Financial sustainability (also known as fiscal sustainability) in public policy means that a government can continue paying for its expenses, such as:
- Public services
- Infrastructure
- Social programs
Sustainability ensures that the government does not become bankrupt or go into excessive debt. It is about managing money wisely so the government can take care of both today’s needs and future generations without financial trouble.
Several analysts assess a country’s financial sustainability by comparing its debt level to its economy. In case the debt is too high, it may struggle to pay interest or respond to economic downturns.
Therefore, to remain financially sustainable, most governments try to control debt and develop policies that support both current and future generations. Want to know more? In this article, let’s understand the concept of financial sustainability in detail.
Why is high government debt risky
Financial sustainability has a direct relation with government debt. If a government has high debt levels, it must pay interest on it. This exposes the country to interest rate shocks. If interest rates suddenly rise, the outflow of government increases. This strains its budget and lowers spending.
Moreover, a country with high debt levels is hit hard during the phase of negative economic growth. If the economy is shrinking, tax revenues usually fall. This makes it harder for the government to pay off its debt and leads to a financial crisis.
What are some major challenges to financial sustainability
The financial sustainability of a government is usually threatened by two major factors:
A) Institutional challenges
This category includes issues like:
- Weak financial management
- Corruption
- Inefficient tax collection
- Poor policy decisions
If a government does not have proper money control measures, it may struggle to maintain stability.
B) Demographic changes
Please note that the population structure of every country is constantly changing. If a country has more elderly people and fewer working-age individuals (who pay taxes), it may struggle to achieve fiscal sustainability.
Consequently, such governments find it tough to fund pensions, healthcare, and other social programs.
How to measure a country’s financial sustainability
Now, having understood the meaning of financial sustainability and the factors that impact it, let’s see what key indicators are used for measuring the financial health of a country:
1. Financial Health Indicators (FHI)
These indicators are used as early warning signs of financial stress. They help governments detect potential risks before a crisis happens so they can take preventive actions. Some common examples are:
- Budget deficit as a percentage of GDP: Measures how much a government is overspending compared to its total economic output. A rising deficit can signal financial instability.
- Debt servicing ratio: The percentage of government revenue spent on paying interest and debt repayments. A high ratio indicates financial stress and reduced ability to fund public services.
- Foreign exchange reserves: Shows the amount of foreign currency a country holds. Low reserves make it difficult to stabilise the economy during crises or pay for essential imports.
2. Financial Health Index
A Financial Health Index is a single number or score. It shows the overall financial health of individuals or households in a country. If the development of a single index is not feasible, experts use a set of indicators to compare financial health across different groups (say rich vs. poor, urban vs. rural).
3. Core indicators for financial health
These indicators analyse financial health based on different factors:
| Factor | Analysis made |
| Gender | Do men and women have equal financial opportunities? |
| Age | Are younger and older generations financially stable? |
| Income | How much are low-income households struggling compared to people above the national income average? |
| Employment type | Do self-employed workers face more financial risks than salaried employees? |
4. Economic indicators (mostly used by the World Bank)
Besides the local government, the World Bank also tracks important economic indicators to assess the financial sustainability of a country. The indicators analysed are:
- GDP (Gross Domestic Product): Measures a country’s total economic output.
- GDP Growth: Tracks whether the economy is expanding or shrinking.
- Inflation: Calculates how much prices are rising and impacting the purchasing power of citizens.
- Debt levels: Determines how much debt the government has compared to its economy.
5. Outstanding government debt as a percentage of GDP
This metric compares how much money the government owes (debt) to the total value of goods and services produced by the country (GDP). A high debt-to-GDP ratio is considered unfavourable and shows financial unsustainability.
6. Financial Soundness Indicators (FSIs)
FSIs measure the financial health of a country’s banks, NBFCs, and financial institutions. Usually, a strong banking system is found in financially sustainable countries.
Conclusion
Financial sustainability in public policy ensures a government can manage its expenses while avoiding excessive debt. Usually, high debt levels expose a country to financial risks, such as interest rate shocks and economic downturns. Such countries find it hard to fund even the basic citizen services.
To assess financial health, several experts analyse indicators like:
- GDP growth
- Inflation
- Outstanding government debt
- Foreign exchange reserves
Moreover, a strong banking system and balanced government spending contribute to long-term stability. Additionally, online marketplaces play an important role in economic growth by promoting trade, increasing tax revenues, and supporting small businesses.
By managing debt levels smartly, countries can secure a stable future for both present and future generations.