How high debt levels undermine economic stability
Investor confidence weakens when debt sustainability is questioned, leading to capital flight and reduced foreign direct investment
Published: 06:04 PM,Apr 17,2025 | EDITED : 10:04 PM,Apr 17,2025
External debt has become a pressing concern for many developed and emerging economies. While borrowing from foreign sources can fuel growth, excessive debt often leads to currency depreciation, inflation, and sluggish economic performance.
Countries with high debt-to-GDP ratios face economic instability as a significant portion of national revenues is allocated to debt servicing, limiting their ability to invest in development.
Several developed and emerging economies are grappling with high external debt levels. Japan’s debt-to-GDP ratio exceeds 250 per cent, the highest in the world. Although much of its debt is domestically owned, external liabilities still exert pressure on the yen, leading to periodic devaluations. However, Japan’s low inflation and investor confidence have helped mitigate some risks. The US holds the largest absolute external debt, exceeding $30 trillion, with a debt-to-GDP ratio above 120 per cent.
The US dollar’s global reserve status provides a buffer, but persistent deficits and rising interest rates pose long-term risks. A weaker dollar raises import costs, fueling inflation and reducing consumer purchasing power. Interest payment outflow of $1 trillion a year due to massive external debt by US put added pressure to current account deficits.
Italy, with a debt-to-GDP ratio exceeding 140 per cent, faces recurrent financial instability. The country’s external debt weakens the euro, increases borrowing costs, and contributes to sluggish economic growth. Argentina has suffered multiple debt crises due to excessive borrowing and weak fiscal management.
Its external debt-to-GDP ratio hovers around 80-90 per cent, with frequent defaults requiring renegotiations with international lenders. Persistent peso depreciation has fueled inflation rates exceeding 100 per cent, eroding wages and savings. Türkiye’s external debt, around 50 per cent of GDP, includes significant foreign-denominated obligations. The Turkish lira has seen sharp depreciation, as high inflation and declining investor confidence strain the economy. A combination of excessive borrowing and current account deficits has forced the central bank to implement aggressive monetary policies, often with limited success.
Countries with high external debt often experience currency depreciation as investor confidence declines. If investors anticipate economic instability or the risk of default, they withdraw capital, leading to devaluation. Argentina and Türkiye have suffered severe currency devaluations due to mismanagement and excessive debt. A weaker currency increases the cost of servicing foreign debt, creating a vicious cycle that exacerbates economic difficulties.
High external debt also contributes to inflation. Depreciating currencies make imports more expensive, increasing the overall price level. To stabilise the currency and attract investment, central banks may raise interest rates, which in turn slows economic activity and heightens inflationary pressures. In extreme cases, governments print money to service debts, leading to hyperinflation, as seen in Argentina. Türkiye has also struggled with persistently high inflation, worsened by a weak currency and inconsistent monetary policies. In Italy, inflation has been exacerbated by debt-related uncertainty and rising energy costs.
A heavy debt burden constrains economic growth. A significant share of government revenues goes toward debt servicing, limiting public investment in infrastructure, healthcare, and education. High debt levels can also lead to credit rating downgrades, increasing borrowing costs and restricting access to international financial markets.
Investor confidence weakens when debt sustainability is questioned, leading to capital flight and reduced foreign direct investment. Sovereign defaults, such as those seen in Argentina and Greece, further damage economic prospects. Additionally, monetary and fiscal policy options become restricted, as governments prioritise debt repayment over economic stimulus measures.
External debt is a double-edged sword. While it can drive economic growth when managed wisely, excessive borrowing poses major risks to currency stability, inflation control, and overall financial health. Japan and the US manage high debt levels due to strong investor confidence, while emerging economies such as Argentina and Türkiye struggle with severe economic instability. Prudent fiscal management, structural reforms, and sustainable debt policies are crucial to mitigating these risks. Without responsible policies, nations risk falling into a debt trap that stifles long-term growth.
International financial institutions, such as the International Monetary Fund and the World Bank, play a critical role in guiding heavily indebted nations through financial challenges. The sustainability of external debt depends largely on its purpose - borrowing for productive investments that enhance economic capacity is far preferable to debt accumulation for non-productive expenditures.
Striking a balance between leveraging external debt for growth and maintaining financial stability is essential to preventing economic crises that could derail long-term progress.
