Question

Give an example of a “debt ratio” for a typical local government. Explain why the debt might be incurred and the implications if the debt ratio is high or low.

Answer 1

One suitable example of a debt ratio for a local government would be the debt to GDP ratio. This would be calculated as total debt divided by the total gross domestic output for that state. This ratio is a very important indicator as to how much the government is funding it expenditure of its total GDP. If the debt to GDP ratio is high then the government would have to either cut its expenditure or increase its revenue via taxation because maintaining high debt as percentage of GDP is not sustainable in the long run and government might default on its obligation to ay back the debt. Even through the debt by the governments are sovereign debt with high credit rating, having consistently increasing debt percentage as of GDP can be disastrous for the government. It can damage its creditworthiness and it would be difficult for it to borrow money from the market. High debt percentage of GDP would normally be associated with certain level of risk so high yield has to given to investor and low debt would mean that debt default would be very low so the yield would be low.