When we hear the word debt, we usually think of something negative, something to eliminate as soon as possible. But for countries, debt works differently. Governments use borrowing as a tool to manage the economy, invest in growth, and respond to crises. The key question is not “Does a country have debt?” (they all do), but “Can it manage the debt responsibly?”
What Government Debt Actually Is
Government debt is the total amount of money a state owes to others.
The usual way governments borrow is by issuing bonds: promises to repay at a future date, plus interest.
These bonds are bought by banks, pension funds, companies, other governments, and sometimes ordinary people.
But there is an important distinction inside government debt:
1. Domestic Debt (Debt owed to the country’s own citizens and institutions)
This is when the government borrows from inside its own economy.
Banks, local pension funds, insurance companies, and households buy the government’s bonds.
- The money circulates within the country.
- The government pays interest to its own people.
- This type of debt is usually safer, because the government controls:
- its banking system,
- its currency,
- and its central bank.
If needed, the government can restructure payments more easily, or the central bank can step in to stabilize markets.
2. Foreign Debt (Debt owed to lenders abroad or in foreign currency)
This is when a government borrows from other countries or global investors.
Often, this debt is owed in dollars or euros.
This type of debt is riskier, because:
- The government does not control the currency it must repay in.
- If the national currency loses value, the debt becomes more expensive instantly.
- In crises, foreign lenders may pull money out quickly, causing instability.
This is why some countries face repeated currency or debt crises, while others do not.
Why Do Governments Borrow?
There are three main reasons:
| Reason | Meaning | Example |
|---|---|---|
| Investment | To build future growth | Schools, hospitals, railways, energy networks |
| Stability | To prevent economic collapse | Financial crisis bailouts, pandemic support |
| Politics | To win public support | Tax cuts, subsidies, social programs before elections |
Some borrowing is strategic, some is necessary, and some is purely political.
Why This Distinction Matters
Two countries can have the same level of debt, but look completely different in terms of risk:
- Japan: Most of its debt is domestic → stable.
- Argentina: A large part of its debt is foreign-currency based → vulnerable to crises.
- Turkey: A mix, where shifts in exchange rates play a big role.
So the key question is not only “How much debt does a country have?”
but also “In what currency, and owed to whom?”
When Is Debt Sustainable? The Key Condition
Understanding whether a country’s debt is “high” or “dangerous” requires more than looking at the debt-to-GDP ratio alone. What matters is the relationship between the cost of borrowing and the pace of economic growth.
Economists often express this as the comparison between:
- r = the interest rate the government pays on its debt
- g = the growth rate of the economy
The rule is straightforward:
If the economy grows faster than the interest the government pays (g > r), debt becomes easier to sustain.
If interest costs rise above growth (r > g), debt pressure increases.
This principle explains several otherwise counterintuitive facts:
- Japan can maintain debt above 250% of GDP without market panic, because borrowing costs are extremely low and most debt is held domestically.
- Argentina, by contrast, has defaulted multiple times even with lower debt levels, because borrowing is expensive and economic growth is unstable.
- The United States can run persistent deficits more comfortably, largely because global demand for the dollar keeps its financing costs comparatively low.
In other words, the size of the debt is not the sole determinant of risk.
What matters more is the trajectory: whether the debt burden becomes lighter over time or steadily heavier.
Countries where economic growth is weak and interest rates are rising face a more challenging environment. In those cases, even a stable level of debt can become harder to service, requiring governments to make adjustments through spending cuts, tax increases, or restructuring of debt obligations.
Why This Matters for Today’s Debt Landscape
Recent global conditions are making the r > g scenario more common:
- Central banks have raised interest rates to fight inflation.
- Economic growth is slower, especially in Europe and parts of Asia.
- Debt accumulated during the pandemic and energy crisis remains high.
This combination means that debt sustainability is now under more pressure than in the years of near-zero interest rates. Countries that previously financed deficits at very low cost must now adjust to higher interest payments, which consume a growing share of public budgets.
