What is Debt to GDP Ratio?
GDP to Debt Ratio is a metric used to compare the debt of a country to its Gross Domestic Product (GDP) and measures the economy’s financial leverage, that is, its capability to repay its debt. A country with high ratio, would not only have difficulty in repaying its debt but would also not be able to seek debt from its lenders, as there are higher chances of it defaulting.
Formula of Debt to GDP Ratio
Given below is the formula to calculate debt to GDP ratio.
Debt to GDP Ratio = Total Debt of a Country/Total GDP of a Country
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For eg:
Source: Debt to GDP Ratio (wallstreetmojo.com)
A country with high ratio will try to boost its economy and growth and in return would also need heavy finances. But due to a high ratio, it is often unable to raise money from domestic and international markets. The countries try to lower their ratio, but it’s not an overnight change and a few years pass by to lower the ratio. The unrest this ratio is often seen during an economic recessionEconomic RecessionEconomic recession is when economic activity is stagnant, and there is contraction in the business cycle, over-supply of goods compared to its demand, and a higher unemployment rate resulting in lower household savings and lower expense, inflation, higher interest rate and economic crisis due to higher fiscal deficit.read more, wartime or other lending practices of the nation. It is expressed as a percentage, but further dimensional analysis can be done to calculate the number of years in which debt can be repaid.
According to the IMF, in 2019, the debt to GDP ratio for Japan is 234.18% being the highest followed by Greece at 181.78% and Sudan at 176.02%. The United States was at 109.45%, France at 96.2% United Kingdom at 85.92%, India at 67.29%, and China at 54.44%.
As per the records from IMF, below is the graph that shows the Debt to GDP Ratio for few countries for 2018 and 2019.
How to Use the Debt to GDP Ratio?
The government uses this ratio for economic and financial planningFinancial PlanningFinancial planning is a structured approach to understanding your current and future financial goals and then taking the necessary measures to accomplish them. Because this does not begin and end in a specific time frame, it is referred to as an ongoing process.read more. With high debt-to-GDP-ratio, the government will often push more money into the economy by printing new currency notes, issuing foreign currency instruments; provide low-interest rates to banks and insurance sectors, and bringing new opportunities for its public. It allows investors in government bonds to compare debt levels between countries.
As per a study conducted by the World Bank, it is found that if the debt-to-GDP ratio exceeds 77% for a long period of time, it slows economic growth by 1.7% for every percentage point of debt above this level. For growing economies, the growth rate will decline by 2% for each additional percentage point of debt above 64%.
Debt to GDP Ratio Examples
Below are some simple examples to understand this concept in a better manner.
Example #1
Let’s say we want to calculate Debt to GDP ratio for 5 countries (hypothetically). For this, we would need their total debt and total GDP.
Calculation of Debt to GDP Ratio of Country A
- =50/75
- =66.67%
Similarly, we can calculate for remaining countries.
As we can see, Country B has the highest GDP, which means it will have difficulty in repaying its debts. It is often assumed that countries having a ratio above 100% has chances of defaulting, which is not true. In the above example, we can understand for Country Z that it can repay 78.26% of the total debt.
Advantages
- It allows investors to compare debt levels between countries before they invest in bonds issued by governments.
- It helps governments, economists to understand the trend and pattern for fall in the economy and help them find a solution to get out of it.
Disadvantages
- The ratio to an extent gives a brief idea about the performance of an economy. However, due to the vastness of data, it’s not possible to get very accurate details regarding debt and the GDP of an economy.
- The comparison between countries cannot be solely done on the basis of the debt to equity ratioDebt To Equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. read more. Every country is different in terms of its size, population. Government policies, inflation rate, etc. Other factors should also be considered to have an equal base for comparison before investing in the stock market.Stock Market.Stock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more
Conclusion
It’s very important for the government to focus on its GDP as well as debt to GDP ratio. Every country marks its place in the world of trade and investments when it has a stable and developing economy. Having a higher ratio places them poorly in the international market and they start losing their scope in the international market. Such economies start providing goods and services at a lower cost, which makes them even more difficult to cope up with their debt (example Greece).
However such is not always true also for countries like the USA, Japan Germany, etc as they are strong economies and show growth year on year basis. It’s important that we not only look at such a financial matrix but also do trend analysis to understand in depth.
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