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Home / IAS Preparation / Debt To Gdp Ratio

Debt to GDP Ratio - Definition, Formula, Working, Impact, Limitations And More

Last Updated on Aug 03, 2023
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The Debt to GDP Ratio points out how strong a nation’s economy is and the likelihood of paying off its debts. It is utilized to compare nations or ascertain whether a nation might be headed for economic turmoil. It is also an easy way of comparing a nation’s economic output or yield (as gauged by the gross domestic output) to its debt levels.

In other words, this ratio gives an account of how much money the nation earns every year and how that compares it to the debt it owes. The debt owed is expressed as a percentage of GDP.

In this article, let us look at what is the debt to GDP ratio, its formula and calculation, its working mechanism, the impact of high debt to GDP ratio, its limitations, India’s debt to GDP ratio for the UPSC IAS Examination, since the topic is important for the Indian Economy section which is a part of UPSC mains GS 3 paper.

Check out the linked article to download the notes on Indian Economy for UPSC exams now!

Latest Updates
  • The International Monetary Fund (IMF) of late proclaimed that India’s debt to GDP ratio augmented from 74% to 90% due to the COVID-19 pandemic. This was predicted to reach 99% in 2021.
  • The global financial organization has also alleged that this is to lessen to 80% after economic recovery.
  • According to a report released by RBI in June 2022, at the end of March 2022, India’s external debt was positioned at 620.7 billion USD, recording a rise of 47.1 billion USD from that of March 2021.
  • The external debt to GDP ratio lowered to 19.9 percent in March 2022 from 21.2 percent in March 2021.

Check out the linked article to download the notes on Green GDP for UPSC exams now!

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What is Debt to GDP Ratio?

The Debt to GDP ratio is the ratio between a nation’s government debt and its gross domestic product (GDP). It is an indicator of how much debt a nation owes and how much it is making to pay off its debts.

Formula and Calculation of the Debt to GDP Ratio

The formula to compute the debt to gross domestic product ratio is as given below:

Debt to GDP Ratio = Total Debt of the Nation / Total GDP of the Nation

It is the ratio between total government or sovereign debts taken by a nation to the total GDP of the nation or the economic yield for an entire year.

A nation with a high ratio will bolster its economy and growth and will require large finances. Owing to the high percentage, it is generally unable to lift money from domestic and global markets. Hence, the nations try to reduce their ratio, which may take a few years.

Check out the linked article to download the notes on Sovereign Wealth Fund (SWF) for UPSC exams now!

How Does the Debt to GDP Ratio Work?
  • The debt to GDP ratio is calculated by dividing a country's total debt by its GDP.
  • A lower debt-to-GDP ratio indicates the country is generating enough income through its economic activities to pay its debts.
  • A high debt-to-GDP ratio indicates the country may have difficulty paying its debts and servicing the interest on those debts.
  • A sustainable debt-to-GDP ratio, as per the World Bank and IMF, is about 150-250% of a country's exports or revenues.
  • The ideal debt-to-GDP ratio varies from country to country. It is based on its economic growth rate, revenue generation capacity, etc.

Impact of High Debt to GDP Ratio on the Economy

A high debt to GDP ratio is undesirable for a nation, as a higher ratio demonstrates an increased risk of default. In a study conducted by the World Bank, a ratio that surpasses 77% for a prolonged period of time may lead to an unfavorable effect on economic growth.

  • Higher debt crowds out investment in capital goods and thus lowers the output in comparison to what would otherwise have occurred.
  • A considerable part of the budget goes towards the payment of interest.
  • Allocation of poor ratings by credit rating agencies.
  • The decreased creditworthiness ratings allocated by global rating agencies tend to raise the government’s borrowing costs.

Check out the linked article to download the notes on Strategic Debt Restructuring (SDR) for UPSC exams now!

Limitations of the Debt to GDP Ratio
  • The major disadvantage of the debt to GDP ratio is that a higher ratio will not always imply an alarming point or a bad phase.
  • The ratio, to some extent, provides a brief idea about the performance of an economy. However, due to the immensity of data, it is not feasible to get very precise details with regard to debt and the GDP of a country’s economy.
  • One cannot exclusively equate nations based on the debt to equity ratio since every nation is different in terms of its size and population, government policies, inflation rate, etc. They should also examine other factors to have an equivalent base for comparison prior to investing in the stock market.

Good vs. Bad Debt to GDP Ratios
  • A study conducted by the World Bank has found that nations whose debt to GDP ratios stay more than 77% for extended periods encounter substantial slowdowns in economic growth.
  • Pointedly, each additional percentage point of debt above this threshold level costs the country 0.017 percentage points in economic growth.
  • This phenomenon is even more strong in emerging markets, where each additional percentage point of debt above 64% annually slows down the growth by 0.02 percentage points.
  • The cumulative or overall effect on real GDP might be significant. Importantly, the estimations control for other variables that may affect growth, such as the original level of per capita GDP.

Check out the linked article to download the notes on Consumer Price Index (CPI) for UPSC exams now!

