One of the important indicators for the performance of an economy is the level of indebtedness, the country has accumulated over the years. Generally higher budget deficits happen when the country is going through an economic slowdown and the government revenue in the form of taxes and duties will fall much short of their requirements. Conversely when the economy picks up the government coiffeurs gets a big bounty which then is used to pay off the previously accumulated debt. A low debt to GDP ratio implies that the country’s economy is on even keel and produces goods and services in adequate amounts. On the other hand a high public debt to GDP rates indicates slow economic growth. One of the important requirements for a European country to join the Euro zone is the implementation of the Maastricht agreement by which the member country should keep its budget deficit to 3% of GDP and the overall debt should not exceed 60% of GDP. All the recent austerity measures in Europe is because of the violation of this agreement.
Let us turn our attention to the debts to GDP ratio of the US
Year Debt to GDP ratio
Look at the jump from the year to 2009. This was due to sub-prime problem. Nearly 15 million Americans didn’t have jobs and big banks, insurance companies were on the verge of bankruptcy. The GDP growth rate dropped and currently this is still the problem. Because of the increased debt to GDP ratio, US is finding it difficult to accelerate the growth rate. Some estimates show that the US economy is operating at 70 percent of its potential. Obama in his latest budget has called for big cuts in expenditure and also increase in taxes which again will slow down the economy. It may take a while for the US to get out of this rut and put the economy back on the growth track.
Now let us look at China
Year Debt to GDP
Clearly a much healthier economy when their annual deficits were less than 20%, their GDP was growing at 10%. Now that the deficit is increasing from 2011, the economy has started slowing down. Current estimates are that the Chinese economy will grow around 7.5% for FY 14. Given the will to implement fiscal discipline, Chinese economy will be back on track and will achieve higher growth rates in the year to come.
Finally, let us turn our attention to India
Currently Indian to debt to GDP is around 70%. This is the highest among the BRICS countries. When our economy was growing around 8 to 9% debt was not a major issue. Now with the inflation measured by WPI is around 7% and the economy growing at 5 percent, there is every possibility that our future debt level will keep climbing up. The more the debt increases, the interest payment will eat away more than 20% of government revenue and so the government’s effort to push the economy on a faster growth track will become difficult.
In conclusion governments of countries that increases its debt level to GDP will have to accept lower growth rate and a stagnant economy.