player and that’s been recognised. It can go even further to play a key role in managing relationships with other countries.”
Maintaining focus
Even if the Brics nations do retain equality in capital contributions, they should offer a plan to increase their US$10 billion contributions within a few years.
Each nation could, for example, agree to offer further commitments of US$5 billion in 2015 and 2016, gradually raising the baseline capital level until the bank’s financing is at least in the realm of the World Bank’s.
This discussion is likely to be under way already, along with the possibility of opening the bank’s balance sheet to outside donors. Allowing the US or European countries to make smaller contributions would be a smart strategy, acting as a show of cooperation and helping to maximise the bank’s lending potential and its status as an international platform.
To make that possible, the Brics must draft a constitution to serve as a foundation as more members join. A clear leadership structure, a formula for investments and member protocols are all needed to keep all participants content and to avoid ostracising future members.
If the Brics nations can agree on these steps and maintain their commitment to the project, the odds are that this new development bank will get off the ground. It will still need to prove that it has the coordination and wisdom to invest its money wisely, but that will come with experience.
Political posturing may constitute a large part of the rationale for the creation of the Brics bank, but the new supranational will be able to do good in some of the neediest parts of the world.
Its emerging-nation backers should strive to ensure that it is both properly constructed and run. That would be the best way to demonstrate why they deserve to be taken seriously on the global stage.