Business, IFR - Mon September 9, 2013

Strong minnows, weak giants

Development banks have never had it so good. Not so long ago, many were threatened with downsizing, even extinction. Some lacked the financial or political clout to make confident decisions; others, notably in emerging markets, struggled to find a coherent role in a Western-dominated world.

These days, multilaterals like the European Bank for Reconstruction and Development, or Brazil’s giant mono-national institution, BNDES, seem omnipresent, striking deals in markets far from their traditional homes. Their minions scour the world for worthy or timely deals; governments lavish billions on them; their officials are feted wherever they go.

It’s worth asking two questions: what went right; and are these vast institutions better at their jobs and prepared for future crises, or just larger?

Two interconnected events, the twin “Western crises” of systemic liquidity and European debt, and the ensuing rise of a more confident and financially viable developing world, answer the first question.

Prior to 2008, some were questioning why multilaterals like the EBRD, built to tout democratic values and private enterprise, even existed. The collapse of the Soviet Union led to the bank’s creation, but the former Eastern bloc, democratic and solvent, then needed little external help. The US pushed for the EBRD’s closure; a former IMF chief, Michel Camdessus, touted a merger with a larger long-term lending institution, the European Investment Bank.

Then the financial crisis intervened, and development banks, were given a “new impetus” in life, said Piroska Nagy, a former IMF economist, now the EBRD’s director for country strategy and policy. “In many countries they assumed a counter-cyclical role, by increasing lending operations when private banks ran into trouble,” she said.

This happened in early 2009, when capital simply stopped flowing from Western to Eastern Europe. The EBRD’s solution was the Vienna Initiative, a US$40bn lending programme devised with the World Bank and the EIB. Not only did the VI probably stave off a new regional funding crisis, it also gave the bank a new lease of life. Officials in Washington and Brussels now saw it as a trusted problem solver. In 2012, the bank was invited to oversee the economic regeneration of four “Arab Spring” countries, including Egypt and Tunisia. Budgets soared, rising 30% between 2007 and 2012 to US$12bn; staffing levels jumped by a quarter.

Elsewhere, the story was the same. Funding at the Inter-American Development Bank, which promotes growth in 48 Latin America and Caribbean nations, jumped 30% between 2007 and 2012, to US$

“There’s been a huge increase in the need for capital since the financial crisis,” said Veronica Zavala, general manager of the IDB’s office of strategic planning and development effectiveness. “At times, it’s been hard to keep pace with demand.”

Lending by the Philippines-based, Japan-dominated Asian Development Bank was US$22bn in 2012, up from US$6bn a decade ago, while co-financing deal values were worth US$8bn, a threefold increase in 10 years.

Much of this increase, said Kazu Sakai, director general of the ADB’s strategy and policy department, stems from a desire among leading industrialised (and mostly Western) nations to channel more capital into higher growth emerging markets, many of which lie in Asia. But the impetus is also internal. Growth-oriented and ambitious Asian governments need financing to build out energy grids, infrastructure networks and institutional capacity, with many looking to the ADB for help.

Acting with impunity

The same is true of the vast monolithic development banks that underpin individual economies. While multilaterals help direct lending and attention to projects, using their diversity and neutrality to draw in and magnify capital from across the world, single-nation development banks, increasingly based in the developing world, are free to act with impunity.

These lenders, some as valuable as entire countries, are incredibly powerful. China Development Bank, formed in 2007 and dominated by one of Beijing’s most driven officials, Chen Yuan, has opened lines of credit worth more than US$100bn with friendly governments in Latin America and Central Asia.

Outstanding loans to Africa, a vital source of minerals and energy, totalled US$19bn at end-August 2013, according to CDB data. BNDES is even more aggressively ambitious. The world’s largest development bank is projected to disburse US$82bn in loans in 2013, up 22% year on year, as it seeks to inject life into Brazil’s stalling economy.

Thus the future of the development bank, at both regional and national levels, seems secure. “We need multilaterals,” said Hung Tran, executive managing director of the Washington-based Institute of International Finance. “They provide support and cohesion, and they help promote the sustainable development of financial markets and financial systems.”

“This business model has a strong role to play in global economics, and in fact it seems to be growing in popularity. Say you decided to close down the African Development Bank. African leaders would then have to go to London or Washington to discuss their own financing needs. That would be a real loss,” said James Boughton, a former official IMF historian, now a fellow at the Centre for International Governance Innovation, a Canadian think-tank.

Growing pains

Yet even as multilaterals grow accustomed to unusual sensations of self-worth – respect, security, reach – many are experiencing uncomfortable growing pains.

Perhaps the most disconcerting of these is financial. Modern multilaterals may have deeper pockets, but in comparison to national development banks, they are puny. The total loan book of BNDES is three times that of the World Bank, and more than twice the size of all regional multilaterals combined.

