Tax Season

Debt-to-GDP ratio shows Canada's strength

Once a way for the Liberal government of Jean Chrétien in the early 1990s to deflect public concerns about the federal deficit, the debt-to-GDP ratio has become the new gauge of a country's fiscal health.
Once a way for a government to deflect public concerns about a deficit, the debt-to-GDP ratio has evolved into a new gauge of a country's fiscal health.

For Canada, it is one measure in which the country is performing better than most.

"Canada's net debt-to-GDP ratio is the lowest in the G7 economies," said Scotiabank president and chief executive officer Rick Waugh back in February 2009. "Even with the Canadian government’s recently announced stimulus package taken into account, the net debt to GDP will remain under 30 per cent."

That means, by Waugh's estimate, Canada will have no more than $30 of debt for every $100 of GDP.

The better way

The debt-to-GDP ratio compares the size of a country's total debt with the size of its gross domestic product and expresses the debt not as a dollar amount but in terms of what percentage of GDP it is equal to.

Measuring debt in this way is a means of figuring out whether a country can afford to maintain its existing debt burden.

Just looking at a nation's debt places too much emphasis on the dollar amount of the borrowings and does not take into account the size of the country's economy.

Greece, for example, has a total debt of slightly more than $400 billion US and stands on the brink of a costly default.

Germany, on the other hand, has piled up borrowing in excess of $5 trillion but is considered to be on the road to recovery.

Of course, the reason for the differing economic prospects is that Germany's GDP, at $3.65 trillion in 2008, is about 10 times as big as that of Greece, which posted GDP of $357 billion in the same year.

Expressing total debt as a percentage of national GDP is one way of looking at borrowing levels within the context of a country's ability to repay this cash.

"The best way to measure debt is not in total dollars but as a comparison to the economy’s total size, known as the debt-to-GDP ratio," wrote Michael Linden, associate director of tax and budget policy at the Washington-based think tank American Progress, in 2009.

The tripwire

Once the debt ratio is determined, however, economists argue vociferously about the proper percentage of debt for a country's economy.

Most economy watchers accept that setting the bar at zero, implying no national debt, would lead to unacceptable cuts to a nation's social services to be a practical goal.

 Country 2010 debt-to-GDP ratio
Japan 227 %
Italy 121 %
U.S. 98 %
Canada  77 %
Source: International Monetary Fund

Conversely, Japan's debt level of more than 200 per cent — nearly twice as high as the next worst debt performer, Italy — would appear to be excessively profligate.

U.S. economists Kenneth Rogoff and Carman Reinhart believe the danger point is a debt-to-GDP ratio in excess of 90 per cent.

"That level has historically been associated with notably lower growth," the two economists wrote in the Financial Times newspaper in January.

Once a country's debt measure pops above that level, the national GDP loses a percentage point of economic growth, they estimated.

Who's in danger?

Using the Rogoff-Reinhart line, Japan, Italy and the United States would appear to be the most at risk.

The World Bank estimates that Japan's debt-to-GDP level will hit 227 per cent in 2010 while Italy's will rise to 121 per cent in the same year.

Even the United States, which has spent billions on its various stimulus packages, could see a debt ratio of 97 per cent by 2010.

By contrast, the World Bank figures Canada's debt-to-income measure will edge up to 77 per cent in 2010.