May 05, 2014 – 03:30 PM
Peter Krauth writes: The group of five nations – Brazil, Russia, India, China, and South Africa, otherwise known as the BRICS – is making some intriguing financial, economic, and political moves.
They’re committing tens of billions of dollars each to organize their own versions of an IMF and World Bank.
Many observers thought the BRICS nations would encounter too many obstacles to collaborate effectively.
But after announcing such plans just over a year ago, the next BRICS summit in July is likely to see the official launch of these institutions.
The implications are huge for investors…
Here’s What Created the Original IMF and World Bank
In the aftermath of World War II, the IMF and World Bank were offspring of Bretton Woods in 1944.
According to the IMF’s own website, they are “twin intergovernmental pillars supporting the structure of the world’s economic and financial order.”
But what purpose do they serve, exactly?
The IMF was established as a “voluntary and cooperative institution” to help counteract what were seen as lingering financial problems that led to the 1930s Great Depression, including abrupt and unpredictable currency exchange valuations and general protectionism.
More recently since the financial crisis, the IMF has made subsidized loans to troubled members, both developed and developing.
The World Bank, formally known as the International Bank for Reconstruction and Development, was initially set up to lend to Western European economies ravaged by WWII. Later, the Bank focused increasingly on developing nations. Its main aim is “to promote economic and social progress in developing countries by helping to raise productivity so that their people may live a better and fuller life.”
So why would the BRICS be interested in setting up its own institutions?
If you consider that these five nations represent 41% of the world population and 20% of global trade, their reasons become a whole lot clearer.
The Drivers Behind the “BRICS Bank”
Proponents of the new currency reserve pool (as an alternative to the IMF) make no bones about why they are forging ahead with their plans.
Russian Ambassador-at-Large Vadim Lukov has commented that “given that governance of the IMF is in the hands of western powers, there is little hope for assistance from the IMF in case of an emergency. That is why the currency reserve pool would come in very handy.”
Lukov speaks from recent, sobering experience.
The financial crisis led to multiple bailouts in Western European nations in particular, including Portugal, Ireland, Italy, Spain, Greece, and Cyprus.
But more recently, when the U.S. Fed finally said it would cut its $85 billion monthly stimulus, the taper tantrum hit emerging markets especially hard.
Hot money fled the BRICS, slamming their capital markets and weighing heavily on their currencies.
The proposed currency reserve pool would act as an insurance policy against such routs. Members could call on the fund if they face a budget deficit or other financial difficulty. An injection of foreign currency would help a member deal with a shortfall.
Although plans were already in the works, the emerging markets sell-off provided extra impetus to reach these goals sooner. Lukov has recently indicated that both institutions would be operational by 2015.
In fact, the members have even determined how much each will contribute: China will commit $41 billion; Brazil, Russia, and India each $18 billion; and South Africa $5 billion. Respectively they are proportionate to the size of each nation’s economy.
But the BRICS are not only interested in helping themselves exclusively.
Their new Development Bank would actually look to finance mainly external projects, as the five members are confident in their abilities to finance internal ventures.
As Ilya Prilepsky, member of the Economic Expert Group explained, “For example, it would be in BRICS’ interest to give a loan to an African country for a hydropower development program, where BRICS countries could supply their equipment or act as the main contractor.”
The Trend Is Picking Up Speed
Things are moving quickly. Russia is drafting the intergovernmental agreements to establish the bank, and Brazil has prepared a preliminary BRICS Development Bank charter.
BRICS members have agreed that the new institutions will be capitalized at $100 billion each. Each one of the countries wishes to host the bank’s headquarters, whose final location has yet to be decided.
Not surprisingly, one point of contention is the currencies to be used in the reserve pool.
China has made noise about wanting to see the yuan being “floated globally” and perhaps eventually supplanting the U.S. dollar. So, the Chinese would certainly like to see the yuan play a leading role in these new BRICS institutions.
But a more diplomatic solution, one in which a BRICS currency consists of a basket of the members’ currencies, may still win out.
Initially, at least, funding will be in U.S. dollars. But don’t expect that to last.
As I’ve pointed out numerous times before, a number of nations, including the BRICS members, have been quietly establishing swap agreements allowing them to trade completely outside of the U.S. dollar.
Increased cooperation between the BRICS nations thanks to these new institutions will only serve to accelerate this trend.
We’re Poised to Pounce
I’ll be keeping a keen eye on the progress of a new BRICS currency reserve pool and BRICS Development Bank.
These institutions could well bring additional stability to emerging markets, quickly making their stock and even bond markets attractive investments as average investors start to benefit.
Their P/E multiples might rise faster than they otherwise would, compressing gains into fewer years.
I’m re-gauging my own radar on BRICS and will be delivering the best investment ideas as I see them arise.
It’s time to look at the BRICS, and the global economic balance, with a totally new set of glasses.