For a new financial order, look east

It is heartening to observe that developing countries, led by China and other BRICS members, have successfully organised alternative sources of credit flows aiming for financial stability, growth and development. By avoiding IMF-type loan conditionalities and the dominance of the US dollar, these new institutions provide a much-needed change in the global financial architecture.

This assumes significance in the context of the demands being imposed on Greece by the troika of the IMF, the ECB and the EU. That the troika should persist with a narrow disciplinary approach speaks of the limitations of the current system.

These limitations bring to the fore the need for institutional alternatives. The launch of financial institutions by BRICS may achieve a superior global financial order.

The financial institutions set up for the purpose include the Asian Infrastructure Investment Bank (AIIB), the BRICS (or New) Development Bank (NDB) , the BRICS-led Contingency Reserve Fund (CRF), and the Silk Road projects.

Of these, the NDB will have $50 billion as starting capital contributed by individual members, to be increased to $100 billion over time. Brazil, Russia, India, China and South Africa will each make an initial contribution of $10 billion. No member can increase its share of capital without consent from the others. While new members from outside BRICS can become members of the NDB, the capital share of the initial members is not allowed to fall below 55 per cent. Members’ shares also determine their direct representation in the decision-making process. In addition to providing liquidity to its members to meet balance of payments crisis, the bank aims to provide protection against global liquidity pressures.

As for the CRF, scheduled to start lending in 2016, the five BRICS members have agreed to earmark $100 billion from their foreign exchange reserves to be used for swap lines. China contributes $41 billion, Brazil, Russia and India $18 billion each, and South Africa $5 billion. In other words, CRF is largely funded by China. While controversies relating to the propriety of the NDB have fizzled down to some extent, the installation of the AIIB portal in June has rekindled the debate questioning the legitimacy of such institutions led by China.

The AIIB’s initial capital of $100 billion, while funded by contributions from members of BRICS, is open to contributions from non-members from advanced as well as developing countries, thus making for 57founding members despite the opposition by the US and Japan. The UK was even subjected to reprisals by the US which continues to oppose the idea of an Asian bank led by China.

The AIIB is commended as a vehicle for providing credit for infrastructure in developing countries, the need for which, by 2020, would be between $1.8 billion and $2.3 billion. It would reduce the dependence of countries on official sources, which in any case is meagre. The opposition to BRICS institutions from advanced countries indicates the mindset of Bretton Woods institutions and their patron, the US, to continue with the asymmetric power relations.

Reservations have continued to be voiced on the feasibility as well as desirability of BRICS institutions. There are concerns that the group will include dissimilar countries. Linking infrastructure projects to the proposed Silk Road raises questions, especially on the possibility of a hegemonic role by China. The CRF raises doubts about loans being managed without conditional clauses.

Reservations on the workability and desirability of BRICS-led financial institutions harp on the major role China is supposed to play in their management, mainly because of its disproportionate economic strength as the second largest economy in the world. This alternative seems to effectively challenge the prevailing order, managed and controlled by advanced countries in the West and led by the US.

Concerns on the BRICS institutions may eventually turn out to be unfounded. As for China’s external payments balance which gives it uneven status within the group, the latter can be made use of by introducing a scheme of clearing agreements in a manner parallel to the Keynes-Sempill scheme advanced in the context of reconstruction needs of post-WWII years. One can here mention the recent moves within BRICS to trade in local currencies, using swaps and other bilateral payments arrangements. The Clearing Union plan still has the potential to sort out the payments problems faced by developing countries today, especially between those with chronic bilateral trade imbalances.

A scheme of clearing account for settlement for payments among BRICS members which avoids the use of any currency as a numeraire is a workable idea. This would follow Keynes’s “banking principle”, defined as “…necessary equality between credits and debits, of assets and liabilities”. Most importantly, “… if no credits can be removed outside the banking system, but only transferred within it, the bank itself can never be in difficulties”. For a Clearing Union “..credits are automatically provided to the debtor countries to spend”.

We advocate a similar clearing account system with nations settling the bilateral trade surpluses and deficits without involving use of non-BRICS currencies. Problems in using surpluses in one currency to meet deficits in another may be sorted out by using prevailing cross rates. In fact, the cross rates can be frozen by having forward contracts in order that those are not affected by exchange rate variations in the major currencies. The net balance, denominated in the respective currency of the surplus/deficit countries, can remain with the NDB, and be offset by transactions by one or more countries.

BRICS financial institutions, along with the proposed clearing account, will herald a new financial architecture which can be beneficial for the global financial system. Since those settlements will not rely on the dollar or other major currencies as a unit of account, exchange rate fluctuations across such currencies will not impact the cross rates between the individual BRICS currencies as long as they are kept frozen with forward contracts renewed over time.

Moreover, arrangements to use the trade surpluses of individual members ,by those in deficit, would add to demand within the Brics by creating new channels for intra-BRICS trade. The transfer of surpluses to meet deficits can even be treated as a loan. Moreover, trade surpluses earned by individual members will remain within BRICS as investment and will not be used as assets in dollars. Finally BRICS may devise ways and means to channelise the capital flows in a manner which strengthens the institutions and generates real demand.

The writer is a national fellow of the Indian Council of Social Science Research and a visiting professor at the Institute for Studies in Industrial Development, Jamia Millia Islamia University