How Debt Shapes Economic Growth in Developing Nations

A farmer in a village wants to expand his farm. He borrows ₹5 lakh from a bank, buys more seeds, tools, and hires workers. With proper planning, his farm grows, and he earns enough to repay the loan while improving his livelihood. Now, imagine if he borrowed more than he could handle—maybe ₹15 lakh. If the harvest failed, repaying the loan would become impossible, putting his farm at risk.

Multiple loans? One solution – Debt Consolidation with LoansJagat!

This story reflects what countries do to grow their economic activities, but they have to tread carefully so that they do not end up sinking into a financial trap. Debt plays a vital role in shaping the economies of developing nations. If managed wisely, it fuels progress. However, when debt levels become too high, it can slow down growth or even cause setbacks.

How Debt Helps Economic Growth

In many developing countries, the government does not provide adequate funds needed for infrastructure, health, and educational programs. Borrowing allows them to bridge this gap and invest in areas that boost their economies. The World Bank has played a leading role in improving debt transparency across the world. Here’s how debt can positively impact growth:

1. Funding Productive Projects

• Borrowed money is often used to build roads, schools, and hospitals. For instance, India borrowed money to build the Delhi Metro, which streamlined public transport and increased productivity.

2. Encouraging Investments

• Countries can use loans to promote industries. For instance, by funding solar energy projects, India increased renewable energy production and created jobs.

3. Threshold for Growth

• Studies suggest that debt does not inhibit growth up to 35-40% of GDP for an economy. For example, for a GDP of ₹10 lakh crore, it can borrow ₹3.5-4 lakh crore safely without risking its future growth.

The Danger of Too Much Debt

While borrowing helps, crossing a certain limit leads to trouble. Let’s explore the challenges:

1. Debt Overhang

• Repayment becomes increasingly difficult once the percentage of debt in relation to GDP rises above 90%.This discourages new investments as businesses fear instability.
• Example: A country earning ₹1 crore a year but needing to repay ₹90 lakh in loans will have little left for development.

2. Impact on Public Spending

• High debt forces governments to cut essential expenses. Some countries spend more than what is allocated in their budgets to interest payments on borrowed funds vis-a-vis health and education services.
• For example, a government incurs debt interest charges of ₹30,000 crores but has allocated only ₹20,000 crores to education; the effect on growth is negative in the long term.

3. Vulnerability to Global Shocks

• Countries with high external debt face challenges like currency devaluations or rising interest rates.
• For instance, if borrowing costs increase by 2%, a ₹5 lakh loan may cost ₹10,000 more annually in interest payments, straining budgets further.

Policy Strategies for Debt Management

To ensure that debt remains a tool for growth rather than a burden, countries should follow these practices:

1. Prudent Borrowing

• Borrow only within sustainable limits. For example, India’s debt-to-GDP ratio was around 57% in 2023, indicating careful borrowing.

2. Invest in Productive Sectors

• Use loans for projects that provide high returns, like renewable energy or digital infrastructure.

3. International Debt Relief

• Collaborate with global institutions to reduce the debt burden. For instance, African nations have benefited from debt relief initiatives, allowing them to focus on growth.

A Quick Comparison: Debt vs Growth

Conclusion

Debt is like a double-edged sword for developing countries. Managed wisely, it can accelerate progress by funding infrastructure, education, and health programs. But excessive debt creates financial burdens, reducing funds for essential services and slowing growth.

Just like the farmer who must borrow within his means to succeed, countries need to maintain a balance. With careful planning, debt can be a powerful tool to fuel economic growth and improve lives.

If you’re an individual looking for financial solutions, like a 5 Lakh Personal Loan, the same principle applies: borrow wisely and plan for the future.