Case Study: Japan — High Debt, Low Stress
Japan is one of the most frequently cited examples in discussions about government debt, for a simple reason:
its debt-to-GDP ratio is the highest in the world, above 250%.
By standard rules, this would appear unsustainable. Yet Japan has not faced a debt crisis, nor does it show signs of approaching one.
The explanation lies in the structure and financing of its debt.
1. Most of Japan’s Debt Is Held Domestically
A large share of Japanese government bonds is owned by:
- Japanese banks
- Pension funds
- Insurance companies
- And increasingly, the Bank of Japan (BoJ) itself
This means Japan is not dependent on foreign lenders who could withdraw funds suddenly or demand higher interest rates.
Borrowing is, essentially, from itself.
2. Borrowing Costs Are Extremely Low
For decades, Japan has experienced:
- Low inflation
- Low interest rates
- A highly stable financial system
Because of this, the government can borrow at very low cost.
This keeps r, the interest rate on government debt, below g (or at least not significantly above it), helping stabilize the debt burden over time.
3. The Central Bank Plays a Direct Support Role
The Bank of Japan continues to purchase government bonds to:
- Keep borrowing costs low
- Ensure stable demand in the bond market
This reduces rollover risk and helps the government avoid sharp increases in interest payments.
Few other countries have such policy space.
4. Japan’s Economy Provides Stability, Even with Low Growth
Japan’s growth is relatively slow, but:
- The economy is large and diversified
- The currency (yen) is widely trusted
- Capital markets are deep and liquid
Trust in Japanese institutions means that investors continue to view Japanese government bonds as safe assets, despite their volume.
What Japan Shows
Japan demonstrates that high public debt does not automatically lead to crisis.
The crucial factors are:
- Who holds the debt? (domestic lenders = more stable)
- In what currency is it issued? (domestic currency = controllable)
- At what cost is it financed? (low interest = manageable)
The Japanese case highlights a core lesson:
Debt risk is not determined just by how much a country owes, but by the financial system that supports it.
Case Study: Turkey — When Debt Meets Currency Pressure
Turkey provides a useful contrast to Japan because its debt challenges are not primarily about how much the government owes, but in what currency and under what financial conditions that debt is financed.
Turkey’s debt-to-GDP ratio is much lower than Japan’s. Yet markets often view Turkish debt as riskier.
The reason lies in the interaction between inflation, interest rates, and the currency.
1. A Significant Share of Debt Is Linked to Foreign Currency
Unlike Japan, Turkey relies more heavily on:
- Foreign investors
- Foreign-currency borrowing (particularly USD and EUR)
- Companies and banks using external debt to fund activity
When the Turkish lira loses value, foreign-currency debt becomes more expensive to repay. Even if the size of the debt does not change, the cost does.
In Turkey, exchange rate movements directly shape debt sustainability.
2. High and Unstable Inflation Raises Borrowing Costs
Turkey has faced persistent high inflation.
This forces interest rates higher, either now or eventually.
Higher inflation leads to:
- Higher borrowing costs for the government
- Higher required returns from investors
- Shorter debt maturity (investors prefer to lend for shorter periods)
This creates a tight financing cycle, where interest payments take up more of the government’s budget.
3. Growth Exists, But Volatility Reduces Confidence
Unlike Japan, Turkey experiences:
- Periods of strong growth
- Followed by sharp slowdowns or instability
Growth that is fast but volatile does not support debt sustainability as well as stable, predictable growth. It becomes harder for investors to trust long-term returns.
4. The Currency Acts as the Critical Pressure Point
Where Japan’s yen acts as a global safe asset, the Turkish lira is more vulnerable to:
- Capital outflows
- Shifts in investor sentiment
- Policy credibility concerns
When confidence weakens, the lira depreciates.
When the lira depreciates, foreign debt becomes heavier.
