TT public debt vs GDP
GROSS domestic product (GDP) is the sum of the gross value added by all resident producers of an economy, together with taxes on products and net of subsidies that are not involved in the value of the product. GDP is one of the most common indicators to assess the health of an economy by taking into account a series of different elements such as consumption, government expenditure, investment and net exports.
GDP growth measures the variation of an economy in the volume of its production or the real incomes of its residents. TT’s GDP growth has declined in recent years, possibly due to external shocks such as oil prices and covid19, which can potentially drive up public debt.
Public debt is the total outstanding debt of the central government, including bonds and other securities that can be generated externally and internally. Debt is vital for financing public spending and closing budget deficits in order to improve the growth and well-being of an economy. However, an excess of its debt-to-GDP ratio can lead to devastating economic problems and possibly deterioration in long-term economic growth, making debt a double-edged sword.
The IMF suggests a debt-to-GDP ratio of 40 percent as a limit for developing countries that should not be exceeded in the long run. However, as of 2014, TT’s ratio increased well beyond 40% to reach an acceleration of 82.7% in 2020. This may hamper TT’s long-term economic growth.
According to Calderón and Fuentes 2013, a study of five Caribbean countries, including the TT, concluded that there is a strong and negative relationship between the ratio of public debt to GDP and economic growth.
This was supported by Checherita and Rother 2010, who explained that economic growth can have a negative linear impact on the public debt-to-GDP ratio, as reductions in economic growth, ceteris paribus, are accompanied by increases in the ratio. public debt / GDP. GDP, which can be harmful to growth. This is demonstrated in times when TT’s public debt-to-GDP ratio increased and real GDP growth contracted, with devastating consequences.
One way in which the accumulation of public debt can discourage economic growth is by raising interest rates, which leads to the crowding out effect. TT constantly experiences budget deficits, reaching as high as 11% of GDP in FY2020. These deficits are financed by debt financing, which can result in higher long-term interest rates.
As budget deficits are sustained by debt financing, crowding out of private sector investment occurs, which inhibits the growth of potential output. Indeed, the increased need for public financing increases the yields on sovereign debt, which would encourage a greater net flow of funds to the public sector from the private sector, pushing up the private / domestic interest rate and causing a rapid crowding out of the private sector. sector borrowing.
This reduces the growth of private expenditure by businesses and households, which has a considerable negative impact on the development of SMEs and rural borrowers and on GDP growth in general. As a result, private sector investment is crowded out by public debt, which lowers long-term economic performance.
Another channel through which high public debt is dangerous for economic growth is external debt distress. The challenge exists when countries are unable to repay their debts. TT’s debt level is already above its IMF threshold and is significantly high. However, if it reaches a position where the government is unable to service its debt, the over-indebtedness will have negative consequences for the country’s investment and economic growth.
Over-indebtedness can hamper private investment as foreign and domestic investors would be discouraged from providing more capital, as they anticipate current and future tax increases. According to Calderón and Fuentes 2013, in light of a greater accumulation of public debt, the government could apply distorting taxes or increase inflation in order to repay the debt, thus limiting the potential for future growth of TT. Therefore, fear of higher taxes slows down investment and leads to lower production.
In addition, TT is open and vulnerable to natural disasters and external shocks. For example, IMF 2013 explains that TT has an 8.9% probability of hurricanes in any given year. Therefore, countercyclical policies of the economy are imperative.
Increased debt servicing requirements reduce the government’s fiscal space to implement countercyclical policies, thereby limiting the economy’s ability to recover from the negative growth effects of economic and natural shocks, thus leading to greater volatility. high and limited growth. Therefore, increasing public debt decreases the government’s ability to execute countercyclical fiscal policies, resulting in increased volatility and reduced growth.
GABRIELLE HOSEIN’s column will be back next week Wednesday