How Can a Country Improve Its Debt-To-GDP Ratio? Pros and Cons

Understanding the Debt-To-GDP Ratio: Types of Debt-To-GDP Ratios

Like businesses and individuals, countries also need to borrow money to finance their big projects. This sometimes might lead to an increase in the country's debt. Different parameters are used to determine the financial standing of any country: the percentage of money it borrowed, the percentage of money it lent, etc. One such parameter is the debt-to-GDP ratio, which shows the ability of the country to pay off its debts. Here, we have wrapped up everything about the debt-to-GDP ratio and the formula to calculate debt-to-GDP ratio.

Key Highlights

  • The GDP ratio is a formula to compare the total debt of any country to its economic productivity.

  • Any country with a high debt-to-GDP ratio struggles to pay back its debt and would need more money from its lender as the risk of default also increases.

  • A lower debt-to-GDP ratio means the country has sound financials. In comparison, a higher ratio indicates the country is facing major challenges in repaying its debt.

What Is the Debt-to-GDP Ratio?

The debt GDP ratio is a metric used to compare public debt to its gross domestic product. It is an essential parameter for the government to know where the country's financial stands in international trade. It shows the capability of any country to repay its debt, where the highest ratio means a country is facing difficulty in repaying its debt and might not see further borrowings from other lenders. It also suggests that a country with a higher debt-to-GDP ratio has a higher chance of defaulting

It is measured in percentage and implies the number of years the country needs to pay back its debt if its GDP is only used to repay the loan.

Formula of the Debt-to-GDP Ratio 

The Debt-to-GDP ratio formula is

Debt to GDP= Total GDP of Country/Total Debt of Country‚Äč‚Äč

  • Debt- The amount of countries' government debt.

  • Gross Domestic Product- total value of goods and services produced over a given period.

Any economy is stable if the country continues to pay interest on the money borrowed from the international market without refinancing or compromising its economic growth. The simple idea is that a high debt-to-GDP ratio means a country faces difficulty paying off its external debts. If any country faces such a situation, creditors may even ask for higher interest while lending.

Types of Debt-to-GDP Ratios 

Different types of debt-to-GDP ratios are -:

  • Government Debt to GDP Ratio: It is a percentage of a country's public debt to its annual economic output.

  • External Debt to GDP Ratio: It is the ratio between the debt a country owes to its non-resident creditors and its nominal GDP.

  • Public Debt to GDP Ratio: The public debt to GDP ratio is the debt held by the private sector, like households and businesses, to its GDP. It shows the financial health of the private sector within the economy.

‚Äč‚Äč‚Äč‚Äč‚Äč‚Äč‚ÄčEditor Picks: US Economic Growth Rate Forecast 2024: US GDP Prediction 2024

Why Is the Debt-To-GDP Ratio Important?

The debt to GDP ratio is an important indicator that shows the ability of any country to manage its debt without risking its economic output. Apart from this, the GDP ratio is also crucial because

1- It Is an Indicator of the Financial Health of a Country.

A debt-to-GDP ratio shows insights into a country's financial health by showing the proportion of its economic productivity concerning its financial health. A lower ratio means the country has sound financials, while a higher ratio means the country is facing major challenges in the repayment of its debt.

2- It Shows the Creditworthiness and the Confidence of Investors.

A lower debt-to-GDP ratio means a country can manage its debt obligation effectively, and creditors and investors can lend or invest in the country without hesitation. It indicates that the GDP ratio boosts confidence in the economy, attracts significant investments in the country, and provides credit at favourable rates. On the flip side, if a debt-to-GDP ratio is high, it shows the government might not be able to honour its commitments and may reduce the confidence of investors and lenders.

3- It Shows the Risk of Default or Financial Stability of a Country.

If a debt-to-GDP ratio continuously rises, it means the country is on the verge of default, especially during economic downturns or instability in the economy. If a country defaults on its debt obligation, it can trigger financial panic in the domestic and international markets and even result in currency depreciation and economic recession.

4- Policy Flexibility and Economic Stimulus.

If any country faces a high debt-to-GDP ratio, it will limit its ability to make financial decisions and implement economic measures, especially during hard times. Also, an enormous burden may allocate resources away from essential public investment, which may hinder the country's long-term economic growth.

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What's a Good Debt-To-GDP Ratio?

According to the World Bank and International Monetary Fund, some parameters are set for sustainable external debt. It suggests that any country can maintain its external sustainability by ensuring its financial obligations are met without borrowing for debt and compromising economic growth. If any country achieves a net present value of external public debt of around 150% of its exports or 250% of earnings, it is considered sustainable at that level.

If you look at the good and bad GDP ratio according to World Bank

  • A Good Debt-To-GDP Ratio Means -:

A debt-to-GDP ratio below 77% is considered favourable for a country's economic growth. If any country maintains a GDP ratio below the 77% threshold, then it can be a healthier economy. Moreover, if emerging markets or emerging countries maintain a debt-to-GDP ratio below 64% annually, then they have a more robust economy, which allows them to have a more robust economic performance over time.

  • Bad Debt to GDP Ratio -:

If any country exceeds the threshold of 77%, then the country makes costs about 0.017% points in the economy. Moreover, emerging markets can be primarily hit by a higher GDP ratio as any percentage below 64% would annually slow the growth by 0.02% points.

Conclusion

The debt to GDP ratio is an important parameter that helps to understand the ability of the country to pay back its debt. If any country has a lower back-to-GDP ratio, then the economy is considered a sound economy, while if a debt-to-GDP ratio is higher, then a country might face financial difficulties.

FAQs

Which country has the highest debt-to-GDP ratio?

Japan has the highest government debt GDP ratio.

What is China's debt-to-GDP ratio?

According to the IMF, China's debt-to-GDP ratio is 83%.

Which country has the lowest National debt?

Brunei has a 3.2% debt-to-GDP ratio.

How do countries manage their debt-to-GDP ratio?

Countries implement various fiscal policies like budgets, debt restructuring, revenue generation, and economic reforms to promote sustainable growth and reduce their debt.

 Which are the top 5 countries with the highest debt-to-GDP ratio?

Countries with the highest debt-to-GDP ratios are:

  • Japan - Japan has the highest debt-to-GDP ratio of 262%. 

  • Venezuela - Venezuela has the second-highest debt-to-GDP ratio at 241%. 

  • Greece - Greece has the third highest debt ratio of 193%. 

  • Sudan - Sudan has a debt-to-GDP ratio of 182%. 

  • Lebanon - Lebanon has a debt ratio of 172%. 

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21 Feb, 2024

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