InvestmentsAug 18 2014

Five-nation bank’s $50bn power play

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Last month, the leaders of Brazil, Russia, India, China and South Africa announced the creation of a Brics Development Bank to fund infrastructure and sustainable development projects.

It is a move that would seem to establish the five countries as a dominant force in emerging markets, reinforced by the fact that the news came out of the Brics Summit, which was hosted in July by Brazil and is now in its sixth year.

The formation of a Contingent Reserve Arrangement (CRA) was also confirmed. This has been referred to as “an additional line of defence” available to the Brics countries to “provide mutual support and further strengthen financial stability”.

The bank will have $50bn (£29.7bn) of capital behind it, with $10bn contributed by each country. The CRA meanwhile will have $100bn at its disposal, with China putting in $41bn, Brazil, Russia and India each committing $18bn and South Africa making up the outstanding $5bn.

Stefan Hofer, emerging markets equity strategist at Julius Baer, suggests the formation of a new development bank is constructive, citing the case of Brazil at the height of the financial crisis.

“The best example is what happened in Brazil, which is that credit dried up and the government-linked banks stepped in. They averted a very severe credit crunch and that’s what partly helped keep Brics growth going,” he says. “The track record in the particular case of Brazil is very strong and speaks in favour of these types of institutions.”

The rotating presidency of the Brics Bank will be Indian initially, but the bank’s headquarters will be in Shanghai, with the first regional office planned for Johannesburg. Mark Tinker, head of Axa Framlington Asia, claims that this puts China at the centre of the institution.

“Over the past few years there has been a lot of infrastructure build, so on the one hand there is a lot of expertise in building infrastructure,” he notes. “On the other hand, one of the criticisms of China is they have built when they didn’t really need to.

“If the Brics Bank lends to Indian infrastructure, you can be pretty sure there will be some favourable prospects for Chinese companies,” he adds. “I think they are looking to open up their capital markets. They are looking for inward investment as well, to the extent they can create long-term investment flows, which is what the Brics Bank is really all about.”

There has been speculation that the bank is a political ploy – particularly on the part of China, the world’s second-largest economy – to challenge the dominance of the US and Europe. The World Bank and International Monetary Fund are typically headed by Americans and Europeans and have been accused in the past of imposing strict reforms on developing countries.

Craig Botham, emerging markets economist at Schroders, says: “To me it looks a lot like a move to gain political influence for the Bric countries in the developing and emerging market world. China doesn’t need further sources of investment funds for its own economy, it has plenty, so its main benefit is going to be the influence it garners elsewhere.

“In terms of whether it will be useful, the UN thinks there’s a lot of unmet financial need in the developing world, so there is demand for this money.”

Mr Botham questions whether the Brics Bank will invest in projects the World Bank would turn down, due to concerns about corruption or environmental damage, for example. He acknowledges that it could be a boon for emerging market investors, however.

“You would think that improved infrastructure would be a benefit to investors because it should reduce costs for companies, making exports easier – and investment in electricity and other utilities should boost industrial production in the long run,” he adds. “The downside is that it might reduce government borrowing, so there might be slightly less debt available to purchase.”

Neil Denman, global emerging markets fund manager at Polar Capital, says the huge infrastructure deficit in emerging markets needs to be addressed. “But $50bn is not really a lot of money,” he cautions. “For me it is the start of something. But there’s a long way [to go] down the road before firstly, the new development bank and secondly, this contingent reserve arrangement, really have clout and have any true power to make changes.”

Ellie Duncan is deputy features editor at Investment Adviser