BRICS' New Development Bank: Turning Tables?

The BRICS leaders early this week reached an agreement to establish a new development bank with an initial capital amount of $50bn, contributed equally by each of the five emerging markets - Brazil, Russia, India, China, and South Africa; as well as a currency exchange reserve of $100bn. This news has ignited hot debates all around, as people are taking sides in (1) whether the bank can effectively challenge the roles of the World Bank and IMF, institutions led primarily by the West, in international lending and (2) whether it can really aid better economic development and poverty reduction in developing countries.

In my opinions, question (1) is important because a success in replacing the West-led world financial system precedes the transfer of world power in the near future. Of course, it should not really matter if A runs the world's largest bank or B does, unless A and B have very different foreign (political) policies and abuse the financial system to enforce impose such policies on other countries, which, sadly, has always been and will always be the reality. However, after all, question (2) is what really matters.

CHALLENGE TO THE WEST?

Exactly around this month 70 years ago, world leaders met at the Bretton Woods Conference to establish both the World Bank (formally, the International Bank for Reconstruction and Development) and the IMF, in which the key players in this creation was the United States and the United Kingdom. Since then, the World Bank has always been led by a US-nominated president and the IMF a European. The creation of the BRICS Development Bank this time around is a clear adoption of the Bretton Woods-type international finance.

Challenge to the West or not, the creation of this bank and the reserve fund will definitely give the emerging markets more independence for their public finance and financial crisis prevention. Though not formally recognized, funding and loans from the World Bank and IMF are often subjective and not purely economic. Some claimed that the first loan ever of the World Bank, which was granted to France for post-war reconstruction purpose, came with the demand from the US that the France government must end its coalition with the Communist party. What can guarantee that the (US-influenced) World Bank or the (EU-led) IMF would nicely provide a helping hand, say, should Russia have a balance of payment crisis in midst of the Ukrainian chaos that is currently happening? Apparently not. Having its own bank and reserve fund clearly helps BRICS insulate their world affairs policies from economic risks.

There is no doubt that the BRICS bank and its reserve fund could never rival the West's counterparts in size, unless some of the top emerging markets maintain the kind of economic growth of China for 10-20 years. Currently the World Bank has ~$324bn worth of assets, and the IMF has $368bn in its reserve quotas, with additional pledged/committed resource of $1 trillion. So the World Bank has 6 times more capital and ratio of BRICS reserve fund to IMF fund stands at 1/10. Due to the fact that rich countries contribute a lot more to the WB and IMF, even if smaller countries switch sides, these two institutions would still have plenty of money available for lending. So, talking about sizes, the BRICS bank seems like a David in front of the Goliath World Bank; not to mention that the BRICS reserve fund might actually be ineffective. Remember that even an economy as small as Greece, when in crisis, requires a lot of capital assistance to get out. The EU and IMF had to provide joint support for this one country 110 billion euros in May 2010, and an extra package of 100 billion euros in July 2011. This number is almost triple the total fund that BRICS has in its new exchange reserve.

Of course no country in BRICS has economic fundamentals as bad as those of Greece (the highest level of public debt in BRICS is 54.9% of GDP in Brazil, compared to Greece's 161.3%, for example), there is still a little problem: systemic risk. Many of these countries are vulnerable to exchange rate and capital flight (sudden-stop) risk, which could and tend to happen to many of BRICS countries at the same time. We still remember when Fed first talk about tapering last summer, Brazil, India, and South Africa all saw huge depreciation of their currencies, which led them to be listed in the so-called "Fragile Five" - the five economies that are extremely sensitive to investors' mood. If these three need credit assistance all at once, that leave $33.3bn for each, perhaps not enough to solve a serious crisis.

Thus, even with their own reserve fund, I doubt that BRICS dare to stand up against the IMF any time soon.

BETTER DEVELOPMENT FUNDING?

As several newspapers point out, this development bank can win the hearts of many African countries which are in desperate need for international funding but could not borrow much due to potential fiscal and structural adjustments that the WB and IMF require as part of the loan packages, not to mention other conditions regarding  human rights, environmental, etc., the values that the West impose on their borrower. BRICS may not care about this, however. Therefore, the creation of BRICS' bank certainly makes credit more accessible to poor countries.

Considering the fact that several structural adjustments imposed by the IMF and WB have been harshly criticized and accused for impeding growth (e.g. worsening the Asian currency crisis 1997-1998), if BRICS choose to have more lenient lending conditions, it may be good news for developing countries. Or, maybe not. I'm simply afraid that imprudent lending would allow (fiscally irresponsible) governments to misspend. The worst scenario for a poor nation would be to spend easily borrowed money on the wrong public projects, since not only it would not bring about economic changes, it would also accumulate huge public debts for that country. Therefore, until the BRICS bank goes operational in 2016 and lays out clearly its lending platform, it is hard to conclude whether this new bank can aid better development for developing countries.

In the end, I don't care much about who leads the world's banking and reserve funds; what really matters is who can better boost growth in developing countries. All BRICS countries have impressive records of economic growth and poverty reduction. However, talking about sustainable growth, I'm a bit skeptical of China, so until it's proven otherwise, let me stay affirmative to the World Bank.