China's Outsized Role in Two New Multilateral Financial Institutions

8 MINS READJul 14, 2014 | 09:46 GMT
Leaders talk at the BRICS meeting during the G20 summit in 2013 in St. Petersburg, Russia.
(Alexei Danichev/Host Photo Agency via Getty Images)
Leaders talk at the BRICS meeting during the G20 summit in 2013 in St. Petersburg, Russia.

The sixth BRICS (Brazil, Russia, India, China, South Africa) summit begins July 14 in Brazil. The three-day summit is expected to see plans finalized for a new financial institution to be known as the BRICS Development Bank and a currency pool to be known as the Contingency Reserve Arrangement. The moves are a part of an ongoing process by which non-Western developing countries are seeking to build mechanisms for loans with fewer conditions than those issued by multilateral Western institutions. It also represents an effort to create insulation from potential fallout from future crises in the Western-led financial system, which BRICS' efforts notwithstanding will continue to dominate the world's financial markets. Within the new BRICS mechanism itself, China will dominate given that its economy and financial power dwarfs those of the other BRICS members.

Many details of the BRICS Development Bank and Contingency Reserve Arrangement have surfaced ahead of their finalization. The bank will start lending in 2016 with an initial capital base of $50 billion ($10 billion will come from each member), with plans to increase the capitalization to $100 billion over the next five years. Each country will not, however, have an equal share in the $100 billion Contingency Reserve Arrangement. Instead, contributions there will be based on the size of each country's economy, thus China will contribute $41 billion of the total. Both mechanisms will help alleviate challenges the BRICS countries face from the international financial system. 

Alternatives to Western Financial Institutions

The last few years have shown that many developing countries' currency and financial markets are exposed to events in Western financial markets. For example, their markets can quickly experience short-term volatility based on quick reactions by investors to decisions or announcements made by the European Central Bank or U.S. Federal Reserve, such as tapering or even the expectation of tapering, by the Fed or by quantitative easing earlier this year. Most developing countries' governments have long-term assets in developed financial markets, giving them a liquidity problem, too. The Contingency Reserve Arrangement would help balance these flows through financing without the constraints of dealing with the International Monetary Fund, an institution the BRICS want to reform in several ways, such as by increasing voting quotas given to developing nations. 

The BRICS Development Bank would also promote infrastructure and sustainable development in emerging countries via loans. Some estimates suggest the developing world lacks about $1 trillion annually in financing for needed infrastructure. Many of the traditional donors and investors into other development banks are now experiencing debt crises at home, limiting their ability to fund loans. Developing countries need all the capital they can get, and any additional modes of development financing are beneficial.

But solving these problems will require more than the current BRICS initiatives can offer. At least initially, the BRICS Development Bank will be relatively small for a multilateral development bank. The European Investment Bank, World Bank, Asian Development Bank, African Development Bank and the Inter-American Development Bank will all have larger capital bases even when the BRICS Development Bank expands to $100 billion. Even at $100 billion, the Contingency Reserve Arrangement would quickly be exhausted in a global financial crisis (though it would prove helpful during a domestic or regional crisis).

Capital Base of Development Banks

Capital Base of Development Banks

The differing global interests of the countries involved will also limit the BRICS Development Bank. The five BRICS members are remarkably different from one another — something that has hampered cooperation before — and their goals often diverge. Naturally, this could well make decision-making at the bank tougher, such as deciding which projects to approve. (To be clear, the BRICS all have similar interests in creating financial architecture, like the bank and the Contingency Reserve Arrangement, to supplement and compete with Western-led financial institutions.) Such a challenge was evident at the Asian Development Bank when China attempted to block an Indian water sanitation project in a region where Beijing and New Delhi have a territorial dispute. The bank's success could also be undermined by projects with questionable economic fundamentals approved for political purposes. China and Russia in particular have made investments abroad for political rather than economic reasons.  

