Public Debt

Saiful Islam
Lecturer, Dept.of Public Administration
Begum Rokeya University,Rangpur.
What is Public Debt

 The public debt is the fund borrowed by a

nation’s government. Governments borrow
from people, banks, organizations, and other
countries. It is an aggregation of all internal
and external debt liabilities pertaining to a
nation.
Contd…..
 When the government runs into a budget
deficit, it must borrow funds from various
sources. In addition, governments borrow
funds for public welfare schemes, wars,
nuclear programs, and infrastructure
projects. Public debt is also used for reviving
dysfunctional public sector enterprises.
 The government often borrows money
domestically or internationally to meet the
nation’s financial needs. The loan could be
for the short, medium, or long term. The
public debt or the sovereign debt helps a
government-run, build, and develop the
country.
 . example, governments take loans to cover 
budget deficits, infrastructure projects, wars,
nuclear programs, public welfare schemes, or
for the operation of public corporations. But
if a country keeps borrowing excessively, the 
debts will pile up. Excessive debts are caused
by the misuse of revenue, tax cuts, tax
relaxations, low revenue from taxes, natural
calamities, and disasters.
 However, public debt burdens the national
expenditure. On top of the principal amount,
the government has to pay interest for the
loans—installments are hefty. Further, for
loan repayment, the public is taxed heavily. 
External debts can affect nations adversely—
they restrict economic growth and
development. Sometimes, countries take
many years to clear their sovereign debt.
Types of Public Debt
1.Internal and External Debt:

 Public loans floated within the country are

called internal debt. Public borrowings from
other countries are referred as external debt.
External debt represents a claim of foreigners
against the real income (GNP) of the country,
when it borrows from other countries and has
to repay at the time of maturity.
 External public debt permits import of real

resources. It enables the country to consume

more than it produces.
distinction between internal and external debts

 An internal loan may be voluntary an external loan is normally

or compulsory voluntary in nature. Only in the
case of a colony, an external loan
can be raised by compulsion.
internal loan is controllable and can while external loans are always
be estimated before hand with uncertain and cannot be estimated
certainty,.  so confidently
Internal loan is in terms of the , while external loans are in terms
domestic currency of foreign currencies.
The Structure of the Internal Public Debt
internal
 (1) Dated and non-terminable
 a) Marketable long-term loans including the

portion subscribed by the Bangladesh Bank;

 (b) Dated loans issued by the Government to

the Bangladesh Bank in exchange for ad hoc

Treasury Bills outstanding; and
 (c) Miscellaneous debt such as the Prize

Bonds issued in 1961.

internal
 2) Treasury Bills — the short-term issues (90/ 180
days) of the Government in order to bridge the gap
between revenue and expenditure.
 3) Small Savings — a non-inflationary means of

finance — effectuated/tapped through instruments

such as Post Office Savings Bank Deposits,
Cumulative Time Deposits, Post Office Recurring
Deposits, National Defence Certificates, 15-year
Annuity Certificates, National Savings Certificates,
National Savings Annuity Scheme, National
Development Banks, National Savings Accoun
2. Productive and Unproductive Debt:

 Public debt is said to be productive or reproductive, when

government loans are invested in productive assets or enterprises
such as railways, irrigation, multipurpose projects etc As such, a
productive public debt is self-liquidating in nature; so the
community experiences no net burden of such debt.
 An unproductive debt, on the other hand, is one which does not
add to the productive assets of a country. When the government
borrows for unproductive purposes like financing a war, or for
lavish expenditure on public administration, etc., such public loans
are regarded as unproductive.
 Unproductive loans do not add to the productive capacity of the
economy, so they are not self-liquidating. Unproductive public
loans thus cast a net burden on the community, as for their
servicing and repayment purpose, government will have to resort to
additional taxation.
3. Compulsory and Voluntary Debt:

 When government borrows from people by using

coercive methods, loans so raised are referred to
as compulsory public debt. Under the Compulsory
Deposit Scheme in India, tax-payers have to
compulsorily deposit a prescribed amount and
defaulters are punished. This is a case of
compulsory debt.
 Usually, public borrowings are voluntary in nature.
When the government floats a loan by issuing
securities, members of the public and institutions
like commercial banks may subscribe to them.
4. Redeemable and Irredeemable Debts:

