BRIC financing to LICs is growing rapidly, driven mainly by China. In contrast with many industrial countries which are facing large fiscal consolidation and consequent challenges to meet their aid commitments, BRICs are in a strong position to continue increasing development financing. This paper contributes to the aid literature by examining the principles and modalities of BRIC financing, contrasting this with the main OECD Development Assistance Committee (DAC) framework, and by drawing their implications for LIC economies and future LIC-BRIC engagement.
While many of these challenges are not uniquely related to BRIC financing and have been discussed extensively in relation to the pros and cons of the approach taken by OECD donors, the rapidly growing BRIC financing has intensified the debate on aid effectiveness and related policy challenges.
- BRICs’ philosophies for development financing differ from those of “traditional donors” (OECD-DAC members) in three significant ways.
* BRIC engagement, with the exception of Russia, is founded on a model of mutual benefits. Most of the financing has been concentrated in the infrastructure sector to support productive activities. Russia, similar to traditional donors, has recently focused on social spending, seeing poverty reduction as the main objective of their ODA.
* Some BRICs, particularly China, tend to provide noncash financing for projects without attachment of policy conditionality. They view this as part of the principle of noninterference of internal affairs and as a means of circumventing corruption. In contrast, traditional donors view policy conditionality on institution building and governance as central to ensuring efficient use of aid.
* Concepts of debt sustainability differ, with BRICs tending to focus on microsustainability of individual projects while traditional donors pay greater attention to long-run debt sustainability by taking into account macroeconomic linkages. Development financing provided by BRICs has helped LICs alleviate some key bottlenecks to domestic economic activity and boost exports but it has also posed a number of challenges.
The concentration of BRIC financing in infrastructure could have large positive growth effects by addressing infrastructure deficits in LICs, raising productivity by reducing business costs for tradables and nontradables sectors alike, and supporting expansion in trade and investment.
However, concerns have been raised about the impact on debt sustainability, subsidized export credits received by some BRIC firms (Brautigam, 2010), and labor practices. These concerns highlight the need to ensure that development financing is used to promote sustainable and inclusive growth.
The rest of the paper is organized as follows.
Section II describes the philosophies and modalities of BRIC financing.
Section III examines the impact of BRIC financing, and Section IV discusses policy implications.
Section V concludes.
While the benefits from BRIC financing are significant, there are real challenges in managing risks associated with these inflows. The policy issues raised by BRIC financing are not new; similar issues arose in the past in relation to aid from traditional donors. Nevertheless, given the recent scaling up of BRIC financing and some of its unique characteristics, it is worth highlighting some of the key policy issues.
Ensuring high returns on projects. As with other sources of financing, it is critical that LICs align BRIC-financed projects with national development priorities. The concentration of BRIC financing in infrastructure is encouraging, but this in itself does not guarantee high returns. An appropriate process of project selection (including through feasibility studies), implementation, and maintenance needs to be put in place to ensure desired outcomes. More generally, sound public investment management is key to translating infrastructure spending into sustained economic growth.
Improving transparency and governance. Efforts should be made to improve data on the size and terms of financing flows, the structure and conditions of packaged deals, as well as the rights of concessions for natural resources. This could also help address some of the concerns about accountability and “imprudent” lending/borrowing to/by LICs. This is in the interest of both LICs and their development partners. On the cost side, competitive bidding for projects would help ensure that financing costs are sourced in a transparent and fair manner. Participation in some existing international initiatives, such as the Extractive Industries Transparency Initiative (EITI) could help.
Safeguarding debt sustainability. Macroeconomic analysis of total project financing, including assessments of risk, implications for public finances (including how maintenance costs will be financed and contingent liabilities associated with some FDI projects) and growth impact, is critical to avoid potential debt sustainability problems while ensuring adequate public investment. More broadly, borrowing decisions need to be made within a sound debt management strategy.
Deepening project linkages to the local economy. LICs and BRICs could work together to build incentives, as part of a total package for development financing, to encourage local employment, foster skills development, and improve technology transfer. LIC governments and firms from development partners could work with local communities and workers to ensure labor regulations and work conditions are conducive to local employment. All in all, a more consultative and comprehensive approach is needed to address current concerns that could undermine long-term engagement between LICs and BRICs that should lead to huge benefits to both parties.
Though there are some differences across BRICs, the philosophies of most BRICs for development financing differ from traditional donors in three main ways: BRICs, with the exception of Russia, provide financial assistance based on the principle of ‘mutual benefits’ in the spirit of South-South cooperation, while Russia and traditional donors emphasize the role of aid in poverty reduction.
Second, BRICs, particularly China, view policy conditionality as interfering with recipients’ sovereignty and tend to provide noncash financing as a means to circumvent corruption, whilst traditional donors view policy conditionality as a means to ensure efficient use of aid.
Third, different emphasis is placed on how to ensure debt sustainability, with some BRICs giving a greater weight to microsustainability and growth while traditional donors paying more attention to long-run macrosustainability. This difference is, however, narrowing with BRICs increasingly appreciating the importance of overall debt sustainability and traditional donors the need for investing in physical capital and seeing results.
- Introduction, Policy Implications and Conclusion to: BRICs’ Philosophies for Development Financing and Their Implications for LICs, prepared by Nkunde Mwase and Yongzheng Yang; IMF Working Paper WP/12/74, March 2012. Readers can access the 25 page paper, here.