When Is Government Debt Sustainable?

Is a government’s debt too high? Economists often focus on the debt-to-GDP ratio and how it changes over time.

The key formula

The change in the debt ratio depends on:

• The interest rate on debt (r).
• The economy’s growth rate (g).
• The primary deficit: the deficit excluding interest payments.

r versus g

• If r > g, interest adds to debt faster than the economy grows, so the debt ratio tends to rise unless the government runs a primary surplus.
• If r < g, the economy grows faster than interest accumulates, so the debt ratio can fall even with some primary deficit.

This is why economists often say “r minus g” is central to debt sustainability.

An example

A country has debt of 80 percent of GDP. If nominal GDP grows 10 percent a year and the interest rate is 7 percent, growth erodes the debt ratio, allowing a modest primary deficit without the ratio rising.

India

India’s nominal growth has often exceeded its interest rates, helping keep debt manageable despite deficits. India’s combined centre and state debt is high, around 80 percent of GDP. The government set a goal of reducing central debt toward about 50 percent of GDP by 2031.

Risks

• Rising interest rates can quickly make debt harder to sustain, as many countries found after 2022.
• Slowing growth.
• Currency risk for debt in foreign currencies.

Olivier Blanchard

In 2019, economist Olivier Blanchard argued that with low interest rates, public debt might be less costly than thought, sparking debate that shifted when rates rose.