 On the criterion of maturity, public debts may be classified as

redeemable or irredeemable. Loans which the government
promises to pay off at some future date are called redeemable
debts. For redeemable debts, the government has to make some
arrangement for their repayment. They are, therefore, terminable
loans.
 Whereas loans for which no promise is made by the government
regarding the exact date of maturity, and all that the government
does is to agree to pay interest regularly for the bonds issued, are
called irredeemable debts.
 Their maturity period is not fixed. They are generally of a long
duration. Under such loans, society is burdened with a perpetual
debt, as tax-payers would have to pay heavily in the end.
Therefore, redeemable debts are preferred on grounds of sound
finance and convenience
5. Short-term, Medium-term and Long-term loans:

 Redeemable loans may further be classified as

short-term, medium-term or long­-term debts.
Short-term debts mature within a short period say,
of 3 to 9 months. For instance, Treasury Bills are an
instrument of credit extensively used as a means of
short-term (usually 90 days) borrowing by the
government.
 Long-term debts, on the other hand, are those

repayable after a long period of time, generally, ten

years or more. For development finance, such loans
are usually raised by the government. Long-term
loans usually bear a high rate of interest.
6. Funded and Unfunded Debt:

 Funded debt is, in fact, a long-term debt,

exceeding the duration of at least a year. It
comprises securities which are marketable on
the stock exchange. Funded debt in its
proper sense is, however, an obligation to
pay a fixed sum of interest, subject to the
option of the government to repay the
principal. In such debts, the creditor bond-
holder has no right to anything but the
interest.
 Unfunded debts, on the other hand, are for a
comparatively short duration. They are
generally redeemable within a year. Unfunded
debts are, thus, incurred always in
anticipation of public revenue, a temporary
measure to meet current needs.
Effects of Public Debt

 1 – Revenue Effect
 When the government acquires funds by

releasing government securities, citizens

either reduce their expenses or save more to
invest in such assets. It thus impacts the
nation’s consumption expenditure.
Consumption expenditure is the amount
spent on goods and services for meeting the
needs of individuals and communities.
2 – Expenditure Effect

 The expenditure of borrowed funds is

different from that of the tax revenue. It is
usually used for special purposes like 
infrastructure development, welfare
programs, or meeting war expenses. Tax
revenue, on the other hand, is used for
regular expenses.
 3 – Other Effects
 The sovereign debt also influences other

national aspects—production, distribution,

consumption, employment, cost of
production, and investment
What are the sources of public debt?
 Two sources of sovereign debts are as follows:
Internal: The government can borrow funds
domestically in local currency from individuals,
financial institutions, and private
organizations.
External: The other way of acquiring funds is
from foreign countries or international
organizations. It could be an international
financial institution, an economic forum, or a
foreign donor.
What are the causes of public debt?
 The government borrows funds for the
following reasons:
1. To run public welfare schemes.
2. Infrastructure development.
3. To revive dysfunctional public
corporations.
4. To meet the budget deficit.
5. To fund wars and nuclear programs.
What are the effects of public debt?
 The public debt results in revenue and
expenditure effects. The public debt, when
acquired from individuals through the sale of
government securities, impacts their
consumption expenditure. Also, the proceeds
from such loans are utilized for specific
purposes.
What is the difference between public
debt and private debt?
 Sovereign debt is a loan acquired by a nation.
Governments borrow from individuals,
organizations, financial institutions, other
countries, and international organizations.
Treasury bills and government securities fall
into that category. On the other hand, loans
availed by private companies or individuals
are called private debts. Personal loans,
business loans, credit cards, and lines of
credit are examples of private debt.
Methods for Redemption of Public Debt

 1. Refunding
 2. Use of Budgetary Surplus
 3. Terminal Annuity
 4. Sinking Fund
 5. Debt Conversion
 6. Statutory Reduction in the Rate of Interest
7. Additional Taxation
 8. Capital Levy
 9. Using Trade Surplus.
1. Refunding:

 The government often issues new bonds for

raising new loans in order to pay-off the
matured loans (i.e., an old debt). Thus, the
government takes a fresh loan in order to repay
an old debt. When the government uses this
method of refunding there is no liquidation of
the money burden of the public debt. Instead,
the debt-servicing (i.e., repayment of the
interest along with the principal) burden gets
accumulated on account of the postponement
of the debt-repayment to some future date.
2.Budgetary Surplus:

 government is able to generate a surplus in

the budget. In such a situation, the
government is left with two options. It can
either reduce taxes or repay some of its old
debt. In general, the government makes use
of the budgetary surplus to buy back from
the market (the people) its own bonds and
securities. As a result, there is an automatic
liquidation of the debt liability of the
government
3. Terminal Annuity:

 In some countries, the government follows the practice

of paying-off the debt on the basis of terminal
annuity. By using this method, the government pays-
off its debt (which includes both interest and the
principal) in equal annual instalments.
 This method often finds favour with the planners and
policymakers in developing countries like India
because it leads to a fall in the burden of public debt
every year. The government is not required to repay
the entire debt at a time (i.e., it is not required to
make one huge lump-sum payment in order to repay
the debt).
4. Sinking Fund:

 Sometimes, this government of a country

establishes a separate fund known as the
‘Sinking Fund’ for the purpose of repaying its
debt. Under this system, the government goes
on crediting a fixed amount of money to this
fund every year.
 By the time the debt matures, sufficient money

gets accumulated in the fund so as to enable

the government to repay the debt along with
interest. In general, there are, in fact, two
alternative ways of crediting sums to this fund.
Contd…..
 the usual procedure is to deposit a certain (fixed) percentage of
its annual income to the fund. A preferable alternative for the
government is to raise a new loan and credit the proceeds to the
sinking fund. However, some economists do not treat the second
method with favour. For example, Dalton has opined that it is in
the Tightness of thing to accumulate a sinking fund out of the
current revenue of the government, not out of new loans.
 Modern economists like J.F. Due, Richard Musgrave and others

look at this sinking fund method as a systematic method of debt

repayment. Under this system the-burden of debt is spread
evenly over an extended period of time (10 – 15 years).
Furthermore, this normal method adds to the credit­worthiness of
the government. Critics, however, argue that this method is a
slow process of debt repaymen
5. Debt Conversion:

 Sometimes, a high interest debt is converted into a

low-interest one. The question here is: when is this
possible? Let us suppose the government contracts
the debt when the existing rate of interest is quite
high. But after some time the market rate of interest
may fall.
 This gives the government an opportunity to convert

its high-interest debt into a low-interest one. And,

the government is enabled to reduce the burden of
public debt. If the interest burden of public debt falls
the government is not required to raise huge
revenue through taxes to service the debt.
 Instead, the government can reduce taxes
and provide relief to the taxpayers in the
event of a fall in the rate of interest payable
on public debt. Since most taxpayers are poor
people and bondholders are rich, such debt
conversion is likely to improve the pattern of
income distribution. If this happens there is
an automatic reduction in the degree of
inequality in the distribution of income.
 6. Statutory Reduction in the Rate of Interest:

 Sometimes, the govern­ment passes ordinances

to reduce the rate of interest payable on its
debt. This happens when the government
suffers from financial crisis and when there is a
huge deficit in its budget. There are so many
instances of such compulsory reduction in the
rate of interest. However, this practice is not
followed under normal circumstances. Instead,
the government is forced to adopt this method
of debt management (repayment) only when
the situation so demands.
7. Additional Taxation:

 Sometimes, the government imposes addi­tional

taxes on people to pay interest on public debt. By
levying new taxes, both direct and indirect, the
government can collect the necessary revenue so as
to be able to pay-off its old debt.
 However, this method is often criticised on the

ground that it creates inequality in the distribution

of income by redistribution (transferring) income
from taxpayers to the bond­holders. This is why it is
said that if income-tax revenue is used to pay
interest on public debt there is a net burden on the
community.
8. Capital Levy:

 In times of war or emergency most governments follow the

usual practice of repaying its debt by imposing a capital levy
on its citizens. Keynes also agreed to this method when he
discussed the different methods of paying for a war. A capital
levy is just like a wealth tax inasmuch as it is imposed on
capital assets.
 This method serves a two-fold purpose:
 (1) Prima facie, it enables to the government to repay its
wartime debt by collecting additional tax revenues from the
rich people (i.e., people who have huge private property and
wealth);
 (2) Secondly, such capital levy, imposed at progressive rates
in capital assets, also helps reduce the degree of inequality in
the distribution of income and wealth.
9. Using Trade Surplus:

 The methods discussed above are used to

repay internal debt. However, when the
government borrows from other coun­tries, it
has to service the debt in foreign exchange.
The burden of country’s external debt is
measured by its debt-service ratio, which is a
country’s repayment obligations of principal
and interest for a particular year on its
external debt as a percentage of its exports of
goods and services (i.e., its current receipts) in
that year.