Trump’s recent tariff policy was partly aimed at curbing trade deficits to offset America’s soaring external debt, over $30 trillion. However, such protectionist measures may backfire by raising domestic prices, straining global trade ties, and ultimately making the debt burden harder to sustain amid slower growth and higher inflation.
The writer is a Chartered Accountant, currently working as CFO
Countries with high debt-to-GDP ratios face economic instability as a significant portion of national revenues is allocated to debt servicing, limiting their ability to invest in development.
Several developed and emerging economies are grappling with high external debt levels. Japan’s debt-to-GDP ratio exceeds 250 per cent, the highest in the world. Although much of its debt is domestically owned, external liabilities still exert pressure on the yen, leading to periodic devaluations. However, Japan’s low inflation and investor confidence have helped mitigate some risks. The US holds the largest absolute external debt, exceeding $30 trillion, with a debt-to-GDP ratio above 120 per cent.
The US dollar’s global reserve status provides a buffer, but persistent deficits and rising interest rates pose long-term risks. A weaker dollar raises import costs, fueling inflation and reducing consumer purchasing power. Interest payment outflow of $1 trillion a year due to massive external debt by US put added pressure to current account deficits.
Italy, with a debt-to-GDP ratio exceeding 140 per cent, faces recurrent financial instability. The country’s external debt weakens the euro, increases borrowing costs, and contributes to sluggish economic growth. Argentina has suffered multiple debt crises due to excessive borrowing and weak fiscal management.
Its external debt-to-GDP ratio hovers around 80-90 per cent, with frequent defaults requiring renegotiations with international lenders. Persistent peso depreciation has fueled inflation rates exceeding 100 per cent, eroding wages and savings. Türkiye’s external debt, around 50 per cent of GDP, includes significant foreign-denominated obligations. The Turkish lira has seen sharp depreciation, as high inflation and declining investor confidence strain the economy. A combination of excessive borrowing and current account deficits has forced the central bank to implement aggressive monetary policies, often with limited success.
Countries with high external debt often experience currency depreciation as investor confidence declines. If investors anticipate economic instability or the risk of default, they withdraw capital, leading to devaluation. Argentina and Türkiye have suffered severe currency devaluations due to mismanagement and excessive debt. A weaker currency increases the cost of servicing foreign debt, creating a vicious cycle that exacerbates economic difficulties.
High external debt also contributes to inflation. Depreciating currencies make imports more expensive, increasing the overall price level. To stabilise the currency and attract investment, central banks may raise interest rates, which in turn slows economic activity and heightens inflationary pressures. In extreme cases, governments print money to service debts, leading to hyperinflation, as seen in Argentina. Türkiye has also struggled with persistently high inflation, worsened by a weak currency and inconsistent monetary policies. In Italy, inflation has been exacerbated by debt-related uncertainty and rising energy costs.
A heavy debt burden constrains economic growth. A significant share of government revenues goes toward debt servicing, limiting public investment in infrastructure, healthcare, and education. High debt levels can also lead to credit rating downgrades, increasing borrowing costs and restricting access to international financial markets.
Investor confidence weakens when debt sustainability is questioned, leading to capital flight and reduced foreign direct investment. Sovereign defaults, such as those seen in Argentina and Greece, further damage economic prospects. Additionally, monetary and fiscal policy options become restricted, as governments prioritise debt repayment over economic stimulus measures.
External debt is a double-edged sword. While it can drive economic growth when managed wisely, excessive borrowing poses major risks to currency stability, inflation control, and overall financial health. Japan and the US manage high debt levels due to strong investor confidence, while emerging economies such as Argentina and Türkiye struggle with severe economic instability. Prudent fiscal management, structural reforms, and sustainable debt policies are crucial to mitigating these risks. Without responsible policies, nations risk falling into a debt trap that stifles long-term growth.
International financial institutions, such as the International Monetary Fund and the World Bank, play a critical role in guiding heavily indebted nations through financial challenges. The sustainability of external debt depends largely on its purpose - borrowing for productive investments that enhance economic capacity is far preferable to debt accumulation for non-productive expenditures.
Striking a balance between leveraging external debt for growth and maintaining financial stability is essential to preventing economic crises that could derail long-term progress.
Trump’s recent tariff policy was partly aimed at curbing trade deficits to offset America’s soaring external debt, over $30 trillion. However, such protectionist measures may backfire by raising domestic prices, straining global trade ties, and ultimately making the debt burden harder to sustain amid slower growth and higher inflation.
The writer is a Chartered Accountant, currently working as CFO