Debt-to-GDP Ratio

What Is Debt-to-GDP Ratio?

The debt-to-GDP ratio is the metric comparing a country's public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio reliably indicates that particular country’s ability to pay back its debts. Often expressed as a percentage, this ratio can also be interpreted as the number of years needed to pay back debt if GDP is dedicated entirely to debt repayment.

Formula and Calculation for the Debt-to-GDP Ratio

The debt-to-GDP Ratio is calculated by the following formula:

Debt to GDP = Total Debt of Country Total GDP of Country \begin{aligned} &\text{Debt to GDP} = \frac{ \text{Total Debt of Country} }{ \text{Total GDP of Country} } \\ \end{aligned} Debt to GDP=Total GDP of CountryTotal Debt of Country

A country able to continue paying interest on its debt — without refinancing, and without hampering economic growth, is generally considered to be stable. A country with a high debt-to-GDP ratio typically has trouble paying off external debts (also called “public debts”), which are any balances owed to outside lenders. In such scenarios, creditors are apt to seek higher interest rates when lending.

Extravagantly high debt-to-GDP ratios may deter creditors from lending money altogether.

What the Debt-to-GDP Ratio Can Tell You

When a country defaults on its debt, it often triggers financial panic in domestic and international markets alike. As a rule, the higher a country’s debt-to-GDP ratio climbs, the higher its risk of default becomes.

Although governments strive to lower their debt-to-GDP ratios, this can be difficult to achieve during periods of unrest, such as wartime, or economic recession. In such challenging climates, governments tend to increase borrowing to stimulate growth and boost aggregate demand. This macroeconomic strategy is a chief ideal in Keynesian economics.

Economists who adhere to modern monetary theory (MMT) argue that sovereign nations capable of printing their own money cannot ever go bankrupt, because they can simply produce more fiat currency to service debts. However, this rule does not apply to countries that do not control their monetary policies, such as European Union (EU) nations, who must rely on the European Central Bank (ECB) to issue euros.

Good vs. Bad Debt-to-GDP Ratios

A study by the World Bank found that countries whose debt-to-GDP ratios exceed 77% for prolonged periods, experience significant slowdowns in economic growth. Pointedly: every percentage point of debt above this level costs countries 0.017 percentage points in economic growth. This phenomenon is even more pronounced in emerging markets, where each additional percentage point of debt over 64%, annually slows growth by 0.02 percentage points.

According to the U.S. Bureau of Public Debt, in 2Q 2021, the U.S. had a debt-to-GDP ratio of 125.5%. To put these figures into perspective, the U.S.’s highest debt-to-GDP ratio was 106% at the end of World War II, in 1946.

Debt levels gradually fell from their post-World War II peak, before plateauing between 31% and 40% in the 1970s — ultimately hitting a historic 23% low, in 1974. Ratios have steadily risen since 1980 and then jumped sharply, following 2007’s subprime housing crisis and the subsequent financial meltdown.

The landmark 2010 study entitled "Growth in a Time of Debt," conducted by Harvard economists Carmen Reinhart and Kenneth Rogoff, painted a gloomy picture for countries with high debt-to-GDP ratios.

However, a 2013 review of the study identified coding errors, as well as the selective exclusion of data, which purportedly led Reinhart and Rogoff to make errant conclusions. Although corrections of these computational errors undermined the central claim that excess debt causes recessions, Reinhart and Rogoff still maintain that their conclusions are nonetheless valid.

Special Considerations

The U.S. government finances its debt by issuing U.S. Treasuries, which are widely considered to be the safest bonds on the market. The countries and regions with the 10 largest holdings of U.S. Treasuries (as of July 2021) are as follows:

1. Japan: $1.31 trillion
2. China: $1.1 trillion
3. United Kingdom: $540 billion
4. Ireland: $320 billion
5. Switzerland: $298 billion
6. Luxembourg: $292 billion
7. Cayman Islands: $250 billion
8. Brazil: $249 billion
9. Taiwan: $242 billion
10. France: $236 billion

What is the main risk of a high debt-to-GDP ratio?

As a rule, the higher a country’s debt-to-GDP ratio climbs, the higher its risk of default becomes. If a country defaults on its debt, it often triggers financial panic in domestic and international markets alike. A study by the World Bank found that countries whose debt-to-GDP ratios exceed 77% for prolonged periods, experience significant slowdowns in economic growth.

How does modern monetary theory (MMT) view national debt?

Modern monetary theory (MMT) is a heterodox macroeconomic framework that says monetarily sovereign countries, like the U.S., need not rely on taxes or borrowing for spending since they can print as much as they need and are the monopoly issuers of the currency. Since their budgets aren't like a regular household's, their policies are not be shaped by fears of the rising national debt.

Which countries have the highest debt-to-GDP ratios?

As of December 2020, Venezuela had the highest debt-to-GDP ratio at 350, which was a sharp increase from its prior reading of 233. This was likely due to the lack of oil demand brought on by the COVID-19 pandemic. Next was Japan with a reading of 266, a relatively modest rise from its prior reading of 238. The U.S. and U.K. were 19th and 20th with debt-to-GDP ratios of 108 and 100 respectively.