in the media

The New Development Bank: Not Merely a Bank

The BRICS bank is both an alternative to the IMF and the World Bank, and a triumph for cooperation over the pursuit of narrow national interests.

published by
China Investment
 on August 14, 2014

Source: China Investment

The impressive cooperation between BRICS countries has long been dismissed as purely for show and with little in the way of substantive results However, this time the group did cause a sensation. In July 2014, it announced the establishment of the New Development Bank (NDB) in Fortaleza, Brazil. Although the international public is taking a wait-and-see attitude toward the future institutional capacity and purpose of the bank, this cooperation has resulted in two achievements whose deep and far-reaching significance can hardly be denied or underestimated by anyone. One is that the NDB marks the beginning of efforts to build a new international financial order, and the other is a shift in international politics as a result of sincere and skillful cooperation between BRICS countries.

A new age of a new international economic order

The five member countries of the BRICS Group have never hidden their dissatisfaction and criticism of the existing international financial order. Following the failure of their attempts to reform the World Bank and the International Monetary Fund (IMF) from within, BRICS countries acted as a group in seeking alternatives to them, and the launching of the NDB and the Contingency Reserve Arrangement (CRA) that goes with it is a milestone achievement in this effort. The World Bank and the IMF are the multilateral pillars of the Bretton Woods system. They reflect the international economic system and the US dollar’s unparalleled dominance in the world financial system from the mid-20th century to the 1970s. Since that time we have seen a “fall of the center and the rise of the rest,” making the institutional arrangements and operational concepts of these two multilateral organizations long outdated. However, it is difficult to reform them. The veto power enjoyed by the United States in particular, has rendered all efforts to reform them from within useless.

The existing international economic and financial order is problematic, not only because rights do not match obligations, but because the power that some countries have in this system exceeds their importance as countries on the global stage. More importantly, because the two multilateral institutions are ineffective and inefficient with regards to developing nations, IMF-World Bank policies can have negative effects on emerging economies. The World Bank and IMF are not only criticized for this by the developing world, but their own economists and executives are also disappointed. The IMF’s slow response to financial crises and its insistence on “austerity” as a lending condition led to the spread of the crises and the continued post-crisis economic slowdown and even stagnation. The World Bank, however, whose duty is to solve problems hindering development, is overladen with bureaucracy and political bias so that its aid can hardly be effective and fair.

Preventing and responding to international financial crises

The establishment of the NDB and CRA is a serious and profound challenge to the current Western-led international economic order and global financial system. The five BRICS countries funded equally the NDB’s initial capital of $50 billion, and the bank is scheduled to start lending in 2016. The development bank is not named after BRICS in order to attract emerging economies from outside the group, including for example Turkey, Mexico, Indonesia, and Nigeria. This shows that the NDB is not just the financial organization of a group of countries, but one with the potential of growing into another “World Bank.”

Of course, the world doesn’t need another “World Bank,” and the NDB is not a replacement for the World Bank. On the issue of development, the NDB places more emphasis on aiding and investing in infrastructure projects in developing nations. The staggering shortage of funding in infrastructure construction is undoubtedly one of the worst bottlenecks hindering economic development in developing countries. The existing multinational development banks usually try to dodge this problem because the environmental problems and resettlement projects resulting from infrastructure projects make investment in these projects highly costly, subject to a very complicated process, and extremely politically sensitive. According to an estimation of the World Bank, international multinational banks meet only 2-3% of the demands for investment in infrastructure. The NDB has decided to make a special contribution to global development in this area, and China’s current achievements and scale in aiding infrastructure projects provide a very reliable endorsement for the NDB’s role in this area.

The CRA is actually a mutual-aid commitment mechanism. The BRICS countries are committed to contributing a total of $100 billion to the CRA. China is making the biggest contribution, $41 billion, followed by $5 billion from South Africa and $18 billion each from Brazil, India and Russia. More importantly, if any of the member states of the bank suffers from long-term shortages of US dollars, they will fulfill their commitments by way of cross-currency swaps, thus making them less dependent on their US dollar reserves.

The BRICS countries will help each other during financial crises to respond to crises in their balance of payments or short-term liquidity. Crises in the balance of payments put pressure on a country’s currency to depreciate quickly, threatening the stability of the entire financial system and international trade. Short-term liquidity problems make it impossible for a government to fulfill its debt obligations as scheduled and dampen market confidence. For reasons of speculation and panic, the country’s bonds will be sold in large quantities and be depreciated. This leads to repeated debt crises in developing countries. A timely infusion of outside funds will keep the financial market from being devastated and help maintain market confidence. However, the IMF’s harsh conditions for lending and its slow decision-making process makes it impossible for it to lend timely support to affected countries and makes it harder for these countries to recover. As a result, the IMF is not an international pillar that developing countries can use to avoid or respond to financial crises. The creation of the CRA shows that emerging economies are not only willing but also able to find and create alternative mechanisms that can help to them build stronger economies. Although we still have to wait and see how the CRA will work, the very fact that a mechanism of cooperation has been reached can in itself can fortify emerging economies’ market confidence.

Challenging the dominance of the US dollar and internationalizing the RMB

The creation of the NDB and the CRA will shake the dominant position of the US dollar in international trade and finance. The dollar is not only widely used in international settlements but is also the basic currency of the IMF and the World Bank. This not only keeps the United States in a position of global economic and financial dominance, but also does harm to global economic impartiality. By taking advantage of its dollar’s dominance the United States can shift its economic crises to other countries, especially developing countries. At the same time, emerging economies and developing countries are exposed to the risk of international financial crises because they heavily rely on the dollar. The United States’ adjustment of its currency policy has a global impact, and the external financial stability of all countries is at the mercy of the United States. This has to change.

