Union Budget 2019: Debt-to-GDP ratio helps determine economic health of countries, their ability to service debts

Often the debt-to-GDP ratio increases during times of extraordinary emergencies like financial downturn or war, when the government needs additional funds to manage the economy.

FP Research June 14, 2019 17:34:48 IST
Union Budget 2019: Debt-to-GDP ratio helps determine economic health of countries, their ability to service debts
  • The indicator is also used by foreign investors to determine whether a country is suitable for investments

  • The higher the ratio, the more likelihood of a country of defaulting on its payment

  • According to a February 2019 report, India’s debt to-GDP ratio is second worst among emerging markets

Every country, whether developing, under-developed or developed, holds significant sovereign debts in order to finance its government and economy. However, debts borrowed in moderation can bolster the economy while excess debts can hamper its growth.

A country’s financial and economic potential is often gauged by its ability to service its debts. The debt-to-Gross Domestic Product (GDP) ratio is one such frequently used indicator, especially by credit rating agencies, which gauges the economic health of a country. The indicator is also used by foreign investors to determine whether a country is suitable for investments.

Union Budget 2019 DebttoGDP ratio helps determine economic health of countries their ability to service debts

Representational image. Reuters.

In simple terms, debt-to-GDP ratio is the ratio of country’s government debt (measured in currency terms) and its GDP, which is the market value of all the final goods and services produced in a financial year. The ratio is often expressed in percentage terms and also gives a hint regarding the time a country will take to repay its debts.

The ratio is calculated in the following manner: Debt to GDP= total GDP of country/total debt of country. The higher the ratio, the more likelihood of a country of defaulting on its payment. Defaulting on repaying debts can make the domestic economy vulnerable to foreign flows and global uncertainties.

Often the debt-to-GDP ratio increases during times of extraordinary emergencies like financial downturn or war, when the government needs additional funds to manage the economy. With the rise of Keynesian economics, the macroeconomic strategy of pumping additional funds for stimulating the economy contributed to the increase in government debts.

According to a World Bank study, if a country’s debt-to-ratio crosses 77 percent for a considerable amount of time, it would hamper economic growth. According to the study, every percentage point increase in debts slows economic growth by 1.7 percentage. For emerging economies like India and China, the problem takes a more acute turn. In such countries, any percentage point increase in debt above 64 percent could slow down the economy by two percentage.

Debt-to-GDP ratio in India and the world

According to a February 2019 report, India’s debt to-GDP ratio is second worst among emerging markets. According to the report, India's government debt-to-GDP ratio is 68.4 percent, second only to Brazil. Asian counterparts like Indonesia, Thailand and China have a better ratio than India.

According to the International Monetary Fund (IMF), advanced economies of North America, Europe, Korea and Japan have a very high debt-to-GDP ratio. The average debt-to-GDP ratio in these economies stands at 103 percentage. Japan has a debt-to-GDP ratio of over 200 percent – the world’s highest. The United States, the world’s sole superpower, has a debt-to-GDP ratio of 106 percent.

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