The fourth Brazil-Russia-India-China-South Africa (BRICS) summit took place in Delhi on March 29. Among the decisions announced, the following were aimed at enhancing trade and foreign investment:
- an agreement to promote the use of national currencies in inter-member trade;
- finance ministers of member nations to examine the feasibility of setting up a BRICS development bank (BDB).
It is crucial to promote intra-BRICS trade, including in national currencies, since consumption in G7 countries – the foremost driver of international trade – has lost steam. However, this article is about the proposal to set up a BDB to fund infrastructure and development projects in BRICS and other developing countries. The coverage of the Delhi summit in the international media was limited; it was mainly about differences across BRICS countries and why it would be difficult for them to work together. An effective riposte would be to set up an efficient BDB promptly.
The BRICS countries are members of the World Bank and also of regional banks such as the Inter-American Development Bank, African Development Bank, Asian Development Bank and the European Bank for Reconstruction and Development. According to some, the effort should be to improve existing multilateral banks rather than set up additional institutions. The principal flaw with this line of reasoning is that the World Bank and regional development banks were set up by G7 countries. And, as majority shareholders, they decide who heads these institutions. Also, their priorities determine lending to emerging economies, as well as the thrust of development studies.
The president of the World Bank was in New Delhi on April 2, 2012. While endorsing the BDB proposal, he implicitly said, “I am enough of an economist that I am not a monopolist.” Separately, in a letter to the Financial Times dated April 5, 2012, Mattia Romani, Nicholas Stern and Joseph Stiglitz expressed explicit support saying such a bank “could play a strong role in rebalancing the world economy by channelling hard-earned savings in emerging markets and developing countries to more productive uses than funding housing bubbles in rich countries”.
Compared with the G7, BRICS countries have relatively low per capita income, although the dispersion within the group is considerable. Therefore, initially the BDB could confine its lending to the five BRICS governments and their public sector firms backed by sovereign guarantees. This would be similar to lending by the International Bank for Reconstruction and Development (IBRD), the dominant group within the World Bank, which only lends against central government guarantees. It could be argued that the BDB should lend less to BRICS and more to the least developed countries (LDCs). However, loans to LDCs would be much riskier.
The BDB would need paid-in capital and callable capital on the lines of the IBRD. Such paid-in capital could be contributed equally, at say $5 billion each. BRICS countries warehouse their foreign exchange reserves principally in G7 government debt securities over a range of maturities. A sizeable proportion of foreign exchange reserves is invested in three-month US Treasury bills, which are currently carrying an interest rate of 0.07 per cent. This interest rate is equivalent to London interbank offered rate (Libor) minus 0.40 per cent since the three-month dollar Libor interest rate was 0.47 per cent on April 9 (Libor is a market-based floating interest-rate index for double-A credits). Hence 0.07 per cent would be the opportunity cost of capital for the BDB, if BRICS were to disinvest from three-month US Treasury bills to provide capital to the BDB.
Currently, the IBRD’s average cost of borrowing over the long term is close to Libor and the lending rate on 15-year or longer maturity loans is Libor plus one per cent. As the BDB would have a lower cost of funding, at Libor less 0.40 per cent, it could lend at Libor plus 0.65 per cent (i.e. 0.35 per cent cheaper than the IBRD). And, after letting the BDB keep 0.25 per cent for its running expenses, BRICS countries would earn one per cent more than on their current investments in US Treasury bills.
The BDB would be better off lending on floating rate terms because member governments would retain the possibility of earning a higher rate of return as interest rates rise over the next five to 10 years. By contrast, borrowers in BRICS countries should fix their borrowing rates at the prevailing low interest rates. This can be done by the BDB offering overlay interest rate swaps on its floating rate loans. The BDB should receive at least a double-A rating and hence have ready access to long maturity interest rate swaps.
India’s outstanding stock of IBRD loans is about $15 billion with an average maturity of eight years and the equivalent “duration” is approximately five years (duration represents the price sensitivity of cash flows to interest rate changes, and can be used to calculate the present value of future cash flows). If these loans were from the BDB, the present value of savings would be $248 million (lower borrowing cost of 0.35 per cent x 5 = 1.65 per cent; 1.65 per cent of $15 billion = $248 million). Additionally, the BDB owners, the BRICS governments, would over the life of the same volume of loans lock in five per cent (one per cent multiplied by five-year duration) of $15 billion — which is $750 million more in interest income, in present value terms, than if this $15 billion had remained invested in three-month US Treasury bills. The BDB’s target loan portfolio over the next five to 10 years could be $200 billion. For purposes of comparison, the IBRD’s current stock of loans stands at about $135 billion.
Another argument in favour of setting up a BRICS development bank is that it would provide funding more readily for infrastructure projects particularly in the irrigation, hydroelectric and nuclear power sectors. As we well remember, the Narmada dam project in India was strongly opposed by well-meaning domestic and international environmental and other civil society groups. Consequently, the World Bank took fright and abandoned the project. Now that the project has been substantially completed, observers would probably agree that the positives of enhanced power generation and irrigation in Gujarat, Maharashtra and Madhya Pradesh have outweighed the considerable negatives. To sum up, the opportunity cost of not having a BRICS development bank up and running within the next few years would be substantial.
The author is India’s High Commissioner to the UK.
These views are personal.