The Centrality of China 

Given the size of its economy, China would play an outsized role in any alternative to Western-led economic institutions. Its fellow BRICS members South Africa, Russia and to a certain extent Brazil, are natural resource-exporting behemoths suffering from the decline in commodities prices that began with the current global economic contraction, limiting their ability to provide funds to the new entities. China, by contrast, is the bloc's most diversified economy.

While China may not directly control the Development Bank and the Contingency Reserve Arrangement, it position in both entities will be paramount given its size, and it will be called upon to address any financial problems that arise. The entities will allow Beijing do some of its overseas investments through a more neutral mechanism, thus diminishing perceptions that China's overseas investments represent a new form of colonialism. 

China is simultaneously trying to create the proposed $100 billion Asian Infrastructure Investment Bank as a competitor to the U.S.- and Japanese-led Asian Development Bank. The BRICS plans are just two of various multilateral mechanisms Beijing is backing, and its economic size makes it natural player, if not leader, in such non-Western mechanisms.

While negotiating the details for the BRICS Development Bank, China wanted the initial contributions to be based on each country's size, like the Contingency Reserve Arrangement. China also wanted the initial start-up to be pegged at $100 billion, and even offered to put up the rest of the money. The other BRICS members quickly shot those ideas down, and it is likely that some sort of settlement was reached where China was given an alternative concession, perhaps housing the bank in a Chinese financial powerhouse such as Shanghai, which Beijing is working to boost into an alternative financial city to London and New York.

Converging Interests 

Despite the fact that the BRICS members' interests often diverge, they do align in some areas. With the BRICS Development Bank focused on infrastructure development, Africa's lack thereof and the importance the BRICS members place on the continent means it will likely be the most logical focus of activity for the bank.

China's interests and investments in Africa are well documented, and Beijing has long helped develop infrastructure in Africa. Similarly, one of South Africa's core geopolitical objectives has been to develop infrastructure links into the heart of Africa, thereby exerting its regional influence on its neighbors. India has historic ties to East Africa and has been increasingly investing in its mining, agriculture and light-end manufacturing due to its proximity to India via the Indian Ocean. For its part, Brazil shares a linguistic and colonial history with Angola and Mozambique, and its mining companies are deeply involved in developing Africa's extensive natural resources — an infrastructure-heavy proposition. Last, even Russia — with seemingly the fewest direct ties to Africa (especially since the fall of the Soviet Union) — has begun investing more in energy, resources and other areas on the continent over the last five or so years.

Another shared interest among the BRICS is the potential expansion of both new financial entities to include other members from the developing world. For institutions like the World Bank or International Monetary Fund to arise from the developing world, the BRICS will need not only widespread support from other key countries, but their participation and involvement as well.  (The World Bank itself started out as a development bank designed to help rebuild Europe after World War II before growing into the global institution it is today.) There are dozens of potential suitors in the developing world that could join both new BRICS entities relatively quickly, but not all of them would have the start-up capital needed to expand the bank. 

Of likely members, Southeast Asian countries such as Indonesia, Malaysia and Thailand have the most financial heft, and the region's financial markets are likely to continue to grow quickly. Indonesia could be best positioned to join as an investor and as a destination of loans on some of its more underdeveloped islands.

The Middle East also could add some capital quickly, but many of the region's countries are dealing with significant internal upheaval at present. The two Middle Eastern countries in the best position to contribute would be Iran and Turkey, which consider themselves leaders in the developing world. Expansion into South America and Africa could yield smaller amounts of capital, though a larger base of members.

Decades, not years, will determine whether the BRICS Development Bank and Contingency Reserve Arrangement ever rival Western-led institutions. In the very long term, the two initiatives' success would mean China — whose economy will be larger than that of the United States at that point — could be the most important member of two major global financial institutions.

Article Search

Copyright © Stratfor Enterprises, LLC. All rights reserved.

Stratfor Worldview


To empower members to confidently understand and navigate a continuously changing and complex global environment.