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Debt Burden

Updated on April 3, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Debt Burden Meaning

Debt burden indicates an entity’s significant amount of debt and the cost of servicing it. Its increase indicates a concerning scenario and emphasizes the urgent need for responsible authorities to implement debt management policies and initiatives to alleviate the risky environment.

Debt Burden

Debt is naturally considered a burden. The borrower is liable to pay the interest and principal without default, regardless of the amount of the loan or the interest rate. Sometimes additional burden also appears, like the loan default fee. Inefficient management of multiple loans and resorting to high-interest rate loans intensifies the burden.

Key Takeaways

  • The debt burden represents an entity’s high debt load and associated debt payment expenses. 
  • Its growth paints a troubling picture and highlights how vital it is for responsible authorities to put debt management strategies and regulations in place to lessen the dangerous environment.
  • It could have an impact on the borrowing entity’s liquidity. In the absence of effective and prompt debt services and dependency on several loans, the situation may deteriorate, or the borrower may enter a debt spiral.
  • It becomes destructive when it reaches a specific level. Examples of countries under significant debt are Djibouti and Angola. Both countries owe a significant amount to China.

Debt Burden Explained

The debt burden is the cost of debt repayment. It has the potential to affect the borrowing entity’s financial health. The condition worsens, or the borrower enters a debt spiral without efficient and prompt debt services and dependence on several loans.

The burden of debt also applies to sovereign states or countries. Public debt is government debt, also known as sovereign debt, and internal and external debt fills the public debt burden. Internal debt primarily occurs when the nation issues bonds to raise capital. External debt gets added when the country borrows from foreign entities, other governments, commercial banks, and international financial institutions.

The external debt burden is a serious issue. High foreign debt might make it difficult for nations to invest in their infrastructure, health spending, or educational systems since a significant portion of tax revenues is diverted to paying off external debts. It impedes long-term economic growth.

Financial institutions use the debt burden ratio to calculate customer loan eligibility. The total monthly outgoing payments towards debt to total income indicate the debt burden ratio formula.

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Example

Many nations struggle due to their high levels of external debt. For example, Djibouti is a country in Africa. In 2021, Djibouti’s debt to China represented more than 70% of its GDP. Angola is a country in southern Africa. Angola owes more than $20 billion in debt to many Chinese organizations as of 2021, including $14.5 billion to the China Development Bank and around $5 billion to the Export-Import Bank of China. The country also took out loans from ICBC, the biggest lender in China. Sri Lanka also owes billions to China. All of these point to a crisis and China’s debt trap model.

China plays an important role in international finance. China has emerged as a significant global lender during the past two decades. Nearly all of these loans are authorized, originating from institutions under the jurisdiction of the state and government entities. Countries with high Chinese debt are largely in Africa, but they are also spread across Central Asia, Southeast Asia, and the Pacific.

Chinese loans to developing countries usually have high-interest rates and shorter repayment windows, unlike bilateral loans from Paris Club countries or international financial institutions like the International Monetary Fund or the World Bank. In addition, they support relatively particular infrastructure projects rather than pursuing more general developmental aims.

Their arrangement is more similar to commercial loans regarding payback terms and confidentiality. However, this challenging situation indicates that China could significantly influence those nations and their infrastructure in the event of repayment problems, as in the case of a troubled Sri Lankan port built with Chinese funds and in which China ultimately acquired a major stake.

Impact Of Debt Burden On Economic Growth

In the long run, the debt burden affects economic growth negatively. It reduces the GDP growth, causes a decrease in assets from investments and profits or capital formation, and increases the tax rate in the future to extract more money to service the debts. It can cause slow growth and deterioration of living standards by reducing the utilization of funds for essential spending areas such as healthcare, education, and infrastructure. As a result, the economy is more susceptible to economic shocks and financial distress

Significant cash flow towards servicing debt obligations restricts the improvement of business operations like production, marketing, or employment by decreasing the spending power. The scenario is also explained by an increase in leverage and depressing investment, the negative book value of equity altogether disclosing a high risk of insolvency.

Frequently Asked Questions (FAQs)

What is the debt burden definition?

It refers to the great effort, trouble, and difficulty of paying off debt. In other words, the significant expense of paying off debt. It involves periodic principal and interest payments against the debt.

How to overcome the debt burden?

Primarily the borrower should refrain from taking further loans to repay the existing loans to avoid the dangerous debt trap condition. The borrower can seek help from external agencies or the bank to restructure and reorganize existing loans, request a penalty waiver, and use or sell off assets to raise money.

What are the consequences of debt burden?

A large debt base increases liabilities and limits the ability to improve business operations. It diminishes the company’s purchasing power and prevents it from engaging in productive investment opportunities. Investors are not attracted to invest in the countries and businesses under the debt crisis, reducing the cash inflows.

This has been a guide to Debt Burden and its meaning. We explain it with an example and its impact on economic growth. You may also find some useful articles here: