Debt to GDP Ratio: 4 Indicators a National Debt Provides

A country’s debt-to-GDP ratio compares a nation’s total public debt against its gross domestic product, or national income. A government’s debt consists of how much it owes to external creditors like private lenders, international aid organizations, or central banks. Countries pay these debts via tax revenue, cost-cutting measures, or issuance of new currency (if the country has a sovereign central bank of its own). Gross domestic product consists of investment spending, exports, government spending, and consumption.

You shouldn’t confuse debt-to-GDP with net-debt-per-capita (how much debt each citizen would owe if you were to divide it up equally) or budget-deficit-to-GDP (the yearly public deficit—as opposed to public debt as a whole—compared to that same year’s GDP).

Debt-to-GDP ratios have real-world benefits and consequences for countries. Consider these four nations’ sovereign debts in relation to their GDP levels:

1. 1. Greece: During the Eurozone debt crisis in the 2010s, Greece was at particular risk of default. Ironically, several European countries with higher debt levels could issue enough Euros to help bail out Greece. They could do so because they had far lower debt-to-GDP ratios than Greece.
2. 2. Indonesia: This Southeast Asian country had a debt-to-GDP ratio of around 36.6 percent as of 2020. For an emerging market like Indonesia, this relatively low proportion of debt-to-GDP makes for an enticing investment to international investors and organizations.
3. 3. Japan: The national debt ratio for this country is significant. Japan clocked in at 254.13 percent debt-to-GDP as of the last quarter of 2020. The country can achieve debt sustainability because it has its own central bank and possesses most of its own assets. As such, it keeps interest rates low by lending to itself through the Bank of Japan.
4. 4. United States: Should the United States ever need assistance paying its external debt, the Federal Reserve bank stands in waiting. It can issue dollars—the world’s reserve currency—to pay off the debt it owes itself in case of an emergency. The United States federal government owns most of its own federal debt assets. As such, its 133.9 percent debt-to-GDP ratio doesn’t present the same issues it would for a country reliant on external sources of funding.

Comparing a country’s total debt versus its GDP provides some meaningful insights into its overall economic position and performance. Here are four reasons why a debt-to-GDP ratio is important:

1. 1. Determines interest rates: The higher a country’s debt-to-GDP ratio, the more likely it is to appear to lenders as a liability. This leads international organizations like the IMF and World Bank to lend to these sorts of countries at higher interest rates. Since these higher rates impinge on a government’s finances, it’s within a country’s interest to keep its debt-to-GDP ratio low. This, in turn, leads to lower interest loans. Alternatively, nations that issue their own sovereign currencies can keep interest rates low even if their debt soars above GDP since they’re effectively lending to themselves.
2. 2. Helps predict economic growth: Many economists think a country’s government debt levels provide important indicators into overall economic growth when you compare them to gross domestic product. If debt-to-GDP surpasses seventy-seven percentage points, that indicates a slow GDP growth rate on the horizon. Exceptions to this rule exist, but it does provide a fairly accurate general forecast.
3. 3. Informs fiscal policy: Among other considerations, a country’s debt-to-GDP ratio determines government spending levels. If it’s high, governments may attempt to pare back on their outflows. If it’s low, they may be more willing to expand programs. The opposite is sometimes true, too. In dire circumstances like a financial crisis or pandemic, governments might take on a higher debt-to-GDP ratio because supporting the economy through a rough patch might help it find its footing quicker once the financial storm is over.
4. 4. Measures financial health: A country’s ability to pay its debts indicates a lot about its overall macroeconomic state of health. Certain wealthy nations with sovereign central banks are notable exceptions, but an exorbitantly high debt-to-GDP ratio can signal a debt crisis or out-and-out default for many middle- to low-income countries. Economic events like these can prove to be catastrophic to the citizens of these nations.

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