MODULE III

PUBLIC DEPT (P.D)

Meaning of Public Debt
Introduction
Public debt is a modern invention and was not heard prior to 18 th century. Bastable holds
that in its present from, the public debt is the creation of the last two centuries. In the modern
times, the growth of public debt is the result of changed economic and political situations all
over the world in all the countries of the world, P.D tendency has been increasing.
Generally, P.D refers to loans raised by a govt within the country or outside the
country.
Each govt like individuals has to borrow when its expenditure its revenue.in short P.D refers to
all type of borrowing by the govt.
Necessity and important of public Debt Or Why govt borrow
Or causes of borrowing or reasons for P.D
a. To fill the budgetary gap
b. Safeguard against natural calamity
c. For financing wars
d. Maintaining a level of economic stability
e. Development purpose
f. Social welfare schemes
g. Commercial enterprises
h. Social and political awakening

Classification of public debt

The public debt of India is classified into following groups namely
1. Funded and unfunded debt
2. Internal & external debt
3. Productive & unproductive debt
4. Active, passive & dead weight debt
5. Compulsory & voluntary debt
6. Redeemable & irredeemable
7. Marketable & nonmarketable
8. Interest bearing & non interest bearing debt
9. Gross debt and net debt
 1. Funded and unfunded debt
Funded debt is a long term debt. It is generally incurred to create a permanent public
property such loans mature after fairly long periods say 10 or more years. Unfunded debts are
generally incurred for meeting day to day requirement. It also known as floating debts. In India
treasury bills issued by the govt are floating debts. They are issued by the govt for 3 or 6
months.
Funding is a process by which short term debt is converted into long term debt.
2. Internal & external debt
Internal debts refers to the public loans floated within the country while external debt
refers to the debt incurred in foreign countries & it includes loans from foreign govts,
international institution etc.
3.Productive & unproductive debt
Productive debt is that debt which is used to build up income yielding assets, which will yield
income in due course of time not only pay the amount interest annually debt also the principal.
E.g. investment in railways, power generation
Unproductive debt refers to the debt which does not increase the productive capacity of
the community. They are burden to the societies. Debt to finance war.
4. Active,Passive & Dead Weight Debt
If by the use of public debt an asset comes into existence, it gives returns too, is not only
productive but it is called an active debt. (Loans for the construction of a dam, industry etc)
If the loan is used for developing social and human capital like hospital, schools etc. which
produce indirect return, it is productive but it is passive debt. But if a loan is used, it is not only
unproductive but it is dead weight debt.
5. Compulsory & voluntary debt
Debt will become compulsory if the state exercises its power & forces the citizens to lend
money. Compulsory deposits scheme fall in this category.
In the case of voluntary public debt the citizen are free to subscribe or not to subscribe govt
bonds. Lenders make then own decisions after knowing the details like the purpose of loan, the
rate of interest, duration etc.
6.Redeemable & irredeemable
Redeemable debts are those for which the govt is committed to repay an appointed date,
whereas loans for which there are no such commitments from the govt are irredeemable debt.
The govt has to make some arrangement for the payment of interest & principal amount in
cause of redeemable debts which the govt generally does through taxation. In the case of
irredeemable debts the govt pays interest & there is no commitment for the payment of the
principal amt. redeemable debts are preferred on grounds of sound finance & convenience.
7. Marketable & nonmarketable debt
Those debts which can be bought and sold in the open market are marketable debts. Those
govt debts which cannot be transacted in the open market are known as non-marketable debts.
8. Interest Bearing & Non-Interest Bearing Debt
All those debts which bear an interest & govt has to make regular and periodical interest
payments to the holders of such securities are interest bearing securities.All those debts which
cannot bear an interest is called non interest bearing debt.
9.Gross debt and net debt: GD is the total amount of debt by the Govt. Net debt is the
GD minus financial assets a govt holds. Usually net debt is less than gross debt.

Redemption Of Public Debt

Redemption of public debt means repayment of a debt. There are different methods used
by a govt to redeem its debt. Some methods are extreme once such as repudiation of debt,
while other may not be redeemed at all but payment of debt with the help of floating another
debt. Thus, various methods of redemption of public debt which are commonly adopted are
explained as follows.
1. Repudiation Of Debt.
It is the easiest way of the govt to get rid of the burden of payment of a loan. Similarly,
it means that the govt refuses to pay the interest as well as the principal. In such cases, govt
do not recognize its obligation to pay the loan. It is certainly not paying off a loan but
destroyed it. In a normal case, govt does not do so as it is obvious that the govt will shake its
confidence among the people and also in the eyes of other nations.
2. Conversion Of Loans
It is another method of redemption of public debt. It means that an old loan is
converted into a new loan. Under this system, a high interest public debt is converted into a
low interest public debt. In this system, when the rate of interest in the mkt falls, the govt
gives notice to the lenders to take their money back, so they are compelled to accept the
lower rate of interest. The govt borrows more money to pay such debts at low rate of interest
and pay to the lenders. In this way, the debt is not liquidated for ever but high burden is
replaced by a low burden debt.

3. Utilization Of Budgetary Surplus

When the govt earns a surplus in the budget, it must be utilized for paying the debt.
Surplus occurs when public reserve exceeds the public expenditure. But this method is rarely
found.
4. Terminal Annuity
In this method, govt pays off the public debt on the basis of terminal annuity into
equal annual installments including interest along with principal amount. This is the easiest
way of paying off the public debt. With the passage of time, burden of debt goes on
decreasing and at time of maturity, most of the amount is paid off. This method is almost
similar to the sinking fund.
 5. Refunding.
In implies to issue of new bonds and securities by the govt in order to repay the matured
loans. It is, thus, a process of replacing maturing securities with new one. Usually, this method
is resorted to at such a time when the burden is too heavy on the govt and it is not in a
position to raise funds from other sources.

