70 Finance & economics The Economist February 13th 2021
the government spends on investment.
(India’s central government, for example,
has budgeted a 26% increase in capital
spending in the coming fiscal year.) It is al-
so less of a worry if the economy is operat-
ing below capacity: public spending can
then “crowd in” additional investment by
improving incomes and profit prospects.
But before embarking on a spending
spree, a conscientious government must
bear other considerations in mind. Is the
economy below capacity because of a lack
of spending, rather than public-health re-
strictions? Are inflation expectations con-
tained? Is monetary easing unable to revive
demand instead? If the answers are yes,
governments can spend with greater con-
viction. But in fact the answers vary across
the emerging world. China is probably
near full capacity. Inflation is too high in
Argentina and Turkey. Most central banks
have room to cut interest rates (though In-
dia worries that cuts will not work until its
troubled banks regain their footing).
Crowding out, if it happens, is probably
more damaging in emerging markets. They
have less capital per person than richer
economies, which should leave them with
more rewarding investment opportuni-
ties. The low interest rate paid by their gov-
ernments is not necessarily a sign that the
return on capital is low. It may also reflect
regulations forcing banks to load up on
government paper. This kind of financial
repression, once widespread, persists in
places like India and Argentina.
Mr Blanchard seems more cautious
about emerging markets than some of
those who cite his work. His Ashoka lec-
ture showed a “prudent level of tentative-
ness that I find very appealing”, said his
host, Arvind Subramanian, himself a for-
mer adviser to India’s government. Mr
Blanchard thinks policymakers in the rich
and poor world alike should ask them-
selves two hard questions: how high might
interest rates rise, relative to growth rates,
in a plausible stress case? And how tight a
budget would be politically possible in re-
sponse? The answers give a rough indica-cause the power of compound interest is
offset by the power of compound growth.
To grasp the weirdness, ponder the fol-
lowing scenario. Suppose a government
can keep debt stable at 60% of gdpwith a
deficit, before interest payments, of 3%.
Then suppose a pandemic strikes, pushing
debt to 80% of gdp. You might think that
this higher debt is harder to sustain, re-
quiring a tighter budget than before the
pandemic. You would be wrong. To stabil-
ise the new debt ratio, the government
needs a 4% deficit instead.
Although this fiscal mathematics is pe-
culiar, it is not novel. The growth-correct-
ed interest rate has been less than zero in
emerging economies 75% of the time, ac-
cording to Paolo Mauro and Jing Zhou of
the imf, who have looked as far back as the
data allow. Economists have nonetheless
been wary of taking this arithmetic too lit-
erally. Emerging economies have tradi-
tionally borrowed in hard currencies, such
as the dollar. If their exchange rate weak-
ens, their foreign-currency debts can in-
crease sharply, relative to the size of their
economies, even if interest rates remain
modest. The cost of borrowing can also rise
quickly if investors fear default, a fear that
can become self-fulfilling. And this rise in
interest rates may not be gentle or early
enough to provide much prior warning.
In recent decades, most emerging econ-
omies have found it easier to borrow in
their own currencies. That makes their
debt safer because their central banks can,
in theory, print the money owed to cred-
itors if need be. But the fear of some kind of
default still lingers. Wenxin Du of the Uni-
versity of Chicago and Jesse Schreger of Co-
lumbia University have compared the
yields on local-currency bonds to those on
American Treasuries “swapped” into the
same emerging-market currency via deriv-
atives. This allows them to disentangle
credit risk from currency risk. They find
that emerging-market bonds typically pay
a premium, which presumably represents
compensation for the risk of default (or
some other form of expropriation, such as
new taxes or capital controls). This premi-
um spiked in March 2020 before returning
to less alarming levels (see chart 2).
Borrowing in rupiah or pesos introduc-
es other dangers. If investors fear a fall in
the currency, they demand a higher inter-
est rate. This is especially likely if the in-
vestors are foreigners with obligations in
other currencies. Countries like Indonesia
borrow mostly in their own currency (over
60% of government debt is in rupiah) but
not from their own people (over half of its
debt is owed to non-residents).
Even if government debt is sustainable,
it may not be desirable. Economists have
long worried that public borrowing can
crowd out private investment (or hurt the
trade balance). That is less of a concern iftion of the debt ratio a country can com-
fortably expect to sustain.
That ratio is likely to be lower for many
emerging economies than for advanced
ones, he believes. They may find it harder
to rustle up tax revenue in a pinch. And
their interest rates have a higher possible
peak, even if their average is lower once
growth is deducted. In the past, conven-
tional wisdom maintained that the safe
debt limit was 60% of gdpfor advanced
economies and 40% for emerging ones.
“These were nonsensical numbers,” Mr
Blanchard said after his lecture. “But the
inequality was right.” Default settings
Emerging markets, local-currency
sovereign-credit spread*, %Source:WenxinDuandJesseSchreger *Medianof 12 countries23.0
2.5
2.0
1.5
1.0
0.5
0
211816141210082006CommoditiesTwin peaks
O
il is makinga comeback, at least on
the face of it. On February 8th the price
of Brent crude rose above $60 a barrel for
the first time in more than a year. Battery
metals, too, are enjoying a run-up. The
prices of cobalt, lithium and some rare-
earth metals have soared since late 2020,
with copper and nickel enjoying a longer
climb. It is tempting to see the surge as evi-
dence of competing bets about the fuels of
the future. For both oil and battery metals,
the reality is more complex.
Some of the rise in oil prices is, of
course, linked to expectations about de-
mand. Oil investors have taken hope that
rising Chinese demand might be matched
elsewhere. In India, consumption of lique-
fied petroleum gas, widely used as a cook-
ing fuel, is up. In America, President Joe Bi-
den’s proposed stimulus of $1.9trn may
bring a jump in economic activity and
therefore oil demand. However, the pace of
economic recovery is not assured. The fal-
tering roll-out of vaccines and the emer-
gence of new, more contagious strains of
covid-19 continue to weigh on oil markets.
Indeed climbing oil prices have much
more to do with constraints in supply than
with confidence in demand.
Most important, Saudi Arabia, the de
facto leader of the Organisation of the Pet-
roleum Exporting Countries, looks deter-
mined to support prices. In January the
kingdom said it would cut production by
an additional 1m barrels a day in February
and March. Elsewhere, output continues to
be restrained. Among some African pro-
ducers, supply is starting to suffer from de-
ferred investment in new projects and de-
clining output from existing ones. In
America, crude output in January was 13%NEW YORK
Why the prices of both oil and the
metals that seek to replace it are rising