This can trigger a feedback loop.
What Turkey Shows
Turkey illustrates the other side of the debt sustainability equation:
A country does not need a high level of debt to face debt stress.
It needs only the wrong currency mix, inflation dynamic, and financing structure.
The takeaway is clear:
- If a country’s debt is denominated in foreign currency
- And financed by external investors
- While inflation and interest rates are unstable
then debt becomes more difficult to manage, even at moderate levels.
Putting Japan and Turkey Together
| Feature | Japan | Turkey |
|---|---|---|
| Who holds the debt? | Mostly domestic institutions | Significant external exposure |
| Currency of debt | Yen (own currency) | Large foreign-currency share |
| Inflation & Stability | Low, stable | High, volatile |
| Investor perception | Safe, predictable | Sensitive to confidence shifts |
| Sustainability signal | Debt high but stable | Debt moderate but vulnerable |
This contrast shows why debt sustainability is not about size, but about:
- Currency
- Confidence
- Financial structure
- Economic stability
Case Study: Turkey — When Debt Meets Currency Pressure
Turkey provides a useful contrast to Japan because its debt challenges are not primarily about how much the government owes, but in what currency and under what financial conditions that debt is financed.
Turkey’s debt-to-GDP ratio is much lower than Japan’s. Yet markets often view Turkish debt as riskier.
The reason lies in the interaction between inflation, interest rates, and the currency.
1. A Significant Share of Debt Is Linked to Foreign Currency
Unlike Japan, Turkey relies more heavily on:
- Foreign investors
- Foreign-currency borrowing (particularly USD and EUR)
- Companies and banks using external debt to fund activity
When the Turkish lira loses value, foreign-currency debt becomes more expensive to repay. Even if the size of the debt does not change, the cost does.
In Turkey, exchange rate movements directly shape debt sustainability.
2. High and Unstable Inflation Raises Borrowing Costs
Turkey has faced persistent high inflation.
This forces interest rates higher, either now or eventually.
Higher inflation leads to:
- Higher borrowing costs for the government
- Higher required returns from investors
- Shorter debt maturity (investors prefer to lend for shorter periods)
This creates a tight financing cycle, where interest payments take up more of the government’s budget.
3. Growth Exists, But Volatility Reduces Confidence
Unlike Japan, Turkey experiences:
- Periods of strong growth
- Followed by sharp slowdowns or instability
Growth that is fast but volatile does not support debt sustainability as well as stable, predictable growth. It becomes harder for investors to trust long-term returns.
4. The Currency Acts as the Critical Pressure Point
Where Japan’s yen acts as a global safe asset, the Turkish lira is more vulnerable to:
- Capital outflows
- Shifts in investor sentiment
- Policy credibility concerns
When confidence weakens, the lira depreciates.
When the lira depreciates, foreign debt becomes heavier.
This can trigger a feedback loop.
What Turkey Shows
Turkey illustrates the other side of the debt sustainability equation:
A country does not need a high level of debt to face debt stress.
It needs only the wrong currency mix, inflation dynamic, and financing structure.
The takeaway is clear:
- If a country’s debt is denominated in foreign currency
- And financed by external investors
- While inflation and interest rates are unstable
then debt becomes more difficult to manage, even at moderate levels.
Putting Japan and Turkey Together
| Feature | Japan | Turkey |
|---|---|---|
| Who holds the debt? | Mostly domestic institutions | Significant external exposure |
| Currency of debt | Yen (own currency) | Large foreign-currency share |
| Inflation & Stability | Low, stable | High, volatile |
| Investor perception | Safe, predictable | Sensitive to confidence shifts |
| Sustainability signal | Debt high but stable | Debt moderate but vulnerable |
This contrast shows why debt sustainability is not about size, but about:
- Currency
- Confidence
- Financial structure
- Economic stability
Case Study: United States — The Privilege of the Reserve Currency
The United States carries one of the largest public debt burdens in the world in absolute terms, and its debt-to-GDP ratio continues to rise. Yet, unlike most countries, the U.S. still borrows at relatively low cost and maintains broad market confidence.
