Brick by Bric: The New Development ethos

Connor Lovell
THE New Development Bank (NDB), or Brics Bank, is to begin lending next month after four years of negotiations. The Shanghai-based institution is the latest addition to the development finance landscape and is poised to announce a phalanx of green energy projects in the next quarter.

The NDB follows hard on the heels of the Asian Infrastructure and Investment Bank (AIIB), which has taken half the time to become operational.

Nonetheless the NDB is a major step towards greater cooperation between the Brics. First conceived as a loose grouping of the four emerging markets of Brazil, Russia, India and China by a Goldman Sachs economist in 2001, and with the addition of South Africa in 2010, the Brics are remaking development finance in their own image.

“It’s the rise of the South, and so we’re talking about countries of the South coming together and very humbly saying that we can set up an institution on our own,” says KV Kamath, the bank’s first president.

With multilateral loans set to overtake bilateral ECA lending and sovereign bond markets as the largest source of development financing in the next five to ten years, developments in the DFI landscape are becoming ever more important in emerging economies.

Lean, mean and … green All five stakeholders have submitted between 15 and 20 proposals for projects, with the main focus on green energy. The bank hopes to approve at least one for each country by the end of April, and a total of $2 billion by the end of the year.

India is pressuring the bank to earmark at least 15 percent of its funds for renewable energy projects. Kamath has intimated that the its first loan will be for a solar power venture in India. South Africa has submitted proposals to fund the hydropower in Lesotho.

Highland Water Project and also hopes to receive working capital for Eskom, an energy company. Russia is also eyeing hydropower projects and China is trumpeting its Silk Road initiative. It is not yet clear what the Brazilian proposals are. Ultimately their success will depend on whether commercial lenders are willing to partner with the new institution and invest in it.

Is it big enough?

According to the World Bank, the BRICS have an annual infrastructure spending needs of $1 trillion to 1,5 trillion. With an initial subscribed capitalisation of $50 billion, and a target of $100 billion to raise on the capital markets, the NDB is unlikely to fill this gap alone. By contrast, the World Bank alone has a subscribed capital base of over $252 billion.

“Our key role is as a catalyst,” explains Kamath, “multilateral banks can’t meet the entire development effort. It’s how you innovate, add value and bring together markets and other players in the banking system to make a difference.”

But Chris Humphreys, a development finance specialist at the University of Zurich, is pessimistic about how much the NDB can grow. He predicts that the larger shareholder base of the Asian Infrastructure Investment Bank (AIIB) — which includes major industrialised countries — will result in a portfolio twice as large as the NDB’s within 10 years.

As a result, Humphreys thinks the NDB will struggle to attain an international AAA rating even in the medium to long-term and should therefore expect higher borrowing costs. Though, domestic agencies in China have already issued the bank an AAA institutional rating.

Goldman Sachs and Standard Chartered have been appointed advisors for international ratings, although no grade has yet been given. But development banks usually have a much higher rating than that of their member governments. For instance, the European Investment Bank retained it investment grade rating even as member governments were downgraded during the Eurozone crisis.

Anyway, a lower international rating may not be that damaging. The NDB, like the AIIB, will have access to the Chinese capital markets, which remain largely closed to international bond issuers. The bank plans to issue $1 billion worth of long-term renminbi- denominated bonds, known as Panda Bonds, sometime in the second quarter.

Regardless, the NDB is already punching above its weight. Part of the impetus behind the NDB is that the Brics were fed up with not being heard in the existing Bretton Woods institutions.

Having an equal stake means that the five emerging economies all have an equal say and, uniquely, no one has veto power.

The US-led World Bank has welcomed the NDB but has quietly set up a new infrastructure fund. The IMF has also responded by implementing long held-up reforms in its governance that give the Brics more influence. But for development finance the important thing is the aggregate amount of funding available. Stephany Griffith-Jones, an economist at Columbia University, tells TXF: “They have not explicitly said why they have done this, though they clearly feel the need to compete. I think that it’s healthy competition, for the best loans, conditions and projects — It encourages a race to the top.”

Breaking new ground

The NDB presents a prime opportunity to break new ground in development and infrastructure finance. Merely by forming the bank in the first place, the participants have shown their dissatisfaction with the existing products on offer. The fact that developing economies presently opt for more expensive financing options in the form of bonds and bilateral loans shows there is considerable scope for to do things differently.

Primarily, the NDB intends to streamline the application process. “Speed is essential for the developing world,” Kamath has said. Existing institutions can be bureaucratic and, in the case of the IMF, loans can come attached with very specific conditions.

Being able to show concrete results can also be politically expedient.

“The idea of having banks that are quick is very attractive. Traditional lenders like the World Bank and the IMF can be very slow and can come with ideological baggage like privatisation,” says Griffith-Jones.

“It also takes on average two years to get a loan and three to five years for a project to launch, so for a politician with a limited term, they are often leaving office just as the money is beginning to be spent and don’t get to see the results.”

However, she warns that speed must not come at the cost of having good banking standards. Credit worthy analysis must be a priority.

Though Kamath has already strictly ruled out lending at concessional rates. At first, simplicity in the products offered will be key. “For the New Development Bank, ‘plain vanilla’ will be most appropriate — they should excel in real engineering not financial engineering,” said Griffith-Jones. In its early years the NDB will focus on co-financing with other multilaterals.

According to sources close to the market, the NDB have held a series of meetings with the Development Bank of South Africa. With a regional office in Johannesburg opening this week, the NDB can be expected to make use of existing institutions and their expertise to insure the success of future projects. A report from the Institution of Development Studies recommends supporting the preparation phase of a project, enabling more to be investment ready by the time it is brought to market.

For later stages, NDB finance could be phased in when the private cash runs out, enabling the tenor of the loans to be extended beyond the period that the private banks are willing to lend. The use of special infrastructure bonds, in which the interest varies according to revenue streams, have also been recommended as an innovative way of lowering the risk of default. Another option that DFIs have made little use of to date are unfunded instruments like guarantees.

Between 1994 and 2014, the World bank only issued 50 guarantees and the African Development Bank none at all. The NDB could potentially leverage more private capital in this way.

The NDB also plans to lend in local currency, the five Rs — the real, rouble, rupee, renminbi and rand. All the Brics are experiencing problems with their foreign exchange reserves so there is unanimous enthusiasm for this move. The problem is particularly acute in South Africa where the government has had to reprioritise spending in order to meet its initial subscription to the bank. Kutoane Kutoane of the Export Credit Insurance Corporation of South Africa (ECIC) tells TXF that he welcomes the prospect of working with the NDB, citing the constraints on South African financiers in accessing dollar liquidity for infrastructure projects in Africa.

Such currency swaps can help avoid mismatches, which are a major cause of debt crises.

“If development banks manage to borrow in local currencies and then lend in the same currencies , then they could even securitise these loans and sell them on the market, creating a diversified source of local currency bonds,” said Griffith-Jones.

Last month, Chinese finance minister Lou Jiwei said he wants the NDB to implement a counter-cyclical policy to kick-start faltering growth in emerging economies.

The success of the Brics Bank will be measured in mortar, in the projects that get built. But in the meantime, no one can accuse it of a lack of ambition. – txfnews.com