By Thomas Kenny. Bonds Expert
Last updated November 2014
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The lower the debt-to-GDP ratio, the healthier the country’s fiscal outlook. And, all else equal, the lower the ratio, the lower its bond yields should be. This relationship is by no means linear, however, as there are countless factors that can influence bond yields.
How High is Too High?
A ratio below 50% is seen as being healthy, while a ratio over 90% is generally regarded as the danger zone. This is only a general guideline, however, since a country can support higher debt if its economic growth also is robust.
Conversely, slow-growing countries can run into trouble at much lower debt-to-GDP ratios than faster-growing nations.
Why a Manageable Debt-to-GDP Ratio is Essential
At a certain point, a country’s debt burden can become so large that its interest costs expand to the point where the government must raise taxes and/or cut spending in other areas to finance the debt. In turn, this has an adverse impact on economic growth. This creates the potential for a vicious circle which slower growth leads to lower tax revenue, which requires the country to take on more debt, and so on.
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Eventually, investors lose faith in the country’s fiscal management, causing bond prices to fall and yields to soar. Naturally, higher yields only serve to increase the cost of maintaining the debt. This is the type of negative cycle has occurred in Europe in recent years, and is a key aspect of the region’s debt crisis .
What is the United States' Debt-to-GDP Ratio?
The Organisation for Economic Co-operation and Development provides a table showing the debt-to-gdp ratios of the major world economies, which can be found here .
A look at this table
reveals that the United States, after crossing the 100% mark early in 2012, has the dubious distinction of owning the eighth-worst ratio in the developed world. The United States was estimated to have a debt-to-GDP ratio of 102.1% in 2012, 104.3% in 2013, and it's on track for ratios of 106.2 and 106.5 in 2014 and 2015, respectively.
What Countries Have the Highest Ratios?
Japan has the highest debt-to-GDP ratio in the developed world in 2014 – 2233% – but this is nothing new. The country has been saddled with enormous debt for years following its stock market / real estate crash of the early 1990s, and – as is the case with the United States – Japanese government bonds still yield next to nothing. Not surprisingly, most of the other countries on the high end of the list are members of the European Union, including Greece (188.2%), Italy (147.7%), Portugal (142.2%), and Ireland (132.0%).
Somewhat counterintuitively, many of the healthiest countries are so-called “emerging markets .” The world’s developing nations endured a series of crises in the 1980s and 1990s, prompting most to reduce debt and pursue more responsible fiscal policies. The result is that many of the world’s developing countries are actually among those with the lowest debt-to-GDP ratios.
Putting it All Together
The final point to keep in mind is that many of the countries with the highest ratios also have high credit ratings. while many of those on the low end of the list (such as Russia and Kazakhstan) don’t have particularly robust ratings. Again, this shows that there is more to a country’s fiscal health – and bond yields – than debt-to-GDP ratio. Still, it is a helpful concept to understand at a time in which governments’ fiscal issues are such a large driver of market performance.