Does Debt to GDP Matter?

In more recent months, it has become fashionable for U.S. economists to argue that America’s growing public debt is not a problem but something to be embraced.

Lawrence Summers and Jason Furman of Harvard penned a recent article “Who’s Afraid of Budget Deficits?”, where they argued that debt reduction should not be a priority. The Tory Government in the U.K., especially under George Osborne, the former Chancellor, used to cut expenditure to balance books. And they failed miserably!  

Olivier Blanchard, former IMF chief economist, views debt is sustainable when the risk-free interest rate is below the economy’s growth rate.

The U.S. Congressional Budget Office (“CBO”) projects USD 900 billion deficit in fiscal 2019. As at February 2019, U.S. debt level was USD 22 trillion. CBO expects by 2029, debt will increase to USD 28.7 trillion or 93% of GDP.

In 2009, Reinhart and Rogoff documented eight centuries of financial crises. Excessive debt accumulation was the cause for slower economic growth (long-term) as they argued. Once debt reaches more than about 90% of GDP the risks of a large negative impact on long term growth becomes highly significant.

A study by the World Bank found that if debt to GDP ratio of a country exceeds 77% for an extended period of time, it slows economic growth.

Meltdowns, in various countries, share some common themes and these include:

·       huge capital inflows are a precursor to a crisis;

·       wave of financial innovation leads to crisis; and

·       financial liberation precedes a crisis.

What about Malaysia?

Malaysia’s external debt (Federal government, corporates and banks) stood at RM924.9 billion or 64.7% of GDP as at end December 2018, according to Bank Negara Malaysia (Star, Feb 14, 2019). Of this, one-third is denominated in Ringgit while the balance is subject to fluctuations in exchange rate. It is therefore useful to monitor debt levels more closely and take steps not to exceed a threshold of say, 75%.

Breakdown of Foreign Currency-Denominated External Debt (% Share)

Source: BNM Quarterly Bulletin (Fourth Quarter 2018)

Reference:

1.     Caroline Baum, Opinion: Does debt matter? It doesn’t until ... it does www.marketwatch.com

2.     Why the $22 trillion national debt doesn’t matter – here’s what you should worry about instead https://theconversation.com

3.     Carmen M. Reinhart & Kenneth S. Rogoff (2009), This Time Is Different, Princeton University Press