BRICS development bank and contingency reserve arrangement

24 July 2014

Ousmène Jacques Mandeng, Global Institutional Relations Group, Prudential Investment Management

The establishments of a BRICS development bank (DB) and a contingency reserve arrangement (CRA) seem to indicate new momentum for change in intergovernmental finance and cooperation. It may mark a rebuttal of the existing framework dominated by the main multilateral institutions but also increasing confidence that China and leading emerging markets can do it on their own. It is only a modest start though.

The BRICS—Brazil, Russia, India, China and South Africa—decided at Durban, South Africa on 26 March 2013 and adopted at Fortaleza, Brazil on 15 July 2014 to form the DB and earlier on 21 June 2014 at Melbourne, Australia and adopted on 15 July 2014 to establish the CRA.

The establishment of the DB and CRA mark a novel albeit not radical approach to formal non-regional based intergovernmental financial coordination. Neither the financing mechanisms nor the finance objectives are new and CRA operations will be closely linked to IMF arrangements. The CRA is modelled to the ASEAN+3 Chiang Mai Initiative Multilateralisation (CMIM) and the DB is based more loosely on the World Bank and the Asian Development Bank (ADB). Irrespective of existing provisions, the critical question is to what extent the DB and CRA are or will become substitutes or complements of the existing multilateral framework.1

The success of the DB and CRA will naturally rest on their capacity to deploy their resources. The CRA is far too small to make a meaningful dent but signals an alternative approach to contribute to and strengthen the global financial safety net.2 The DB will struggle to contribute decisively to the vast array of development finance institutions. As they stand, neither the CRA nor the DB are likely to upset the existing intergovernmental finance framework. However, they must be seen as an initial effort only. The CRA is considered here to represent the more remarkable BRICS facility in concept but the DB is likely to have a more immediate impact.

This note will focus on access/lending and the governance structure of the two institutions. It will not debate the case for new intergovernmental institutions, effectiveness of the multilateral institutions generally, nor whether oversight at the CRA and DB is likely to be adequate to ensure adequate operations.

Contingency reserve arrangement

The CRA treaty specifies:3

The access under the CRA shows that the CRA is a small facility relative to the constituents’ foreign exchange reserves. The low proportion of the IMF delinked portion illustrates BRICS’ reluctance to act outside the surveillance framework and capacity of the IMF. This is likely to have at least two effects: The facility’s small access reduces leverage of the CRA over its borrowers; the facility produces coordination with the IMF but is reduced to a small near negligible add-on to IMF lending. To conduct lending outside the IMF will require some surveillance and enforcement mechanism. The CMIM with the establishment of the ASEAN+3 Macroeconomic Research Office (AMRO) has been trying to create an autonomous surveillance capacity.

The conventional central bank swap approach marks the limited capacity of the facility. Actual and future lending capacity, similar to supporting the IMF, will depend on countries’ foreign exchange reserves. The treaty makes no reference to the possibility of mobilising local currency resources. As such it risks merely perpetuating prevailing conditions guiding access to external liquidity support. The treaty offers though the possibility to alter access and other conditions.

The governance structure of the CRA maintains an approach similar to the IMF but offers important deviations. Voting power at the CRA is a function of economic potency (“power of the purse”) like at the IMF. The imposition of consensus voting though ensures that every constituent can exercise a veto unlike at the IMF where the U.S. is the only country that can exercise that right for important decisions requiring an 85 percent majority (the Eurozone that is not a member of the IMF, also has in aggregate a blocking minority). This implies a much flatter voting power structure for Governing Council and some Standing Committee decisions. At the same time the distinction between creditors and debtors for some voting items appears to foster a creditor-debtor divide which was seen as one of the greatest governance challenges at the IMF. The creditor-debtor divide may unduly undermine building a sense of mutual and like-minded interests that marked the success of the early IMF.

Development bank

The DB treaty specifies:6

The DB holds a broad remit and can engage on a large range of projects both public and private. The broad remit may offer important flexibility in deploying resources and in combination with a very flat governance structure, aided by the small membership, may convey greater nimbleness and adaptability of the new institution compared with its established peers. The latter may well represent its strongest comparative advantage. The voting structure, voting limits and provisions for senior staff appointments are seen here to limit incorporations of other large countries and will prevent the DB to become more universal in its membership.

1 The BRICS are considered here to be based on similar principles and concerns as the Group of Five (G5) and later Group of Seven (G7). The G5 and G7 were the outcome of increasing apprehensions about the effectiveness of the main multilateral fora, notably the International Monetary Fund (IMF). However, the G5 and G7 have remained informal arrangements, maintained only ad hoc policy coordination but relied in particular on the IMF as a de facto secretariat.

2 The global financial safety net is generally understood to provide external emergency assistance in the event of severe balance of payments pressures.

3 All CRA references are from the Treaty for the establishment of the BRICS contingent reserve arrangement, Melbourne, 21 June 2014.

4 The IMF Articles of Agreement have a provision for a Council to maintain a specific focus on the international monetary system but a Council was never adopted.

5 The delinked portion for the CMIM is 20 percent with a pending proposal to increase it to 40 percent.

6 All DB references are from the Articles of Agreement of the New Development Bank, Fortaleza, 15 July 2014.

7 Except for the first term of the first Vice-Presidents whose mandate is for 6 years.