Debt to GDP Ratio: Use with Care

Brian Sturgess - November 2017



One of the most widely used and misused statistics is the ratio of public debt to national income as a measure of a country’s solvency. The debt-to-GDP ratio itself is measured with a country's gross sovereign debt in the numerator and Gross Domestic Product (GDP) in the denominator. A debt-to-GDP ratio of 1.0 (or 100%) means that a country's debt is equal to its gross domestic product. It is used extensively by credit rating agencies, but making sense of any particular ratio is difficult.

Controversy over the use of the debt-to-GDP ratio to determine the health of an economy was stimulated by the publication of a paper in 2010 by Carmen Reinhart and Kenneth Rogoff entitled “Growth in a Time of Debt” which analysed 44 countries over 200 years. The paper concluded that when government debt exceeded 90 percent of GDP the rate of economic growth declines by about one percentage point annually. The authors’ choice of debt to GDP categories to categorize the data was arbitrary. Moreover, economic growth also declined in other categories of debt to GDP: under 30 percent, 30 to 60 percent and 60 to 90 percent. As Japan and the USA have shown there is no necessary connection between bankruptcy and a high ratio since in these cases one has the world’s reserve currency and in the other case the debt is largely held domestically. But a high debt to GDP ratio can signal problems as in the cases of Argentina, Venezuela and Iceland.

The biggest problem with the debt-to-GDP ratio concerns the measurement of debt, although measuring GDP also generates many issues particularly in emerging markets. Debts and debt instruments range from the simple to the complex and their value is not independent of the structure of interest rates and difficult to measure factors such as levels of confidence. The financial crisis of 2007 exploded the notion that the true value of debt instruments such as Collateralised Debt Obligations could be measured with any degree of certainty.

Measuring public sector debt is no easier particularly given the fact that a great deal of public sector debt is held by central banks as a result of quantitative easing programmes. Furthermore, the measurement of public debt ratios and estimates of sustainability are also crucially dependent on accounting policies. Too many governments account for debt on a cash basis and not on accrual basis that measures long-term assets and liabilities when they fall due.

Ian Ball, Chair of the Chartered Institute of Public Finance and Accountancy has noted that the application of current best practice International Public Sector Accounting Standards (IPSAS) would lead to large revisions of national debt to GDP ratios. For example, Greece’s debt measured conventionally at 179 percent of GDP in 2016 would weigh in at only 68% if total public sector debt was calculated using IPSAS. Unfortunately, these accrual standards are not applied universally so intercountry comparisons are flawed and lack transparency.