What is a Sustainable Debt to GDP Ratio?
  • According to the World Bank and the International Monetary Fund (IMF), a nation can attain sustainable external debt if its subsequent and present external debt service obligations are met in full, without the accrual of more debt and without compromising growth.
  • Both of the organizations state that a country can obtain external debt sustainability by bringing the net present value (NPV) of external public debt down to around 150 percent of a nation’s exports or 250 percent of a nation’s earnings.

Top 10 Countries with the Highest Debt to GDP Ratio

Here is a list of the top 10 countries with the highest debt to GDP ratio:

  • Japan - Japan has the highest debt-to-GDP ratio of 262%. This is due to its persistent budget deficits. The government extensively borrows to finance stimulus packages and social welfare programs.
  • Venezuela - Venezuela has the second-highest debt-to-GDP ratio at 241%. This is a result of its economic crisis, hyperinflation, and government mismanagement.
  • Greece - Greece has the third highest debt ratio of 193%. It suffered a severe debt crisis in recent years. It required multiple bailouts from international creditors.
  • Sudan - Sudan has a debt-to-GDPatio of 182%. This is influenced by its political instability, armed conflicts, and economic challenges.
  • Lebanon - Lebanon has a debt ratio of 172%. Its ratio surged due to increases in public spending, a decline in growth, and political instability.
  • Eritrea - Eritrea has a debt ratio of 165%. This is due to its limited access to financial markets and economic sanctions.
  • Singapore - Singapore's high ratio of 160% is mainly due to its investment in infrastructure, education, and healthcare.
  • Libya - Libya has an elevated ratio of 155%. This is caused by its political instability, armed conflicts, and oil production disruptions.
  • Italy - Italy's ratio stands at 151%. This is due to factors like a sluggish economy, a large public sector, and excessive government spending.
  • Bhutan - Bhutan has a debt-to-GDP ratio of 135%. This increased due to investments in infrastructure, education, and healthcare.

India’s Debt to GDP Ratio

The debt to GDP ratio is the total debt of the country as a percentage of its GDP. It indicates how capable a country is to pay its debts. A lower ratio is better.

  • India's public debt to GDP ratio has remained stable at around 70% since 1991.
  • The COVID-19 pandemic has increased India's public spending. This has led to an increase in the debt-to-GDP ratio.
  • As per IMF projections, India's debt-to-GDP ratio will stabilize by 2021 and then start declining by 2025.

Check out the linked article to download the notes on Balance of Payment (BoP) for UPSC exams now!

What does the Debt to GDP Ratio mean for Individual Investors?

For individual investors, the debt-to-GDP ratio can be a useful tool for gauging the overall health of an economy. A high debt-to-GDP ratio can be a sign of potential problems. This might include inflation or currency devaluation. This can make it more difficult for businesses to operate. It can lead to lower investment returns.

Here are some of the things that individual investors should consider when looking at a country's debt-to-GDP ratio:

  • The trend of the debt-to-GDP ratio over time. If the ratio is increasing, it is a sign that the country is borrowing more money.
  • The size of the country's economy. A large economy can typically support a higher debt-to-GDP ratio than a small economy.
  • The country's interest rate policy. If the country has a high-interest rate, it will be more difficult to repay its debts.
  • The country's ability to repay its debts. If the country has a history of defaulting on its debts, it is a sign that it may be unable to repay its debts in the future.

Check out the linked article to download the notes on Investment Models for UPSC exams now!

Conclusion
  • A nation’s government needs to concentrate on its GDP and debt to GDP ratio.
  • Every nation marks its place in trade and investments when it has a steady and evolving economy.
  • Having a higher percentage places them poorly in the global market, and they begin to lose their scope in the world market. Such economies start supplying goods and services at a reduced cost, making it even harder to cope with their debt (for example- Greece).
  • The debt to GDP ratio, apart from a few exceptions in countries like Japan, works well for other countries to ascertain how well-positioned the economy is.
  • It also proves to be very helpful for investors and economists to arrive at a conclusion corresponding to a nation and its growth.

We hope that all your doubts regarding the topic Debt to GDP Ratio UPSC have been addressed after going through this article. Testbook offers standard quality of study material for various competitive exams. Download the Testbook App now and be successful in your UPSC preparations.

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Debt to GDP Ratio UPSC FAQs

The Debt to GDP ratio is important as it suggests how efficient a nation is in paying off its debts. It fundamentally is the ratio between a nation's debt to the nation's gross domestic product (GDP). The lesser the ratio, the sounder the economy.

As of 2020, of the nations for which the IMF possessed data, Venezuela had the utmost level of general government debt to GDP ratio at 304%. It was followed by Japan, with a reading of 254%.

A high debt to GDP ratio might be an indicator of increased default risk for a nation. A country defaulting in paying off its debts can spark fiscal consequences on a global scale.

Some of the major effects of high debt to GDP ratio are:Crowding out effect.A significant portion of the budget goes towards the payment of interests.Credit rating agencies give low ratings.Cost of borrowing will increase.

Public debt is the money borrowed by the government of a nation. In the Indian framework, public debt contains the overall liabilities of the Union government that have to be paid from the Consolidated Fund of India. It does not include the liabilities contracted against the public account.
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