Tuesday, August 12, 2014

Today's Editorial 11 August 2014

                 Charting a new course

Source: By Alok Ray: Deccan Herald
At the recent sixth BRICS (Brazil, Russia, China, India and South Africa) Summit held in Brazil, two important developments have taken place which may have far reaching consequences for the global economy. A New Development Bank (NDB) has come into existence with an initial capital of $50 billion, contributed equally by all the five countries. This would eventually go up to $100 billion over time. The primary purpose of the NDB is to finance infrastructure projects in the developing countries. Thus, it would be like a mini World Bank which currently provides project-tied loans.

In addition, a Contingent Reserve Arrangement (CRA) or a reserve pool of currencies of $100 billion would be created. This is to serve as a cushion against temporary balance of payment difficulties and speculative attacks causing exchange rate instability in such countries. Out of the total initial capital of $100 billion, China (which has $4 trillion reserves in its kitty) will contribute $41 billion, Brazil, Russia and India would give $18 billion each, and South Africa would contribute $5 billion. It would start lending from 2016. Thus, its role would be like that of IMF which currently provides temporary balance of payments loans to countries.

Basically, these two arrangements are designed to serve as competitors, if not alternatives, to World Bank and IMF as far as these countries are concerned. The most important distinguishing feature of these new institutions, unlike World Bank and IMF, is that each member will have equal voting rights and no country will have veto power.

Why are such new institutions needed? In the so-called Asian financial crisis in the late 1990s, several Asian countries faced sudden capital flights, causing a sharp depreciation of their currencies with severe adverse consequences for their economies. When they approached the IMF for emergency assistance, it forced them to adopt contractionary monetary and fiscal policies which further aggravated the recession. In 1998, some of these Asian countries (including Japan, China and Taiwan which together had massive foreign exchange reserves) wanted to establish an Asian Monetary Fund to provide emergency balance of payments support. But USA vetoed this idea, insisting that all assistance must be routed through IMF where US and its western allies had majority control. Similar things happened more recently in the Eurozone where the IMF, the European Central Bank (ECB) and the European Commission (EC) imposed harsh austerity measures on troubled European countries (like Greece) that led to prolonged recession and massive hardships. Moreover, the recession in the Eurozone affected the BRICS countries by reducing their exports and thus indirectly they too suffered.

Voting power

The developing countries and the majority of global population have very little say in the working of IMF and World Bank. Voting power at IMF and World Bank is allocated on the basis of economic power as it existed after the World War II when these two institutions were created at Bretton Woods in USA. Though the world has changed drastically since then, the voting power has not changed or has changed, after a lot of prodding, only marginally at glacial speed. The top five powers (the US, Japan, Germany, the UK and France) hold about 38 per cent of total voting power, though they contain only about 10 per cent of world population. By contrast, China and India - the number one and three in terms of GDP at PPP exchange rate in the world today – with nearly 40 per cent of world population, command less than 6.5 per cent of total voting power.



Though there is lot of excitement in the developing world over these developments, the sceptics are pointing to lingering border disputes and the economic and political rivalry within the BRICS (between China and India and between China and Russia, in particular) which, according to them, will make it difficult to agree on many matters. They also apprehend that with equal voting rights and in the absence of the IMF style ‘conditionalities’ loans may well be provided without adequate safeguards which would affect the financial viability of these institutions. China, if it provides more than equal resources to the contingency fund, may, at some point, want to exercise more than equal power.

The western media is more concerned that Russia, being isolated by the west in the wake of its fight with Ukraine and some other CIS countries, is getting legitimacy and flexing its anti-west muscle through the BRICS grouping. Also, China may further its foreign policy interests with economic aid diplomacy by using the BRICS Development Bank. In fact, India, too, had this concern and that is why it insisted that all members of BRICS must have equal voting rights and powers. Incidentally, the Asian Development Bank (ADB) which was also modelled after World Bank, has been dominated by Japan.

How things will pan out in future cannot be predicated with certainty. Given the huge infrastructure funding requirements of the emerging economies (India, for example, often talks about the need of a $1 trillion infrastructure fund) the $50 billion fund of the NDB is too small to fill up the funding gap. So, in order to be really effective, its resources need to be augmented a lot. There is no way it can replace the IMF or World Bank in the foreseeable future but it can play a very important complementary role. The New Bank is open for other developing countries to join, subject to the stipulation that the joint shareholding of the original five would not go below 55 per cent. If more countries join and the operations of the New Bank and the New Fund expand to cover more countries, IMF and World Bank would face stiffer competition. The World Bank president has welcomed the competition provided by the New Bank. In all likelihood, the competition would change the way World Bank and IMF function, make them more democratic and representative, and that would be a win-win for the world as a whole.


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