The total loan book of BNDES is three times that of the World Bank, and more than twice the size of all regional multilaterals combined

This disparity – between what multilaterals promise, and what they can realistically deliver in terms of lending and jobs – is keenly felt. A telling moment came during the opening address at this year’s ADB conference in New Delhi, delivered by India finance minister P. Chidambaram. “He spoke eloquently of India’s hunger for infrastructure investment,” Sakai said. “He said Asian countries needed a bigger ADB, and that despite the recent expansion in lending, we are still too small.”

To put the minister’s frustration into perspective, India needs around US$1trn in annual funding, just to keep pace with its infrastructure needs. By contrast, the entire World Bank Group invests around US$50bn in global projects. “In terms of development and helping poorer countries develop, it’s difficult to say ‘enough is enough’,” said the IIF’s Tran. “There are always more projects to fund better and more productively, but there’s a limit on how much multilaterals can help.”

Another headache, one that takes a variety of forms, is the ability to influence events. Every multilateral has its own set of aims and ambitions, based on the economic make-up of the region it supports.

Latin America, dominated by giant state-run firms, notably in the mining and energy sectors, desperately needs a thriving private sector. Only then, economists say, can the region support a growing middle class and move from a cyclical to a more diversified and stable economy. The IDB calls for “sustainable economic growth” in its charter, yet relegates the private sector to seventh in a list of potential lending candidates, appearing almost grudgingly to admit that private firms “are also eligible for IDB financing”.

The bank clearly recognises this conflict. IDB’s Zavala is careful to note that the IDB “is not in the lecturing business. We find that business works better with a loan than with a lecture”. Yet she also points to the importance of reducing regional dependence on commodity exports, particularly at a time when China, the great consumer of metals and energy, is slowing.

Economic diversity, Zavala said, “is something that’s in our minds, and on the minds of each of our member countries. The key is how to do it. All of them want to have less dependence on commodities”. She pointed to positive examples: a thriving software sector in Uruguay, and fast-growing service sectors in Mexico and Colombia. Others have flagged concerns about the increasing emasculation of the private sector by the region’s dominant economy, Brazil.

Perhaps the biggest challenge – beyond poverty in Asia, the lack of a viable private sector in Latin America and Central and Eastern Europe, or the infrastructure gap in Africa or India – for regional multilaterals is helping member states avoid the middle-income trap. This happens typically when economic expansion in a fast-growing country stagnates after hitting middle-income levels. Brazil got snared by it in the late 1980s; Russia in the 2000s. The same fear grips leaders from Beijing to Jakarta to – again – Brasilia.

Everyone interviewed for this story muttered about its dark powers. “The key challenge for us is helping countries across [Asia] avoid falling into it,” said the ADB’s Sakai.  Zavala added to this sentiment: “That is the big next challenge for all our member countries. Will policies across Latin America allow us to continue growing, to continue prospering, or will economies slow, and will we fall into the trap.”

Pioneer: Korea

Both, separately and unbidden, mention the Republic of Korea, which broke through the trap, emerging as a faster economy with a sustainable blend of consumption, investment, services and exports, as an exemplar. The ADB is drawing lessons from the country’s largely successful public-private partnership programme, while the IDB is studying Korea’s ability to build infrastructure, energy efficiency, and institutional capacity.

This fear of the middle-income trap is very real. Yet again it reflects the clear frustration felt by multilaterals, aware of a region’s or a country’s economic failings, yet stymied, either by policy or a lack of finance, in their ability to help. Multilaterals cannot win this argument: governments complain constantly of the need to secure new credit lines to fund local firms or mend social safety nets, yet err when it comes to funding a bank whose stated aim is to spread the wealth.

A new creation…

This explains the mooted creation of the BRICs Development Bank, the result of sporadic talks between strange bedfellows. Brazil, Russia, India, China and South Africa have little in common but a catchy acronym, yet their leaders appear determined to create a new development bank, at least in name. In early September the five nations agreed to set up a US$100bn fund to guard against financial shocks and support emerging market economies and currencies.

The bank’s mere existence provokes a range of emotions among development bank officials. Some profess indifference; others are dismissive. Uncertainty remains about whether it will ever see the light of day and who will oversee and host it. (South Africa seems the most likely headquarters).

Zavala points to billion dollar projects the IDB is working on across Latin America, with the IMF, the EIB, and others. “I can’t imagine the new institution [the BDB] being able to do this. They don’t have the brainy side we have,” she said. “We have knowledge of the region, we have thousands of officers working across the region. That’s the really important thing.”

Carlos Braga, a former head of economic policy and debt at the World Bank, now a professor of at IMD business school in Lausanne, is more scathing. “What would the motivation be for a country like China to build something over which it doesn’t wield absolute control,” he asks. “Besides, Brazil and China already have their own successful development banks. So even if they create [the BDB] it will be a marginal player at best.”

Yet the mere fact that a new, emerging market-focused development bank is being floated at all points to a core frailty within regional development banks. Multilaterals are stronger, better funded, and more needed than ever before. Yet they lack influence and, when compared with their national development banking peers, financial clout.

No amount of financial crises will ever change that.

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