During recent years, emerging economies have increased their cross-currency swaps and China is doing very well in this regard. In 2012 China announced a currency swap deal with Brazil that made it possible for their bilateral trade to be settled in their respective currencies. China doesn’t confine its currency swaps to other BRICS countries. It has conducted fruitful negotiations for this purpose with Australia and the United Arab Emirates, both of which are allies of the United States. China’s currency swaps with the United Arab Emirates pose the most potential danger for the dollar, and the United States would use force to ensure that its oil dollar trade system is not challenged. China’s currency swaps not only challenge the dollar’s dominance but are also an important step to internationalizing the RMB. The currency swap mechanism between member countries of the CRA and the 41% share China has in it play another marked role in internationalizing the RMB.

The BRICS cooperative mechanism and its future

The creation of the NDB and the CRA has another great benefit. It effectively embodies the cooperative mechanism of the BRICS countries and demonstrates its broad future more directly than the establishment of a new international economic order. At the same time, it is also a manifestation of China’s emerging power and it’s role in international.

The framework arrangements of the NDB are a result of balanced, compromised, and mutually beneficial negotiations. During the two long years of negotiations, they were often believed to have run aground and it was true that self-interests of the BRICS countries led to differences and deep concerns over the formation of the NDB. It is obvious that BRICS countries differ greatly in terms of economic scale and strength. The international community generally believes that other BRICS countries want to use China’s strong economic position to boost their own visibility and importance in international economics and politics. At the same time, they are cautious about China, which is much stronger than they are, and they fear that the BRICS Group is becoming China’s international policy tool. These calculations of self-interest and worries do exist and they permeated the BRICS negotiations. As a result, differences arose over where the NDB should be headquartered and how much each country should contribute to its capital. And it was even reported that the negotiations ran aground at one point.

It is obvious that the NDB established at the Fortaleza summit is a result of compromises between the BRICS countries. It was created by taking every member country’s priorities into account. This not only shows that the BRICS countries were wise enough to seek common ground and cooperation while preserving differences, but more importantly it indicates that as a big power, China did not seek unilateralism and it exercised self-restraint in securing power. This will have a profound effect on China’s role in cooperative agreements with other BRICS countries and with the broader international community.

The institutional arrangements of the NDB show that the focuses of dispute were resolved through compromise during the negotiations. The arrangements are not obviously dominated by a big power, and importance is placed on equality and mutual benefit. The biggest disagreement in the negotiations was over how much each country should contribute to the initial capital of the bank. India and Brazil were obviously cautious about China’s great economic strength, and the Brazilian president even said on public occasions, “we don’t want an American-dominated order, nor do we want China to dominate it either.” China wanted to contribute more to the initial capital and expand the scale of the bank. Afterning coming to a compromise, China gave up its demand that member countries share obligations and responsibilities for the bank on the basis of their economies and strength. Instead China agreed to have each member country contribute the same to the capital and enjoy equal decision-making power. Another issue the member countries were widely divided over is the location of the headquarters of the bank. China hoped that it would be located in Shanghai, but India insisted that it would be in New Delhi. The three other countries also expressed their hope that they would have the headquarters in their respective countries, though the final competition was between Shanghai and New Delhi. Shanghai eventually emerged as the headquarters, but the first president will be from India and China will be last of the member countries to name a president.

An interesting and difficult problem in international cooperation is how the stronger makes the weaker believe that its actions and promises are sincere and reliable. This is also the famous “credibility dilemma of the stronger.” In international cooperation between the stronger and weaker states in which a third party cooperative mechanism is absent, the motives of the stronger are questionable while the weaker does not have and effective method through which to punish the stronger for breaking promises. If the stronger wants to make the weaker believe they are credible, it has to try every means to exercise self-constraint in securing power and in its actions, which is not something all stronger countries want to do.

The BRICS Group indicates the rise of a group of emerging economies, but China is still too big for it. In terms of economic strength alone, China can unilaterally create a development bank several times larger than the NDB without difficulty. In addition with its high credt rating, China can secure large quantities of financing in international capital markets without the help of other BRICS countries. However, China chose to create the multilateral NDB and eventually agreed that the four other BRICS countries have the same rights as it has, though these countries are incomparable with China in terms of economic size and strength. China compromised and exercised self-restraint in securing power, thus achieving greater credibility in international cooperation; something large, rapidly rising international powers find it very hard to achieve. It was because this credibility was lacking or weak that the Thucydides’s trap was created and there emerged panic and doubts about China’s rise.

The launching of the NDB is of deep and far-reaching significance because it is about far more than just the birth of a multilateral financial institution. The BRICS Group, which created the bank, is in itself both an economic group and an international political force. Economically, the NDB has turned alternatives to the IMF and the World Bank from a possibility to a reality. Politically, the NDB demonstrates that an emerging big power exercised self-restraint in securing power to make countries with different levels of strength cooperate with each other on an equal footing.

This article was originally published in Mandarin in China Investment.

Carnegie India does not take institutional positions on public policy issues; the views represented herein are those of the author(s) and do not necessarily reflect the views of Carnegie India, its staff, or its trustees.