BRIC's Approaches to Development Financing – Their Implications for LICs

he coming unto the scene of development financing by Brazil, Russia, India and China (BRICs) has intensified the debate on aid effectiveness and related policy issues. Indeed, unlike aid from OECD donors, BRIC financing (excluding Russia) focuses on mutual benefits without attachment of policy conditionality. Nevertheless, as with other sources of financing, low-income countries (LICs) will need to ensure high returns for BRIC-financed projects through sound public investment management.

The scaling up of public investment associated with most BRIC financing is likely to have large positive growth effects.

BRICs, with the exception of Russia, provide financial assistance based on the principle of ‘mutual benefits’ in the spirit of South-South cooperation. Brazil, China, and India see themselves as ‘development partners,’ not ‘donors’. Their experience as recipients of traditional development assistance and their identification with other recipients also contribute to their sensitivity to the term ‘aid’. Indeed, the term is sometimes contentious. China, for example, does not regard itself as providing aid.

Should there be Conditionality and Tied Aid? 

In addition, these BRICs do not attach conditions on governance, institutional reform or economic policy and performance to their cooperation. Conditionality, they argue, would undermine the principle of respecting “national sovereignty” and of promoting “solidarity”. The policy of no-conditionality partly reflects some BRICs’ own recent development history and its policy of noninterference. The Chinese, for instance, believe that the long-term development of a country is ultimately the responsibility of the recipient and not of the development partners’.

In response to criticism of its “tied aid”, China argues that financing tied to purchases from the source country can help circumvent the issue of financial mismanagement and misappropriation of funds.

Though conditionality has often been criticized as intrusive and of weakening country ownership of reforms, tied aid has reportedly not been able to address concerns about transparency and corruption, especially given the general lack of comprehensive, meaningful, and timely statistics. This is consistent with findings in the literature that there is no significant positive relationship between aid allocations and the quality of institutions.

Meeting of the minds on debt sustainability

There have also been differences in the approaches to assessing debt sustainability between some BRICs and traditional donors. China and India generally focus on a project’s economic viability while traditional partners emphasize long-term debt sustainability at the economy-level. China makes a distinction between productive and non-productive investments; the latter are generally financed through grants while the former generally by loans. In contrast, traditional partners pay more attention to debt sustainability at the macroeconomic level, often based on the results of the IMF/World Bank Debt Sustainability Analysis.

Overall, the differences are, however, narrowing with BRICs increasingly appreciating the importance of overall debt sustainability and traditional donors the need for investing in physical capital.

Benefits of BRIC Financing

The scaling up of public investment associated with most BRIC financing is likely to have large positive growth effects. Indeed, BRIC financing has played an important role in alleviating infrastructure bottlenecks in many LICs and should help them tap their natural resources.

Vivien Foster, Lead Economist at the World Bank, and Joseph Onjala, a research fellow at the University of Nairobi, noted that it has resulted in a 35 percent improvement in electricity supply, a 10 percent increase in rail capacity and a reduction of the price of telephone services (1). BRIC financing of infrastructure could have positive supply side effects, and consequently improve export competitiveness. Importantly, BRIC financing can also help strengthen regional trade linkages.

In addition to these, Montie Mlachila, Deputy Division Chief at the IMF, noted that the strong focus of BRIC financing in improving access to trade and natural resources has been associated with a sharp increase in trade flows and foreign direct investment between LICs and BRICs (2). Issouf Samake, Senior Economist at the IMF, and Yongzheng Yang, the IMF’s Resident Representative in the Pacific, find significant growth spillovers from BRICs to LICs both through direct channels (such as bilateral trade) and indirect channels (such as global commodity prices) (3).

Dealing with Challenges

While BRIC financing has generated significant economic benefits for LICs, it also poses challenges that call for better economic management to minimize the associated risks and expand future benefits.

The first of these challenges is ensuring high returns on projects. As with other sources of financing, it is critical that LICs align BRIC-financed projects with national development priorities. 

A second challenge is 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. 

Safeguarding debt sustainability will also be key. 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. 

The final challenge will be to deepen 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. 

Nkunde Mwase and Yongzheng Yang work in the Strategy Policy and Review and Asia and Pacific Departments of the International Monetary Fund.

This is a synthesis of the IMF Working Paper 1274 www.imf.org/external/pubs/ft/wp/2012/wp1274.pdf

Footnotes

(1) Foster, V., Butterfield, W., Chen, C., and N. Pushak, 2009, Building Bridges: China's Growing Role as Infrastructure Financier for Africa (Washington: World Bank); Onjala, J., 2008, “A Scoping Study on China-Africa Economic Relations: The Case of Kenya,” Available via the internet: http://www.aercafrica.org/documents/china_africa_relations/Kenya.pdf. 
(2) Mlachila, M., and M. Takebe, 2011, “FDI from BRICs to LICs,” IMF Working Paper 11/178 (Washington: International Monetary Fund).
(3) Samake, I., and Y. Yang, 2011, “Low-Income Countries’ BRIC Linkage: Are There Growth Spillovers?” IMF Working Paper 11/267 (Washington: International Monetary Fund).

This article was published in GREAT Insights Volume 1, Issue 4 (June 2012).