Microeconomic Indicator in FOREX:
Government Debt to GDP Ratio
What is the Debt to GDP ratio?
Debt-to-GDP ratio is basically the ratio between the country’s total earning, i.e. GDP to its total debt. It is calculated by dividing total debt the nation has as of a particular year to that of its GDP for that year. It is generally represented in percentage as it is a ratio. This debt-to-GDP ratio indicates the country’s ability to pay off its debts. If the debt-to-GDP ratio of a country is higher, it means that the country might struggle to repay its debt. If this ratio is abnormally high, the country is more likely to get defaulted by failing to repay the debt. If the debt-to-GDP ratio is low that means the country is in a comfortable position and can repay the debt easily.
This ratio is also useful to calculate the number of years the country would take in order to pay back the debt if its entire GDP is dedicated to the repayment alone. Debt-to-GDP ratio also measures the financial leverage of an economy. One of the important criteria for the countries to undergo Euro convergence was that government debt-to-GDP to be below 60%.
How does Debt to GDP ratio affect the economy?
According to the economic experts, the debt-to-GDP ratio should be below 77% for the country’s economy to be stable. But there is a catch. There is a huge difference between debt denominated in domestic currency compared to the debt that is denominated in foreign currency. A country can pay back the debt denominated in domestic currency by revenues received from the taxes they levy but to pay back the foreign currency debt, the country has to convert its tax revenues in the foreign exchange market to foreign currency, which can have a negative impact on the value of its currency.
For example, the debt-to-GDP ratio of Japan is 228% but its economy is stable because its debt is based out of its own people and not foreign banks. If this ratio crosses 77% for a long time, it will have a strong negative impact on the economy of a country. Almost 1.7% of the country’s economy gets affected if there is a high debt-to-GDP ratio for a long time. This percentage differs for the emerging markets. If the debt-to-GDP ratio is more than 64% for a long time, almost 2% of the country’s economy gets affected. So it is very important for the country to maintain this ratio to have a strong and stable and economy.
Reliable source of information on ‘Debt to GDP Ratio’ for Major currencies:
There is a lot of information with respect to the Debt to GDP ratio in the sources provided below. You can familiarize yourself with the Debt to GDP ratio of the respective country along with the historical data related to that country’s Debt to GDP ratio. You can also compare the ratios of one country to the other using this web portal. The graphical representation of the historical Debt to GDP ratio data will give you a clear understanding of how these ratios changed over time. You also get to change the graphical representations according to your preference. A ton of more information related to the latest news in that regard is provided to give you a better understanding.
GBP (Sterling) - https://tradingeconomics.com/united-kingdom/government-debt-to-gdp
What do traders care about the Debt to GDP ratio and its impact on the currency?
As we know the government debt to GDP ratio indicates the ability of the country to pay back its debt, higher Debt to GDP ratio for a long period means the country is more likely to get defaulted on its debt. This questions the foreign banks and governments to lend money and provide debt to these countries. So they increase the interest rates as there is a higher risk involved. Also, the economy of the country slows down when there is a higher debt to GDP ratio. Weaker economy indicates the depreciation of the currency. Hence this ratio will be an important factor for the traders to consider while they trade foreign currencies on forex.
Frequency of the release
Debt to GDP ratio is released by the government of a country annually. Every financial year this ratio is released and compared to the previous year’s data. Governments review the total debt that the county has for that year and divide that data with the current year’s GDP to arrive at this ratio so that the data is accurate and real time.
The Bottom Line
If a country’s debt-to-GDP ratio is abnormally high for a pretty long period, it indicates a recession. Because a country’s GDP will go down in a recession. This can also affect the common people living in the country as the government tends to increase the taxes to keep up the revenue. Also, if there is a high return on the debt that is borrowed, the lending governments will have more faith in the county to repay their debts. If there is very less return on the debt that is borrowed, that will question the lenders, as there is high risk. The best example of this is The United States. Even though there is a huge debt on this country, lending governments wouldn’t mind providing debt to them as there is a high yield on their debt that is provided to them. So they wouldn’t mind providing more debt as the US is considered extremely safe in this regard. The other important factor to consider here is that lending governments earn a lot of interests on the debt that is provided to superpowers like the US. So they wouldn’t mind the US not paying back their debt as they can earn high interests from the debts they have provided.
In Trader’s perspective, it is better to have an overall view on how the country’s debt to GDP ratio is, and approximately forecast if the country is more likely to pay back their debts or no. This is especially for the long term holders. If this factor is ignored, there are high chances of the currency they are holding depreciate in the long run, if that country gets defaulted on its debt.