When the national debt makes headlines, the huge figure can sound scary especially when it reaches record highs or is presented as an amount each citizen “owes.”
As a taxpayer and individual investor, is this something you should be concerned about? Learn more below about how public debt works and how it might affect you.
What is the national debt?
The national debt is the total amount of money a country (through its national government) owes to both local and foreign lenders.
Governments can borrow money by issuing debt securities like Treasury bills and bonds or by taking out loans from financial institutions or development banks.
They do so to fund programs and projects that may benefit the economy and taxpayers. Borrowing is also done to cover budget gaps when a government spends more than it earns (known as a budget deficit).
The 2 main types of national debt are internal and external debt. The former is the money owed to lenders within the country, such as local banks and domestic bond investors, usually in Philippine pesos.
Meanwhile, the latter is owed to foreign lenders, like other countries or international organizations, usually in US dollars.
How can the national debt affect you?
Here are the things that may happen when a government takes on debt:
1. Effects on the economy
Borrowing money isn’t automatically a good or bad thing, whether the borrower is an individual, business, or government entity.
What sets governments apart are their extensive financial resources. Governments have a lot more sources to tap for debt repayments than individuals and businesses do.
However, nations also have a wider range of needs and responsibilities and so borrowing can be unavoidable.
- More money for government programs
Borrowed money can help with economic development if managed well. Sovereign debt may not be a cause for concern if it allows the economy to grow at a much faster rate than the debt does.
- High repayment costs
The more a government borrows, the more it spends on repaying the principal and interest of its debts. This expense is known as debt servicing.
With more money going to debt servicing, less of a government’s budget can be allocated to daily operations and initiatives that could help boost the economy.
This may lead to slower growth if the costs of repaying debt become too high. Such expenses may even prompt a government to keep borrowing to meet its obligations or to cut back on public services and programs.
- Default risk
Though it’s a relatively rare event, it’s still possible for a government to get into too much debt and be unable to pay it back.
A default can ruin the credit standing of a country. With a bad credit rating, it can be difficult to secure loans that could help with recovery.
2. Effects on taxpayers and investors
To address rising public debt, the government may take measures that can affect you as a citizen and investor.
- Increased taxes
Governments can either cut down on spending or increase revenues to keep debt manageable. For the second option, a government can impose higher taxes, improve tax collection efficiency, or do both.
If taxes are raised, consumers may change their spending habits to stretch their budgets. People might choose to spend less or seek cheaper alternatives to their needs and wants.
- Inflation and interest rates
Another way a government can pay down ballooning debt is to print more banknotes. However, more money in circulation reduces the value of a currency, which can affect its purchasing power.
This measure can cause faster inflation, which may lead the country’s central bank to try to control the rise in prices. This is usually done through changes in interest rates.
When interest rates are raised to control rising inflation, investments can be affected in different ways. For example, higher rates can make new interest-paying investments like bonds more attractive.
As consumers and businesses spend less amid high prices and borrowing costs, company revenues may take a hit and make stocks less appealing.
- Effects of a default
A government defaulting on its debt can ruin investor confidence and cause sharp declines in financial markets.
Bondholders may not get back the money they invested as well as the expected interest payments in case of a default.
Should you worry about the national debt?
To know how likely it is for a default to happen, you can check a borrower’s creditworthiness. There are credit rating agencies that offer insights into the debt levels and overall financial health of even national governments.
You can also compare a country’s public debt with the rate of its economic growth, which is measured through changes in the gross domestic product (GDP).
The debt-to-GDP ratio shows how much a country owes compared to what it produces in goods and services. The higher the ratio, the higher the risk of debt slowing economic growth and even leading to a default.
Another thing you can check is the amount of external versus internal debt. Money owed to local lenders is generally easier to manage since payments are made in the country's own currency and go back into the local economy.
Meanwhile, external debt can be more expensive to repay when a country’s currency weakens. It may also come with stricter repayment terms and harsher consequences if left unpaid.
You should assess a government’s ability to repay and support economic development to know if borrowing hurts or helps a country and its citizens.
