Are we having head over heels in debt?

CA Bhanu Kandel

A national debt, if it is not excessive, will be a national blessing. These timeless nuggets of wisdom of Alexander Hamilton are always pervasive and prevailing. There is also an old saying that there are four things that every person has more of than they know; sins, foes, years, and debt. Undoubtedly, when it comes to national debt, every rupee is accounted for with accuracy.

The national debt is the public and intra-governmental debt owed by the federal government. It is also called sovereign debt, country debt, or government debt. Regardless of what it’s called, public debt is the accumulation of annual budget deficits. Each year’s budget deficit is financed either through grants or through national debt. It’s also a secret tool for the political leaders to win vote banks by levying less tax and bridging the gap through national debt. Governments tend to take on too much debt because the benefits make them popular with voters. A nation’s deficit affects its debt and vice-versa. Increasing the debt allows government leaders to increase spending without raising taxes.

Investors usually measure the level of risk by comparing debt to a country’s total economic output, known as gross domestic product (GDP). The debt-to-GDP ratio gives an indication of how likely the country can pay off its debt. Investors usually don’t become concerned until the debt-to-GDP ratio reaches a critical level. 

To measure the magnitude of national debt, it is widely compared with the GDP of the given nation. As per the latest data published on ‘Trading Economics’, the country with highest national debt is Japan which has Debt to GDP ratio of 238% followed by Greece which is 177%. Surprisingly, USA also tops the chart by its debt/GDP ratio of 107%. On the flipside, Brunei has the lowest debt/GDP ratio of 2.4% followed by Afghanistan (7.1%). Out of about 168 countries which owe national debt, Nepal is ranked in the 129^th position from the top by its debt/GDP ratio of 30.2% compared to 30.4% in previous year. If we compare the SAARC nations, Bhutan tops the chart (110%), followed by India (69.62%), SriLanka (86.8%) Pakistan (84.8%) and Nepal (30.2%) upto last year.

However, grass is not greener on the other side. As per the recent Report on Quarterly Debt Position published by Financial Comptroller General Office (FCGC) of Nepal, there is a sudden rise in the debt/GDP ratio to 34.54% at the third quarter end of FY 2076/77 from 31.90% of previous quarter. The current total government debt amounts to Rs. 1,196 billion out of which external debt is Rs. 714 billion and internal debt is Rs. 482 billion. Out of total increment in debt by 8.18%, external debt is increased by 9.18% and internal debt is raised by 6.75%. The increment in external debt majorly constitutes currency devaluation whereas rise in internal debt is through treasury bill and bonds. Despite a low spending in capital expenditure, the sudden jump in the internal borrowing should have been to provide grants to newly established local bodies in the federal structure.

Above figures shows that developed and developing countries owe public debt for financing their economic growth. There is no doubt that the enormous economic growth of China is supported by its massive national debt which is more than 50% of its GDP. When used correctly, public debt improves the standard of living in a country. It allows the government to build new roads and bridges, improve education and job training, and provide pensions. This spurs citizens to spend more now instead of saving for retirement. This spending by private citizens further boosts the economic growth.

Debts are like children; the smaller they are the more noise they make; in case of Nepal, the Spanish proverb perfectly depicts the market hype. The data shows that the debt/GDP ratio of Nepal (34.54%) is way below than the SAARC average (55.14%). It is also far below the tipping point of 77% as recommended by The World Bank. Let’s put it other way, that is per capita national debt. In the South Asia region, Bhutan has the highest per capita country debt of $3,503 followed by India ($1,367) and Pakistan ($ 1,122) whereas, as of 15 April 2020, Nepal has per capita national debt of $ 332 (approx. Rs. 40,000) compared to $ 312 of the year 2018.

In the short run, public debt is a good way for countries to get extra funds to invest in their economic growth. Public debt is a safe way for foreigners to invest in a country’s growth by buying government bonds. This is much safer than foreign direct investment. It’s also less risky than investing in the country’s public companies via its stock market. Public debt is attractive to risk-averse investors since it is backed by the government itself. When debt approaches a critical level, investors usually start demanding a higher interest rate. They want more return for the greater risk. If the country keeps spending, then its bonds may receive a lower credit rating. This indicates how likely the country will default on its debt.

Moreover, interest on debts grows without rain. As interest rates rise, it becomes more expensive for a country to refinance its existing debt. A large chunk of the national revenue has to go toward debt repayment, and less toward government services. Much like what occurred in Europe, a scenario like this could lead to a sovereign debt crisis. The recent debt crisis of Italy is the epic example of how not to overly rely on external debt.

To conclude, in the long run, public debt that’s too large is like driving with the emergency brake on. Over dependency on the external debt can be a possible cause of debt repayment default and ultimately economic collapse of the nation. Moreover, misuse of long term national debt to meet short term recurring expenses and to gratify the vote bank could be devastating. At times, nothing is perfect and it all depends on our perception towards things and what all we can do to make things look better. To avoid the boomerang, government need to carefully find that sweet spot of public debt which must be large enough to drive economic growth but small enough to keep interest rates low. 

(Kandel is a senior Chartered Accountant)