Public Debt

Public Debt - Introduction

• Govt functions were limited in 18th and 19th century – budgets were
balanced
• Economic problems, in 20th century increases govt intervention
• Govt function increased and the budget were found inadequate
• Govt started borrowing from public, banks and foreign sources
• Amounts borrowed by the govt were given the name public debt
• With the passage of time public debt became normal feature of DCs
and UDCs
Public Debt - Introduction
• Public debt increases the govt resources resulting in so many
developmental and non-developmental works
• Against the public debt has to pay interest
• On the one side the interest payments are increasing, on the other
side, the debt burden is also increasing
Classification of Public Debt
• Productive Debt Vs Unproductive Debt
• The debt which is spent on productive purposes is called productive loan.
• These are loans spent on those projects which yield the revenues for the govt
• With the help of such revenues, the cost of loans i.e. interest can be paid
• With productive loans the productive efficiency of the economy increases
• The debts used to make unproductive expenditures are called unproductive
debt
• Such debts do not lead to increase the productive capacity of the economy
• These do not raise any revenues for the govt and are burden for the economy
• Debt for assistance of flood affected people or for defence purposes
Classification of Public Debt
• Volunteer Debt Vs Forced Debt
• The debt given by public and banks to govt voluntarily is volunteer debt
• For example bonds issued by govt on which it pays interest
• If the govt gets the loan from public and bank forcefully, it will be forced debt
• This type of loan is raised during emergencies and wars
• When govt is in severe need of funds it can force the people to provide loans
• Normally the loans are volunteer and govt can not asked forcefully without
consent of the people
Classification of Public Debt
• Funded Debt Vs Unfunded Debt
• The debt for repayment of which govt sets-up a separate fund is called
funded debt
• Each year govt deposits a specific amount in this fund
• At maturity the repayment is made through this fund
• These are long term debt or floating debt
• Unfunded debt is the debt for whose re-payment govt does not establish any
special fund and are raised to meet temporary gaps in income and
expenditure
• The interest against such loans is paid through the daily routine income of the
govt.
• At the time of repayment, govt raises new debt from the market
Classification of Public Debt
• Redeemable Debt Vs Irredeemable Debt
• Redeemable debt is the debt whose principal is paid-out after the maturity of
its time period while interest is paid at the determined time periods
• For repayment of such debts, govt sets-up a sinking fund
• Irredeemable debt is the debt whose principal is never paid out by the govt,
interest payments are made at regular predetermined time intervals
• In real life most of the loans are redeemable
Classification of Public Debt
• Internal Debt Vs External Debt
• Debts raised from internal sources e.g. people, commercial banks and central
bank called internal debt
• Borrowings through post office saving schemes, national saving schemes and
selling of securities
• Debts obtained from external sources e.g. foreigners, foreign financial
institutions, foreign banks and foreign govts are external debt
• For example debts from international capital market, world bank and IMF
• So many people prefer internal debt over external debt
Sources of Public Debt
• Borrowings from individuals
• Borrowings from Non-Bank Financial Institutions
• Borrowings from Commercial Banks
• Borrowings from Central Bank
• Borrowings External Sources
Importance of Public Debt
• Abandonment of Laisseze-Fair Policy: Adam Smith and other
classicals believed in Laisseze-Fair economy and they wanted to
restrict the role of govt. They believe in very limited role of the state
• Unpopularity of Taxes: In case of DCs and UDCs it is generally found
that people as well as businessmen are reluctant to pay the tax.
• Facing Natural Calamities: If any country faces natural calamities like
flood and drought etc the normal budgets are not capable to provide
funds
• The Defence and War Expenditures: Wars between nations that
continued for longer time
Importance of Public Debt
• Meeting the Budget Deficits: So many countries have to face budget
deficits which are about 6 to 8% of their GNP.
• Fighting of Depression: When the expenditures are increased and
employment will increase through multiplier process and depression
would come to an end.
• Controlling of Inflation: Increasing loans from public will reduce their
purchasing power. The supply of money in circulation will comedown.
This will happen when govt spends public debt productively.
• Financing of Economic Development: The amount raised through
debt will be used in productive as well as social activities thereby
causing economic development
Effect of Public Debt
• Consumption and Investment
• National income
• Income Distribution
• Resource Allocation
Debt Burden - To be contd… 14-03-2020
• Internal Debt Burden
• External Public Debt Burden
• Both are divided into:
• Direct Money Burden
• Indirect Money Burden
• Direct Real Burden
• Indirect Real Burden
Measurement of Public Debt – Further Effects
• Debt burden be measured by the ratio of public debt and total
national income. (Prof. E.D. Domar)
• Debt Burden = D/Y where D=Total public debt and Y=Total NI
• In order to measure the tax burden it should be compared with the
level of unemployment. (Prof. Learner)
• More a govt borrows greater will be its burden on the tax payers
which might discourage savings, investment and work-effort
• Ricardian Equivalence
Redemption of Public Debt
• Repudiation of debt: Getting rid of loans by refusing to pay the
principal as well as interest.
• Use of Budget Surplus: If revenue exceed expenditure the surplus can
be used to repay the old debts
• Terminal Annuity: The govt may re-schedule its debt
• Sinking fund: Setting up a fund known as “Sinking Fund” and
depositing a specific amount every year in the fund. Using the fund to
repay debt and interest
• Debt Conversion: Loan with the higher interest is converted into the
loan of lower interest.
Redemption of Public Debt
• Compulsory reduction in rate of interest: Govt can reduce interest
rate and the persons or institutions who have provided the debt will
be forced to accept it.
• Capital Levy: In order to redeem a debt, a govt can impose a specific
tax on the amounts of capital goods. The role of such tax should be
progressive.