Local borrowing that’s not enough to stop a global debt crisis

Hello and welcome to Trade Secrets. So, a cracking start to India’s chairing of the G20 leading economies this year, with a fractious meeting of foreign ministers last week that failed even to agree a joint statement. As usual, I’m not expecting a great deal of actual progress out of the economics and trade bits of the G20 either. It might be interesting to see where discussions come out on the rise of industrial policy, a measure of the shifting intellectual centre of gravity if nothing else. That’s the subject of the second item in today’s newsletter, the first being some slightly good news among the bad about the global sovereign debt issue.

The persistence of original sin

Bad luck if you thought the emerging market sovereign debt stresses were easing. Unhelpfully for governments with dollar-denominated debt, the US currency has just strengthened again after weakening in January. The latest numbers from the Institute of International Finance’s debt monitor show an overall sharp fall in debt-to-GDP numbers in 2022, but they’re still rising for emerging markets.

Nor are governments creating a coherent way of restructuring defaulted bonds, which I wrote about last summer, especially given the problems with China having emerged as a major creditor. After three years of talks, poor old Zambia has yet to get a clean exit from its default, as its finance minister protested about last month in an FT interview. The great brains of the sovereign debt markets are seeking creative solutions: my colleagues at Alphaville discuss one intriguing suggestion here.

But hold on, wasn’t there a solution to being exposed to dollar movements? Weren’t emerging markets supposed to eschew the “original sin” of borrowing in dollars and issue debt in domestic currencies instead? Well, yes, and it has happened somewhat. The Bank for International Settlements has just published a paper showing progress: local-currency bonds have taken a markedly bigger share of overall and foreign holdings.

This is definitely a positive move, but there are two caveats. One, the move to local currency issuance is much stronger in some of the bigger leading middle-income countries such as Brazil, Mexico and Chile (India and China now borrow almost exclusively in their own currencies), while the smaller and poorer nations have been much slower to shift. Second, there’s volatility involved in local currency issuance too. Even if there’s no automatic rise in the debt burden in response to the exchange rate, the BIS says it turns out that investors targeting returns in dollars are less willing to buy debt denominated in local currency if it weakens against the dollar. Having your original sin absolved doesn’t automatically get you into paradise.

So: have EMs made progress in insulating themselves against a strong dollar? Somewhat, yes. Is that enough to stop the wave of defaults? Sadly, no.

Subsidies, maybe — tariffs, no

Industrial policy is the big issue of the moment, and I’ll have plenty to say about it — as indeed I already have, see here, here and here — as the big trading powers shell out their subsidies and write their regulations. There has been some really good writing on this recently, especially the tendency for such policy to try to hit too many goals at once. See the Wall Street Journal’s Greg Ip on the history of US industrial policy here and two contributions from the FT — a Swamp Notes newsletter on the subject and a wise opinion from our editorial board.

Here I want to focus on a particular issue, the use of trade instruments in industrial policy. There was a surge of interest in this around the beginning of the Covid-19 pandemic and it’s got bigger since. I wrote a Trade Secrets column last week about India’s attempts to boost manufacturing: while New Delhi’s production subsidies are probably wasteful, its tariffs designed to protect an in-country supply chain are actively pernicious.

If subsidies go too far they end in overproduction, which is trade-distorting and inefficient but not intrinsically restrictive, and the cost becomes obvious to taxpayers. By contrast, tariffs and other trade restrictions are deliberately restrictive of competition and often function without direct fiscal outlay, so don’t similarly alert the public that they’re being ripped off. The really bad examples of US industrial policy down the decades (textiles, steel, the Jones Act for shipping) have used trade restrictions and created fiercely well-organised lobbies.

By contrast, successful recent examples of industrial policy in emerging markets often include voluntary trade liberalisation. Perhaps the most striking episode was the great wave of unilateral tariff-cutting by developing countries in the late 1980s/early 1990s, as they grasped the opportunities available from joining the international supply chains juiced by the information technology revolution. See this chart from Richard Baldwin’s writing on the subject here.

I’m no unabashed fan of President Joe Biden’s Inflation Reduction Act, but it should be noted that at least most of it is less restrictive than the infamous electric vehicle tax credits with their domestic production requirements. The impact of industrial policy is all in the design, and trade instruments are very frequently a bad way to do it.

As well as this newsletter, I write a Trade Secrets column for FT.com every Thursday. Click here to read the latest, and visit ft.com/trade-secrets to see all my columns and previous newsletters too.

Trade links

The European Commission’s plan (in my view absolutely indefensible) to link trade preferences for developing countries with the return of asylum seekers is deservedly attracting more criticism.

Remember last year’s crisis in the US baby formula market that trade restrictions were making worse? Well, the folks at the Cato Institute say the problem’s still there.

The Peterson Institute argues that India’s discovery of a huge deposit of lithium (Iran also reckons it’s found one) could ease the global scramble for the metal, which is becoming a big supply chain issue. But the fact that the deposit is in the contested region of Kashmir on the border with Pakistan complicates matters somewhat.

Michael Froman, former US trade representative under Barack Obama during the long-ago era when the US actually tried to sign trade deals, has been given the very nice job of president of the US Council on Foreign Relations think-tank.

Trade Secrets is edited by Jonathan Moules