Debt Overhang

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DEFINITION of 'Debt Overhang'

A debt burden that is so large that an entity cannot take on additional debt to finance future projects, even those that are profitable enough to enable it to reduce its indebtedness over time. Debt overhang serves to dissuade current investment, since all earnings from new projects would only go to existing debt holders, leaving little incentive for the entity to attempt to dig itself out of the hole. In the context of sovereign governments, the term refers to a situation where the debt stock of a nation exceeds its future capacity to repay it.

BREAKING DOWN 'Debt Overhang'

A debt overhang can trap companies and countries in a vicious downward spiral, as a greater proportion of cash flow or revenues go to servicing existing debt, creating an operating deficit that can only be filled through incremental debt, which adds to the debt burden.

Countries faced with a debt overhang face a steady erosion in living standards, due to reduced spending in vital areas such as education, health and infrastructure.

Eventually, the only way out of a debt overhang is either through forgiveness of part or most of the debt by creditors, through bankruptcy (for a company) or debt default by a nation.

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