Public Debt and its Management | UGC NET Economics – Notes

Meaning of Public Debt

• Modern governments need to borrow from different sources when current revenue falls short of public expenditures. Thus, public debt refers to loans incurred by the government to finance its activities when other sources of public income fail to meet the requirements. In this wider sense, the proceeds of such public borrowing constitute public income.

• However, since debt has to be repaid along with interest from whom it is borrowed, it does not constitute income. Rather, it constitutes public expenditure. Public debt is incurred when the government floats loans and borrows either internally or externally from banks, individuals or countries or international loan-giving institutions.

• What is true about public borrowing is that, like taxes, public borrowing is not a compulsory source of public income. The word ‘compulsion’ is not applied to public borrowing except in certain exceptional cases of borrowing.

Classification of Public Debt

• The structure of public debt is not uniform in any country on account of factors such as categories of markets in which loans are floated, the conditions for repayment, the rate of interest offered on bonds, purposes of borrowing, etc.

• In view of these differences in criteria, public debt is classified into various categories:

  1. Internal and external debt

  2. Short term and long term loans

  3. Funded and unfunded debt

  4. Voluntary and compulsory loans

  5. Redeemable and irredeemable debt

  6. Productive or reproductive and unproductive debt/deadweight debt

1. Internal and External Debt:

• Sums owed to the citizens and institutions are called internal debt and sums owed to foreigners comprise the external debt. Internal debt refers to the government loans floated in the capital markets within the country. Such debt is subscribed by individuals and institutions of the country.

• On the other hand, if a public loan is floated in the foreign capital markets, i.e., outside the country, by the government from foreign nationals, foreign governments, international financial institutions, it is called external debt.

2. Short term and Long Term Loans:

• Loans are classified according to the duration of loans taken. Most government debt is held in short term interest-bearing securities, such as Treasury Bills or Ways and Means Advances (WMA). Maturity period of Treasury bill is usually 90 days.

• Government borrows money for such period from the central bank of the country to cover temporary deficits in the budget. Only for long term loans, government comes to the public. For development purposes, long period loans are raised by the government usually for a period exceeding five years or more.

3. Funded and Unfunded or Floating Debt:

• Funded debt is the loan repayable after a long period of time, usually more than a year. Thus, funded debt is long term debt. Further, since for the repayment of such debt government maintains a separate fund, the debt is called funded debt.

• Floating or unfunded loans are those which are repayable within a short period, usually less than a year.

• It is unfunded because no separate fund is maintained by the government for the debt repayment. Since repayment of unfunded debt is made out of public revenue, it is referred to as a floating debt. Thus, unfunded debt is a short term debt.

4. Voluntary and Compulsory Loans:

• A democratic government raises loans for the nationals on a voluntary basis. Thus, loans given to the government by the people on their own will and ability are called voluntary loans. Normally, public debt, by nature, is voluntary.

• But during emergencies (e.g., war, natural calamities, etc.,) government may force the nationals to lend it. Such loans are called forced or compulsory loans.

5. Redeemable and Irredeemable Debt:

• Redeemable public debt refers to that debt which the government promises to pay off at some future date. After the maturity period, the government pays the amount to the lenders. Thus, redeemable loans are called terminable loans.

• In the case of irredeemable debt, government does not make any promise about the payment of the principal amount, although interest is paid regularly to the lenders. For the most obvious reasons, redeemable public debt is preferred. If irredeemable loans are taken by the government, the society will have to face the consequence of burden of perpetual debt.

6. Productive (or Reproductive) and Unproductive (or Deadweight) Debt:

• On the criteria of purposes of loans, public debt may be classified as productive or reproductive and unproductive or deadweight debt. Public debt is productive when it is used in income-earning enterprises. Or productive debt refers to that loan which is raised by the government for increasing the productive power of the economy.

• A productive debt creates sufficient assets by which it is eventually repaid. If loans taken by the government are spent on the building of railways, development of mines and industries, irrigation works, education, etc., income of the government will increase ultimately. Productive loans thus add to the total productive capacity of the country.

• In the words of Findlay Shirras: “Productive or reproductive loans which are fully covered by assets of equal or greater value, the source of the interest is the income from the ownership of these as railways and irrigation works.”

• Public debt is unproductive when it is spent on purposes which do not yield any income to the government, e.g., refugee rehabilitation or famine relief work. Loans for financing war may be regarded as unproductive loans. Instead of creating any productive assets in the economy, unproductive loans do not add to the productive capacity of the economy. That is why unproductive debts are called deadweight debts.

Comparison between Private and Public Debt

• In certain respects government borrowings resemble the private ones. Like a private borrower the government may also borrow either for consumption or for investment purposes. It will also be paying interest in such borrowings, but the dissimilarities between the two are more glaring.

• A private economic unit can not borrow internally that is to say; it can not borrow from itself. However the government usually borrows internally, that is from its own subjects and from within the country.

• While a private economic unit can repay the debt either out of its earnings or out of its accumulated assets or by borrowing from other sources (thus substituting one debt for the other), such need not be the case with the government. The government is the creator of currency and can pay its debt straight–away by creating more of it. The fact that it does not do so only reflects its concern for the welfare and stability of the economy and not the lack of power to do so. However, external debt can be discharged in this manner only if it is repayable in local currency. But creation of domestic currency can not be the means of repaying if the foreign debt is repayable in foreign currency or gold. In that case, foreign currency will have to be procured through export earnings or through some other means failing which gold will have to be paid out.

• Public borrowings have a profound effect on various dimensions of the economy—distribution, capital accumulation, economic growth, and income and employment stability and so on. This way public debt is both a source of problems and a tool of economic management in the hands of authorities.