Public debt refers to borrowing by a
government from within the country or from abroad, from private individuals or
association of individuals or from banking and NBFIs.
of Public Debt
Internal and External:
When a state finds that it is not possible to obtain further money by taxation,
it resorts to borrowing from citizens and financial institutions within the
country. This is ‘internal
borrowing’. The state may accumulate funds by raising short-term loans or
long-term loans or by both. If the
state is passing through a very critical period, then it can borrow all the
money which the nation saves. In
that case trade and industry will suffer a lot because no money is left to
finance them. In the normal period,
however, the state can borrow only surplus funds which are left with the
businessmen after meeting all the needs of the business.
is that which is raised from international money markets, foreign governments,
and from international agencies like International Monetary Fund.
When a state is in need of money, it tries to get as much loan as it can
from other states. The foreign governments do not advance loans without a limit.
They minutely study the budgetary position of the borrowing country, the
tax-bearing capacity of the nation, the per-capita income of the people and the
purpose for which the loan is desired. If
the position of the budget is sound and the taxable capacity of the nation is
high, then a foreign government may advance sizable loan to the borrowing
Productive and Unproductive:
The debt that is expected to create assets which will yield income sufficient to
pay the principal amount and the interest on it, is known as ‘productive
debt’. In other words, they are
expected pay their way; they are self-liquidating. J.L. Hanson has referred such a debt as ‘reproductive
On the other
hand, unproductive debt is the debt that is raised for financing unproductive
assets or heavy unproductive expenditures.
Such a debt is a deadweight debt. Debt
invested on wars or prevention of war is a deadweight debt.
Short-term and Long-term:
The loans that are repayable within a period of one year, they are termed as
‘short-term loans’ and if they are taken for more than one year, they are
referred to as ‘long-term loans’. Following
are the reasons for raising short-term loans:
If, at any time, the expenditure of the government exceeds the revenue,
then she takes recourse to short-term borrowing.
If, at any time, the rate of interest in the market is very high and the
government is in need of large fund to finance her various projects, then it
raises loan for a short-period of time only and waits till the prevailing high
rate of interest comes down.
The commercial banks find a very safe and profitable opportunity to
invest their surplus funds in the government short-term loans.
government is in need of large funds and the short-term loans are not enough,
then she takes recourse to long-term borrowing.
Long-term loans entail following advantages:
Long-term loan provides an opportunity to the state in undertaking large
projects like construction of canals, hydroelectric projects, buildings,
highways, etc. As these loans are
not to be repaid at a short notice, so the government safely spends them on
Long-term loans are also unavoidable for strengthening country’s
Long-term loans provide good opportunity for commercial banks and
insurance companies to invest their surplus funds. As the rate of interest on long-term loans is higher than on
the short-term loans.
Long-term loans can be repaid by the government by the time which is
favourable or convenient to her. She
can also convert these loans at a lower rate of interest later on.
If at any time, the rate of interest is low, the government can contract
a long-term loan and with the amount thus raised some public work programmes at
of Increase in Public Debt
War or war-preparedness, including nuclear programmes
To cover the budget deficits on current account
To undertake public welfare schemes
Urge for economic growth
Inefficiencies of public organisations and corruption
of Public Debt
gap between revenue and expenditure through temporary loans from central
bank. In Pakistan, the
Government issues what are called ‘Treasury Bills’ which are repayable
within one year.
reduce depression in the economy and financing public works programme.
curb inflation by withdrawing the purchasing power from the public.
economic development esp. in under-developed countries.
the public sector for expanding and strengthening the public enterprises.
arms and ammunition financing.
of Debt Redemption
of surplus revenue: This is an old method
and badly out of tune with the modern conditions.
Budget surplus is not a common phenomenon.
Even when there is a surplus, it cannot be used for making any
substantial reduction in the public debt.
of government bonds: The government may
buy her own stocks in the market, thus wiping off its obligation to that
extent. This may be done by the
application of surplus revenues or by borrowing at low rates, if the
conditions are favourable.
annuities: When it is intended completely
to wipe off a permanent debt, it may be arranged to pay the creditors a
certain fixed amount for a number of years.
These annual payments are called ‘annuities’.
It will appear that, during the time these annuities are being paid,
there will be much greater strain on the government finances than when only
interest has to be paid.
of high-interest-rated loans to low-interest-rated loans:
A government may have borrowed when the rate of interest was high.
Now, if the rate of interest falls, it can convert a high-rated loan
into a low-rated one.
fund: This is the most important method.
A fund is created for the repayment of every loan by setting aside a
certain amount every year out of the current revenue.
