TT’s public debt vs GDP

SHIVANI MAHASE

GROSS domestic product (GDP) is the sum of gross value added by all of an economy’s resident producers, together with any product taxes and deducting any subsidies which are not involved in the product’s value. GDP is one of the most common indicators for gauging an economy’s health by taking into account a series of different elements such as consumption, government expenditure, investment and net exports.

GDP growth measures an economy’s change in the volume of its outputs or real incomes of its residents. TT’s GDP growth has been declining in recent years, possibly due to external shocks such as oil prices and covid19, which can potentially drive up public debt.

Public debt is central government’s total outstanding debt inclusive of bonds and other securities that can be generated externally and internally. Debt is vital to finance government expenditures and fill budgetary gaps to improve an economy’s growth and welfare. However, an excess of its debt-to-GDP benchmark can lead to overwhelming economic problems and possibly a deterioration in long-term economic growth, which makes debt a two-edged sword.

The IMF suggests a 40 per cent debt-to-GDP ratio as a boundary for developing countries that should not be breached on a long-term basis. However, from 2014, TT’s ratio progressed far beyond 40 per cent to an accelerated 82.7 per cent in 2020. This can hinder TT’s long-term economic growth.

According to Calderón and Fuentes 2013, a study that included five Caribbean countries inclusive of TT, concluded that there is a robust and negative relationship between the ratio of public debt-to-GDP and economic growth.

This was supported by Checherita and Rother 2010, who explicated that economic growth may possess a negative linear impact on the public debt-to-GDP ratio, as reductions in economic growth, ceteris paribus, are accompanied with increases in the public debt-to-GDP ratio, which can be deleterious for growth. This is evidenced in periods when TT’s public debt-to-GDP ratio increased and real GDP growth contracted, leading to devastating consequences.

One medium by which public debt accumulation can deter economic growth is through higher interest rates resulting in the crowding-out effect. TT persistently experiences budget deficits, reaching as high as 11 per cent of GDP in fiscal 2020. These deficits are funded through debt-financing, which can result in higher long-term interest rates.

As more budget deficits are supported through debt-financing, a crowding-out of private sector investment occurs, which inhibits potential output growth. This is because the greater need for public financing increases the sovereign debt yields, which would encourage a greater net flow of funds into the public sector from the private sector, pushing up the private/domestic interest rate and causing a rapid crowding-out of private sector borrowing.

This reduces private spending growth by businesses and households, which poses a substantial negative impact on the development of SMEs and rural borrowers and the growth of GDP at large. Therefore, private sector investment is crowded-out by public debt, which diminishes economic performance in the long run.

Another channel in which high public debt is dangerous to economic growth is through the external debt overhang. The challenge exists when countries are unable to service their debt obligations. TT’s debt level already surpasses its IMF threshold and is significantly high. However, if it increases to a position where the Government is unable to service its debt, the debt overhang will have adverse consequences for the country’s investment and economic growth.

Debt overhang can hinder private investments as foreign and domestic investors would be discouraged from supplying further capital, because they anticipate increases in current and future taxes. According to Calderón and Fuentes 2013, in light of a greater public debt accumulation, the Government may enforce distortionary taxes or increase inflation in order to service the debt, thus limiting TT’s potential for future growth. Therefore, the fear of greater taxes dampens investment and results in declining output.

Moreover, TT is open and vulnerable to natural disasters and external shocks. For example, IMF 2013 explicates that TT has an 8.9 per cent probability of hurricane strikes in a given year. Therefore, the economy’s counter-cyclical policies are imperative.

Increased debt service requirements reduce the Government’s fiscal space to implement counter-cyclical polices, hence limiting the economy’s ability to recover adverse growth effects from economic and natural shocks, thus resulting in higher volatility and limited growth. Therefore, heightened public debt diminishes the Government’s capacity to execute counter-cyclical fiscal policies, bringing about increased volatility and reduced growth.

GABRIELLE HOSEIN'S column will be back next week Wednesday