6. Compulsory Reduction In Rate Of Interest

Another method of debt redemption is the compulsory reduction in rate of interest .

7. Additional Provision Of Taxation

Generally, new taxes are imposed to collect the revenue. These funds can be utilized
to repay the loans as well as interest. With this method, redistribution of income can easily be
transferred from tax payers to the hands of bond –holders.

8. Year-Wise Partial Repayment

This is a method by which a part of debt is repaid every year from the budget
revenues so that the total debt is paid off after some years. One difficulty, however, is that the
budget should be surplus every year to do this.

9. Sinking Fund
First of all, this method was established by Huge. This method is the most systematic
and best method of repaying public debt. In this system, the government establishes a separate
fund known as ‘sinking fund’. A fixed amount of money is credited by the government to this
fund. So by the time ,the debt matures ,the fund accumulates enough amount to pay off not
only the principal amount of the debt but also the interest on the loan as well.
Sinking fund is of two types as (a) Certain Sinking Fund, and (b) Uncertain Sinking Fund.
A ‘Certain Sinking Fund ‘is one which the government credits a fixed sum of money annually.
‘Uncertain Sinking Fund’, on the other hand, is one in which the amount is credited, when the
government secures a surplus in the budget. There is one danger of this method i.e. A
government, whom is in need of money, may not have the practice to wait till the end of the
period of maturity but may utilize the fund for the purpose other than the one for which
originally the fund was instituted. In modern times, the sinking funds are not accumulated.

10. Capital Levy

This method has been the most controversial method of debt repayment. Capital levy
provides for imposing “all at once” tax on all the capital value possessions of the people. All
capital goods are taxed above the capital possessions of minimum limit of value. This method
has been suggested by economists like Ricardo, Pigou to levy the capital to pay heavy debts
taken during the time of war and other emergencies.
The following arguments are put forward in favor of capital levy.
(i) In capital levy, only the rich are affected and the poor are untouched. The richer
sections earn huge profits during war time through the rise in prices. Hence, they
 should be subjected to heavy taxation after the war for the repayment of war time
debt.
(ii) This is the only effective way of immediate liquidation of public debt through the
imposition of capital levy on the richer sections.
(iii) The burden of capital levy falls on those rich persons who are able to pay it and it
satisfies the canon of equity.
(iv) It does not create inflation.
(v) Quick payment is possible
(vi) To pay principal amount and the interest, it is an important source of public revenue.
(vii) Earlier repayment of public debt through capital levy provides psychological relief to
the people.
(viii) It is useful to reduce the disparity in the distribution.

Prof. Shirras also rejected the idea of capital levy on the following
ground:
(i) It will adversely affect the capital creation.
(ii) Capital levy will be burden on everyone and as a result, it reduces the willingness to
work and save.
(iii) It is not easy to evaluate properly. The cost of completion of records will alarmingly be
high.
(iv) It is an injustice as it spares those who do not save.
(v) There is no surety of its non-repetition in future.
(vi) It will lead to corrupt practices by government official while assessing the value of
property.
(vii) It will lose the confidence in the financial administration.
(viii) It will create unfavorable repercussions in industries.

Redemption of Public Debt

Redemption means repayment of a loan. All govt. loans, excepting permanent
investment in self supporting industries, should be repaid promptly

Advantages of Debt Redemption

1. It saves the government from bankruptcy.
2. It discourages extravagant expenditure of the government.
3. It maintains the confidence of the lenders.
4. It would be easy for the government to float loan in future.
5. It reduces the cost of debt management.
Public Debt Management
Refers to debt policy formation that seeks to achieve certain objectives and the
implementation of such a policy. It also refers to various authoritative decisions. Public debt
management is the methods which are adopted by the government through the process of
floating, refunding & repayment of public debt.
 The objective of the management of public debt refers to the aim that the method of
borrowing funds and the repayment of loans by the government should not have any
adverse effect upon the economic situation of the country. Moreover, the methods of
borrowing funds and repayment of loans should help to maintain economic stability, i.e., it
should reduce inflationary or deflationary effects upon the economy, and should make
available the needed funds to the government. Therefore, all those methods which are
adopted by the government to achieve these objectives, through the process of borrowing
funds and repayment of loans, come under public debt management.

The Principles Of Public Debt Management

1. The Interest Cost Of Servicing Public Debts must be Minimized
2. Satisfaction of the Needs of Investors.
3. Funding the short term debt into long term debt.
4. Public Debt Policy must be co-ordinate with Fiscal and Monetary Policy.
5. Proper adjustment of maturity’s
The principles of debt management are elaborated as follows:
1. Minimum Interest Cost of Servicing Public Debt
The first and foremost principle of debt management should be that the interest rates on the
government obligations should be kept as minimum as possible.
2. Satisfaction of the Investors
It is agreed that public debt should be managed in such a manner that it must satisfy the
needs of the investors.
3. Funding the Short Term Debt into Long Term Debt
Another principle of debt management is that it should help to convert short-term
borrowings into long –term borrowings.
4. Public Debt must be in co-ordination with fiscal and monetary
For the proper implementation of the developmental schemes in the economy co-
ordination of public debt policy with fiscal and monetary policy must be there. In the long- run,
it would lead to maintaining economic stability and economic growth.

5. Proper Adjustment of Maturity

The ideal principle of debt management is that it must have proper adjustment of maturity
with a view to bring high degree of liquidity in the market.