For the BRICS bank, a tough road ahead

 Published: July 23, 2014

Russell Green

The announcement of a new BRICS Bank displays the desire of emerging economies to move away from Washington D.C.-style lending institutions. But between India’s bureaucratic efficiency and China’s indifference to humanitarian, environmental and regional concerns, they resemble John F. Kennedy’s tart characterisation of the very place they hope to leave behind. Much work lies ahead for the creators of these new multilateral financial institutions before the first loan can be made.

How were they able to agree?

Simply reaching sufficient agreement to announce the new BRICS Bank represents a significant achievement for the six-year-old BRICS group. While it may seem silly to organise a serious international grouping based on a clever acronym, the BRIC countries are the four largest economies in the developing world. They have economic heft, but do they have much in common?

Unlike, say, OPEC, 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.

 There may be value in giving each member equal voting rights in the institution to avoid concerns about Chinese domination, but it may not be practical 

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. So apparently their joint desire to plant a flag on the global economy sufficiently overcame mutual differences.

Escaping Western hegemony

What does it mean to be freed of the dominance of developed economies for a development bank? Where have these countries disagreed with developed countries on World Bank policy, for instance?

The preponderance of the friction on lending policy at the International Financial Institutions (IFIs) 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.

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 governments have not always been enthusiastic about World Bank scrutiny and transparency in the past. They must be vigilant to ensure that BRICS Bank money is used wisely and gets repaid.

Developed countries have also imposed high-minded lending values, the benefit of which 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. But if they are, it is best that the existing IFIs are not affiliated with it.

If they do maintain high standards, then it is not clear where their comparative advantage lies. As Robert Kahn at Council of Foreign Relations (CFR) rightly identified, the World Bank and regional development banks largely fill current demand.

From what has been announced, 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? The allocation of vetoes matters. If equal vote means equal veto power, like in the UN 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.

On the other hand, can an institution survive being funded primarily by China and Russia, the only two BRICS with excess reserves, when their influence 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 they see long-term value in the institution. U.S. taxpayers would not accept such a bargain, but China and Russia have less need to answer to their own taxpayers.

Unanswered questions

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. The first pits the desire to be free of Western-imposed constraints on lending, versus 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 its primary benefactor.

While the BRICS Bank project was put together in an impressively short two years, most of the difficult questions remain unanswered. These tensions — critical to the bank’s viability — will not be easily resolved. I expect it will be several years before the details are sufficiently ironed out for the BRICS Bank to open its doors.

(Russell Green is the Will Clayton Fellow for International Economics at Rice University’s Baker Institute and a former U.S. Treasury official.)