iFund- What does Debt-to-GDP ratio mean to investor?

2019-09-06 08:47
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Looking at the long-run dynamics of debt to GDP ratio of a country is always more critical. While any country can choose to have a higher debt level as to meets its economic goal in the short run, the growth in debt should not exceed its economic growth rate for an extended period of time as this simply means that the country is not effectively using its debt and the ability to pay off the debt is deteriorating.

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Debt-to-GDP is one of the key ratios that are ongoing monitoring by analysts, investors and economists. The equation is simple with a country’s public debt in the numerator and its gross domestic product (GDP) in the denominator. In general, the debt to GDP ratio is used to gauge a country’s ability to repay its debt. It can also be interpreted as the number of years required to pay back the country’s public debt if GDP is dedicated entirely to debt repayment.

 

Which countries have the highest debt-to-GDP ratio in 2019?

As of June 2019, Japan continues to be the nation with the highest debt-to-GDP ratio at 234%, which then followed by Greece (182%), Sudan (176%), Venezuela (172%), Lebanon (161%) and Italy (128%). Other major economies like United States is placed at 12th position (109%), Singapore at 13th (109%), France at 18th (96%), Spain at 22nd (95%), Germany at 79th (56%) and China at 85th (54%).

 

How to analyse the debt-to-GDP ratio?

The debt-to-GDP ratio is a frequently used ratio among rating agencies, but analyziing it may not be that simple and straightforward. It is not necessary that a ratio exceeding 100% indicates a bankrupt or insolvent country. For example, Japan’s debt to GDP ratio has been over 200% for over a decade, however it received little attention from the rating analysts as most of the country’s debt is held by its own citizens, which diminishing greatly the risk of defaulting. On the other hand, Ukraine defaulted in 2015 when its debt was merely 30% of the GDP, but the debt was mainly held by foreign governments and investors. As such, it is not only the size of the debt matters, the ability to meet the payments is even more important. Besides, a higher debt-to-GDP ratio is acceptable if an economy is growing fast because its future earnings will be used to pay off the debt more quickly. Countries with a viable plan of action to deal with such high ratio is also preferable and may face less downgrade risk than those without a plan.

 

China’s debt to GDP ratio is only 54%, but why are investors always concerned about it?

This is because apart from counting the public debt of China, it is also important to look at the total debt level of the country, which includes corporate and household debt too. Indeed, China’s total debt now exceeds 303% of GDP and makes up about 15% of all global debt as of July 2019. Debt is increasing again in 2019, spanning from household, government and the financial sector as China needs to boost the economy amid the trade war with the United States. For instance, 60% of the corporate debt in China is related to state-owned enterprises (SOEs), of which, over 50% are debts of local government financing vehicles. Therefore, if counting all these, the public debt level of China is obviously much more than what we see on the table.

To conclude, looking at the long-run dynamics of debt to GDP ratio of a country is always more critical. While any country can choose to have a higher debt level as to meets its economic goal in the short run, the growth in debt should not exceed its economic growth rate for an extended period of time as this simply means that the country is not effectively using its debt and the ability to pay off the debt is deteriorating.

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