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FRM Part II · FRM Exam Part II · Country Risk: Determinants, Measures, and Implications

A country has a government debt-to-GDP ratio of 80%, average interest rate on debt of 5%, real GDP growth of 2%, and inflation of 1% (nominal growth is approximately 3%). Ignoring other effects, what primary budget surplus as a percentage of GDP is needed to keep the debt-to-GDP ratio stable?

The stabilizing primary surplus equals the gap between the interest rate and nominal growth multiplied by the debt ratio: (5% minus 3%) times 80% gives 1.6% of GDP. Option A is therefore the required primary surplus.

  1. A1.6% of GDP
  2. B4.0% of GDP
  3. C2.4% of GDPCorrect
  4. D0.8% of GDP

Explanation

Stabilizing requires primary surplus = (r - g) x debt/GDP = (5% - 3%) x 80% = 1.6%. Check: interest 4.0% of GDP minus growth-financed capacity 2.4% of GDP (3% x 80%) = 1.6%. So the correct figure is 1.6%, which is option A.

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