Debt to GDP RatioExplained, Advantages & Disadvantages, and Examples
What is the debt-to-GDP ratio?
The debt-to-GDP ratio is a comparison between the government debt a country owes and its gross domestic product (GDP).
This metric provides an indication of how strong a given country’s economy is and how likely it is to be able to repay its debts.
This ratio is easy to calculate and provides analysts with a simple way to compare debt as a percentage of GDP.
Essential Points
- The debt-to-GDP ratio is a metric comparing a country’s government debt to its economic productivity.
- In order to calculate this ratio, a nation’s debt is divided by its GDP.
- Investors may look to a country’s debt-to-GDP ratio before making investments in its bonds in order to determine the likelihood they will be repaid.
- This ratio could be used to easily determine how many years a country would require to repay its debt if GDP were to be used.
How To Calculate the Debt-to-GDP Ratio
In order to calculate this ratio, a country’s debt is divided by its GDP.
The formula is:
Debt-to-GDP Ratio = Total Government Debt / Gross Domestic Product
The resulting number will indicate how easily a country is able to pay for its debt.
A low debt-to-GDP ratio indicates that the country will have a relatively easy time paying for its debts.
However, a high ratio may indicate that a country will have difficulty paying off these debts.
Creditors will often look to this ratio in order to determine what interest rates they may be willing to accept in order to lend money, as well as if they wish to lend money at all.
The information to calculate this ratio can often be relatively easily found online from government sources such as the National Income and Product Accounts published by the Bureau of Economic Analysis.
Using the Debt-to-GDP Ratio
Governments often use this ratio for financial or economic planning.
For instance, some countries that have a high debt-to-GDP ratio will try to put additional money into their economies by printing more money, giving lower interest rates to banks, and providing the public with increased opportunities.
This ratio is also used by investors who want to purchase government bonds to compare the debt level of different countries.
When countries default on their debt, it can cause serious financial issues in not only the markets of the defaulting country but also in international markets.
Generally, as a country’s debt-to-GDP ratio gets higher, the risk of default increases.
Governments do try to keep this ratio from getting too high, but doing this is sometimes difficult, such as during a recession or a war.
During these difficult times, governments will often borrow money in an attempt to improve growth and increase aggregate demand.
Advantages
- This ratio is a good way for investors to compare the debt levels of various countries before investing in government-issued bonds.
- This ratio can also help economists and governments to better understand their country’s economy.
Disadvantages
- The debt-to-GDP ratio gives only a limited view concerning a country’s economic performance. It does not give very accurate information about the GDP or debt of a country because of the enormous amount of data involved.
- Countries cannot be compared to each other solely on the basis of this ratio because countries are so different in size and have such different populations, along with many other differences.
- Investors should consider many factors in addition to this ratio before investing in a country’s stock market to be able to adequately compare countries.
What Are the Problems Associated with a High Debt-to-GDP Ratio?
If a country has a high debt-to-GDP ratio, it may indicate the country is at an increased risk of default.
Then, if a country does default, it can cause global financial ramifications.
Final Thoughts
Governments are generally very concerned with their debt-to-GDP ratio.
It is an important way of judging the health of their countries’ economies.
If a country has a high debt-to-GDP ratio, it can hurt its position in international markets.
In some cases, when this happens, the country will sell their goods and services for less money making it more difficult to improve their situation.
Although, when this ratio is high, it does not always seem to hurt a country.
Some countries, such as Germany and the United States, have continued to grow even with a high debt-to-GDP ratio.
This shows the importance of judging each country individually and looking at the ratio over a period of time.