THE BLOG
07/21/2014 01:30 pm ET Updated Sep 20, 2014

BRICS Bank Is Mostly a Jointly Managed Sovereign Wealth Fund (SWF), and Opportune Time for a Japan-India SWF

Amid some fanfare, a new Development Bank, otherwise called the BRICS Bank, modeled on the multilateral development banks, as well as a Contingent Reserve Arrangement modeled on the IMF, were signed into existence by the members of BRICS -- Brazil, Russia, India, China, South Africa, on July 15, 2014 (see here and here).

Having attended many Board meetings of the World Bank Group as part of the Executive Offices, I was struck by similarities and also some major differences.

Much of the media has reported that each country is committing $10 billion to the BRICS Bank -- that number is merely subscribed capital and it turns out that 80 percent of that is in fact callable capital that has much less value than paid-in capital. Paid-in capital is $2 billion each and is to be paid over the seven following installments:

Each member country is to pay-in U.S. dollars, millions, in the following yearly schedule:
1. $150 million
2. $250 million
3. $300 million
4. $300 million
5. $300 million
6. $350 million
7. $350 million

Also, because the installments are staggered over about the next 8 years, the Bank's financial robustness will become a matter of discussion.

Edwin Truman, a former senior US Treasury (Finance Ministry) official points out that a key factor in deciding if it is a multilateral development bank or whether it is rather a jointly managed sovereign wealth fund (SWF) is whether or not it can borrow on the basis of the "full faith and credit" of the member governments.
SWF, by definition, is a separate pool of government-owned or government-controlled financial assets that include some international assets. They may be financed directly from foreign currency reserves, directly or indirectly from export earnings, from privatization revenues, and pension fund contributions. The central point is that they are financed out of public resources.

Because the credit ratings of Brazil, Russia, South Africa and India are not robust enough to command borrowing on the capital markets at relatively low rates, and it is only China's economy among the BRICS that can currently support massive borrowing on the capital markets to enable relatively low-interest lending, it again points to the BRICS Bank being a SWF-like entity. SWFs generally do not borrow on the capital markets and instead use their own corpus of funds to invest in other countries, almost never their own country. Technically, some SWFs do have the ability to borrow, but rarely do so in practice.

Therefore, with a limited ability to borrow and with a limited membership, the BRICS Bank cannot be a way to meet even a significant fraction of India's massive infrastructure investment needs, sometimes estimated at about $1 trillion over 5 years.

China already has massive investment vehicles of its own, far larger than the BRICS Bank, to invest abroad. They include the China Investment Corporation (CIC) with over $575 Billion in assets under management and State Administration of Foreign Exchange (SAFE) Investment Company Ltd., and yet another entity SAFE Co-Financing that are partly handling the incredibly large $3.31 trillion foreign reserves of China (see here and here and here).

Why then does China need a BRICS Bank and why did it insist on having the headquarters in Shanghai? True, the initial Presidency went to India, but it is a rotating arrangement changing every 5 years, unlike the permanent headquarters in China. In the case of the World Bank, it is known to be US dominated, since its headquarters are in Washington, DC and its president has always been an American despite many attempts at change. Further, the World Bank president chairs Board meetings unlike the BRICS Bank, where the president is not also the Board Chair.

It is fair to say that Chinese economic/financial/business activities in other developing countries have a mixed record. Some have speculated that Chinese investments under the flag of China are eliciting backlash in various parts of the world, and they have learned that a "multilateral" flag and associated immunities offer more risk-management potential than a narrow national approach. In the case of the BRICS Bank, the Articles make clear that:
"The Bank may co-finance, guarantee or co-guarantee, together with international financial institutions, commercial banks or other suitable entities, projects within its mandate"
and therefore, Chinese investment vehicles (as well as those public and private investment entities of other BRICS countries) can naturally access information on projects the BRICS Bank is planning, as compared to those entities from other prominent non-member investor nations that could naturally be barred.

Another point is whether there is any truly concessional lending possible, such as the World Bank's International Development Association (IDA), where wealthy countries give funds so that the institution can lend at less than 1 percent over a 30 year term to the poorest countries and for those projects where economic/financial return is in the distant future or mostly indirect, like building schools and public hospital infrastructure that are both needed, but where returns are complex to quantify.

Membership of the BRICS Bank, at this time, is only the 5 countries, and new members can only be admitted by a majority of three out of the five members, so if the US and Japan were to apply for membership it is unclear if some members would veto that. While every member country of the United Nations is potentially able to join the BRICS Bank, at this time membership is not broad-based, again therefore looking more like an investment fund that is jointly managed by the 5 countries that will invest in or lend to countries that are not members. That broadly parallels a jointly managed sovereign wealth fund.

Opportune Time for a Japan-India Sovereign Wealth Fund

The experience in creating the BRICS Bank has shown the broad feasibility for Japan and India to form a jointly managed and financed sovereign wealth fund headquartered in India.

There are two reasons for having the headquarters in India:

1. Most of the investments will be made in India (since a Japanese SWF cannot invest in Japan). Japan believes that India is fast becoming one of the most attractive investment destinations.
2. Some proportion of the investments will be made in Africa, Asia, Latin America where India's diaspora have had historical economic/business involvement and influence, and/or those countries are part of India-Japan's modern sphere of relationships.

These give incentives for Japan to team up with India in creating this joint SWF, despite the relative size-differential of the foreign reserves being very large - Japan has $1.3 Trillion in foreign reserves as compared to India's $316 Billion
.
Japan has already supported India's currency in turbulent times and has been a key partner in difficult economic times since it extended its first yen loan to India in 1958, before it supported any other country, following the devastating World War.

Many times, there have been bureaucratic contemplations in both countries on the need and potential to create an individual country SWF. Naturally, if it becomes yet another bureaucratic exercise, there will be little progress in the complex subject-specific negotiations that are required. And never before has there been a jointly organized and financed SWF that can also borrow on the capital markets at relatively low cost in order to lend at modest interest rates and even participate in debt-equity swaps.

Both Prime Ministers Shinzo Abe and Narendra Modi of Japan and India, respectively, have promised new modalities and methods of functioning. A joint SWF for vitally needed infrastructure, professionally managed and structured, would be an ideal focus where such visions can coalesce.