Not unlike personal debt, the concept of national debt deals with the notion of how much a government owes its creditors. These debts are usually represented in the form of national bonds or bills, that the respective financial arm of the government issues. In layman terms, these notes serve as an I.O.U in which the government borrows money and promises to repay it at a later date, with interest. The more a government borrows and raises through these credit notes, the larger the national debt becomes. These amounts increase indefinitely until a government has successfully paid off all its debts.
What is the Difference Between National Debt and Budget Deficit
To be clear, national debt and budget deficits are two different things. National debt refers to the total outstanding IOUs issued by a government over a period and has not been repaid yet, while budget deficit refers to the annual difference between a government’s spending and its revenue in addition to the outstanding debt that has already been incurred by a government.
Due to a government’s expenditure over the course of its annual operations, as well as additional spending that might result from measures taken to stimulate the economy, a nation might go into budget deficit if its earnings from taxes and other income-generating activities fail to cover its spending. Some of the dangers of continuous budget deficit include exponential interest rates on borrowing, and potential inflation as the government issues more fiat currency to combat interest rates.
Both of these outcomes bear extremely bad news for stocks, primarily because continuous budget deficit only serves to heighten the risks of a financial crisis in the near future. Taking into consideration the fact that inflation weakens the spending power of a nation and her citizens, as well as the potential risks of default on payments, investors should take notice whenever their country’s national debt starts to rise.
How National Debt Affects the Stock Market
Ever since the COVID-19 pandemic reached ASEAN shores, governments in the region have been struggling to cope with the financial impact caused by the pandemic. As such, national debt has risen across the board due to quarantine measures, increased government spending on medical relief, and financial stimulus packages given to support those affected by the pandemic.
For example, the Thai government authorised its debt ceiling to be raised from 60% to 70% in 2021. Approving an additional 1.5 trillion Thai Baht in total borrowing to offset the fallout from the COVID-19 pandemic, the country’s national debt is forecasted to rise to about 58.8% of its national Gross Domestic Product. As for Indonesia, her central bank ratified an agreement to take on an additional 439 trillion Indonesian Rupiah in government bonds through 2022 as part of deal to split the financial burdens of the Indonesian government. These two instances are clear examples of how additional government spending in the aftermath of a global pandemic, leads to budget deficits and rising national debt.
The concern many investors might have pertaining to increased debt in these regions is due to inflation and a weakening currency. As each nation takes on additional debt, their liquidity is called into question as interest rates rise. This directly lowers stock market returns as high interest rates increases the costs of borrowing for companies. Furthermore, the government’s lack of liquidity pressures them to issue more currency. This overflow of currency lowers the value of existing fiat in the pool, further weakening spending power and the actualised value of investments. Inflation just rising a few percentage points severely lowers the value of multi-million-dollar investments.
Should Investors Worry?
As national debt rises and government bonds increase, higher interest rates and lower stock market returns will occur. With a country’s government issuing more securities to cover its deficit, the supply of bonds will increase, and this will affect the existing ones, causing them to earn less at their fixed-interest rates. In addition, with debt commanding a bigger portion of an investor’s budget, he or she will then have less on hand to invest. Also, as purse strings get tightened, the consumption of goods and services will start to decrease. A lack of spending equates to company revenues being affected, and with falling profits, comes a decline in stock prices. Therefore, as investors, you’ll need to be aware of what a rising national debt means for the future of your country’s economy and its financial market.