The reason is rooted not in the level of debt, but in the role of the U.S. dollar in the global financial system.
1. The Dollar as the World’s Reserve Currency
The U.S. dollar is used globally for:
- Trade settlement
- Commodity pricing
- Investment flows
- Central bank reserves
- Global financial contracts
This makes U.S. Treasury bonds the default safe asset of the international system.
When uncertainty rises, demand for U.S. debt often increases, not decreases.
The U.S. does not simply “issue debt”; it issues the benchmark against which global finance is measured.
2. Deep and Highly Liquid Financial Markets
The United States has:
- The world’s largest bond market
- Transparent legal institutions
- A long record of honoring obligations
This means investors can always enter and exit the market easily.
High liquidity makes Treasuries uniquely attractive for pension funds, banks, and foreign governments.
3. Borrowing in Its Own Currency
Unlike Turkey or many emerging economies, the U.S. borrows primarily in its own currency.
This means:
- The U.S. cannot run out of dollars
- It does not face foreign-exchange repayment pressure
- Market demand for bonds remains structurally strong
Even when the U.S. debt rises, the mechanics of repayment remain under domestic control.
4. Rising Debt Still Comes with Costs
The U.S. position is strong, but not without challenges:
- Interest payments are consuming a growing share of the federal budget
- Demographic pressures and healthcare spending continue to expand
- Political gridlock complicates fiscal adjustment
- Rising interest rates increase refinancing costs
The privilege of the reserve currency allows time and flexibility, but not immunity.
What the U.S. Case Demonstrates
The U.S. highlights a third debt model:
| Feature | United States |
|---|---|
| Global Role | Issues the world’s reserve currency |
| Debt Holders | Domestic + extensive global investor base |
| Borrowing Currency | Almost entirely U.S. dollars |
| Market Confidence | Supported by institutional depth |
| Sustainability Risk | Rising interest burden, long-term deficits |
The United States can sustain high debt because the world’s financial system is built around its currency and capital markets.
However, long-term sustainability still depends on:
- Maintaining global confidence
- Keeping inflation expectations anchored
- Avoiding political shocks that undermine credibility
This is not a guarantee; it is a strategic advantage that must be preserved.
References
- International Monetary Fund (IMF) – Global Debt Monitor
- Global public & private debt totals, medium-term projections
- https://www.imf.org/en/Blogs/Articles/2025/09/17/global-debt-remains-above-235-of-world-gdp
- Danmarks Nationalbank – What is Government Debt?
- Clear domestic vs external debt explanation
- https://www.nationalbanken.dk/en/what-we-do/government-debt/what-is-government-debt
- Investopedia – External Debt Definition
- Simple definition of foreign/external debt and risks
- https://www.investopedia.com/terms/e/external-debt.asp
- Financial Times
- US government debt trajectory (“US debt to overtake Italy’s debt burden”)
- https://www.ft.com/content/34194bfa-b8ea-4301-8212-a554ee721aeb
- Reuters – IMF warning on global government debt
- “IMF sounds alarm about high global public debt”
- https://www.reuters.com/world/asia-pacific/imf-sounds-alarm-about-high-global-public-debt-urges-countries-build-buffers-2025-10-15/
- The Guardian – Why government debt is NOT like household debt
- FormatResearch (summarizing Eurostat)
- Euro-area debt at 88.2% of GDP / country ranking
- https://formatresearch.com/en/2025/10/22/debito-pubblico-all882-del-pil-nellarea-euro-eurostat/
- Wikipedia – Government Debt
- Basic definition, concepts, and structure
- https://en.wikipedia.org/wiki/Government_debt
- Wikipedia – Debt-to-GDP ratio
(AI assisted post)
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