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Kennedy famously called Washington, D.C., a city with Southern efficiency and Northern charm. The new BRICS bank announced this week displays the emerging economies’ desire to move away from Washington-style lending institutions. But between Indian bureaucrats loath to make decisions and China’s reputation for steamrolling humanitarian and environmental concerns, they may not move very far away after all. This blog reviews some of the challenges the New Development Bank will face.
How were the BRICS countries able to agree?
Simply reaching sufficient agreement to announce the new bank represents a significant achievement for the 6-year-old BRICS group. While it may seem silly to organize a serious international grouping based on a clever acronym, the BRIC countries are the four largest economies in the developing world. (South Africa was admirably added to Brazil, Russia, India and China somewhere along the way to include an African representative, although there are nine larger developing economies, including Nigeria’s.) They have economic heft, but do they have much in common?
State-owned bank assets, % of total (2010). Source: Global Financial Development Report 2013 and China Financial Sector Assessment Program Report 2011.
Unlike OPEC, for example, their economic fundamentals differ dramatically. Russia, Brazil and South Africa export different commodities, while China exports manufactured goods and India exports services. Two are current account surplus and three are deficit countries.
What they most need to succeed is trust. Russia and India have long histories of conflict with China. Brazil and Russia are not famous for being creditworthy. South Africa is a solid neutral party, but also, frankly, a lot less significant than the other members. Apparently, their joint desire to plant a flag on the global economy sufficiently overcame these differences.
Escaping Western hegemony over lending policies
What does it mean for a development bank to be freed of the dominance of developed economies? Where have these countries disagreed with developed countries on World Bank policy, for instance?
The preponderance of the friction on lending policy at the IFIs (international financial institutions) reflects typical lender-borrower conflict. Developed countries, most often net lenders, want high standards to make sure money is used responsibly and repaid. The developing countries, most often net borrowers, resent outsiders imposing conditions on the use of money inside their own country.
The conditions placed on loans are broadly either prudential or values-based. Prudential conditions protect the financial integrity of a loan — ensuring that the money is used wisely and gets repaid. Values-based conditions protect its moral integrity, ensuring that money does not fund unsavory activities.
Any lender must pay attention to prudential concerns to survive. But given business practices in the BRICS — especially where government is involved — this cannot be taken for granted. The BRICS have not been enthusiastic about World Bank scrutiny and transparency in the past.
The benefit of maintaining high-minded lending values can be more reasonably debated. High environmental standards, for instance, may feel like a luxury that poor borrowing countries cannot afford. Some Western-imposed mandates feel more like development fads. Most are legitimate values that the BRICS should aspire to follow.
If the BRICS are comfortable with lowering their lending standards I do not doubt they will find plenty of projects to fund — and it is best that the existing IFIs are not affiliated with it. If they are not, and are able to maintain high standards, then it is not clear where their comparative advantage lies. As Robert Kahn at the Council on Foreign Relations rightly identified, the World Bank and regional development banks largely fill current demand.
Getting institutional governance right
From recent announcements, it seems the BRICS bank will take a very democratic approach to governance by giving each member equal voting rights. Undoubtedly there is value in such an equal arrangement for symbolic solidarity, as well as to avoid concerns about Chinese domination. But is it practical?
Some consideration rests on the allocation of vetoes. If equal voting rights means equal veto power, like in the U.N. Security Council, the institution may be doomed.
Despite its shortcomings, this arrangement may be the only way to overcome their mutual trust deficit. Mihir Sharma has already pinned the BRICS bank as a vehicle for the Chinese to commandeer the friendlier public image of the three southern BRICS as a front for China’s foreign economic policy. Maybe Russia had the same thought as China. They are the two countries best placed, by virtue of their structural current account surpluses, to provide more funds for institutional growth. But such funds rarely come without strings.
On the other hand, can an institution survive that is funded primarily by China and Russia when their voice and vote is no greater than any other member? If adequate checks are put in place to prevent Chinese dominance, will China remain interested in this project?
This works as long as the countries with underweighted representation (by IFI standards) see long-term value in the institution. For instance, Sharma cites “Jim O’Neill’s theory, that the BRICS bank is a ‘low-risk rehearsal’ for the global leadership role at the IMF, the World Bank and the U.N. that China expects to shortly play.” That would not convince U.S. taxpayers to accept such a bargain, but China and Russia have less need to answer to their own taxpayers.
Difficult decisions ahead
The BRICS clearly want something tangible to demonstrate their global prominence and the power of non-Western values. Yet the new BRICS bank faces two critical tensions that its members must navigate. The first challenge pits the desire to be free of the IFI’s constraints on lending that chafe developing countries against the need for prudential lending. The second sets the high-minded desire for equality of governance against the reality that lack of Chinese dominance may result in institutional neglect by the bank’s primary benefactor.
While the BRICS bank project was put together in an impressively short two years, most of the difficult decisions remain unanswered. These tensions will not be easily resolved, and will determine the bank’s viability. I expect it will be several years before the details are sufficiently ironed out for the BRICS bank to open its doors.
Russell A. Green, Ph.D., is the Will Clayton Fellow in International Economics at Rice University’s Baker Institute. Green spent four years in India, where he served as the U.S. Treasury Department’s first financial attaché to that country. His engagement in India primarily focused on financial market development, India’s macroeconomy and illicit finance, but included diverse topics such as cross-border tax evasion and financing global climate change activities.