The sum to be set aside is so calculated that over a certain period,
the total sum accumulated, together with the interest thereon, is enough to
pay off the loan.
of Public Debt
If the debt is taken for productive
purposes, for e.g., for irrigation, transportation, railway, roads, information
technology, human skill development, etc., it will not mean any burden.
Infact, they will confer a benefit.
But if the debt is unproductive it will impose both money burden and real
burden on the economy.
(a) Burden of internal debt:
Internal debt involves a series of transfers of wealth within the country, i.e.,
from lender to government and then later on at the time of redemption from
government to lender. Money is thus
transferred from one section of the community to other sections.
In this case the money burden on the economy is zero.
But there may be real burden on the
community. In order to repay the
interest and the principal amount of the debt, the government has to levy taxes.
What the taxpayers pay the lenders receive.
The lenders are generally rich people and tax burden is fall on poor
especially in the case of indirect taxes. The
net result may be that the wealth is transferred from poor to rich. This is the loss of economic welfare.
(b) Burden of external debt:
External debt also involves a series of transfer of wealth from the foreign
lender to the borrowing country, and when it is repaid the transfer is in the
opposite direction. As the
borrowing country paid interest to the foreign lenders, a direct money burden is
fall on the whole community.
The community is also suffered from real
burden of external debts. Government
has to cover the amount of interest to be paid to the foreign lender by heavily
taxing the income of the community. As
a result the production, consumption and distribution of income is badly
affected. Moreover, the foreign
lender has direct involvement in the economic activities of the country.
of Public Borrowing in a Developing Economy
should cover at least current expenditure on normal government services and
borrowing should resort to finance government expenditure which results in
creation of capital assets.
borrowing for financing productive investment generates additional
productive capacity in the economy
is used as an instrument to mobilise resources which would otherwise hoarded
in real estate or jewellery
provides the people opportunities to hold their wealth in the form of safe
and stable income-yielding assets, i.e., government bonds
management of public debt is used as a method to influence the structure of
has become a powerful tool of developmental monetary policy
are two ways in which the governments of under-developed countries raise
resources through public loans:
borrowing, i.e., sales to the public of government bonds (long-term) and
treasury bills (short-term) in the capital market
borrowing, i.e., issue to the public of debt which is not negotiable and
is not exchange in the capital market, for e.g., National Saving
are two forms of loans, i.e., voluntary and forced loans.
Forced loans or compulsory borrowing is a compromise between taxation
and borrowing. Like a tax it is
a compulsory contribution to the government but like a loan, it is to be
repaid with interest.
of Public Borrowings in UDCs
UDCs there are no or very small organised capital and money markets.
The resources are too inadequate to fulfil the capital needs of the
are hoarded in non-productive sections of the economy, for e.g., real estate
savings in rural areas cannot be mobilised effectively because rural incomes
do not move through monetary channels
response to government securities is also poor because of rising prices.
Effects of Public Debt on Production,
Consumption, Distribution and Level of Income and Employment
on Production: Public debts are raised to
finance productive enterprises of various kinds, e.g., steel works, cement,
multipurpose projects, construction of ships, railway lines and highways,
heavy electrical and engineering works, mining, oil refining, etc.
on Consumption: When people subscribe to
government loans, they generally have to curtail consumption.
Since investment of funds raised by borrowing raises the level of
employment and as a result raises the level of consumption.
on Distribution: Public loans transfer
money from rich to government. The fiscal operations of the government are to benefit
the poor primarily. The incomes
of the poor increase directly through increased employment or it benefits
them in directly through the enlargement of social services.
on the Level of Income and Employment: In
modern times, public borrowing is resorted to in order to raise funds for
financing agriculture, industry, mining, transportation, communication, etc.
It increases employment opportunities, the level of income and
standard of living.
Classification of Public Debts
Debt: Deadweight debt is one which is not
covered by any real assets. In
the words of Hicks: “Deadweight is that which is incurred in consequences
of expenditures which in no way increase the productive power of the
community, yielding neither money revenue nor a future flow or utilities.”
The loan raised during war period is a deadweight debt because for
such debts no real assets exist to balance them.
Debt: Sometimes government raises loans
for spending on such projects which neither yield money income nor help in
raising the productivity of the country.
They simply provide enjoyments to the citizens such as public parks,
museums, public buildings, etc.
Debt: Active debt is one which is spent on
those projects that directly help in yielding money income and increasing
the productive power of the community.
Classification of Public Debt
J.L. Hanson has classified public debt
into four main classes:
Debt: When a
debt has assets to balance it, it is called reproductive debt.
For instance, if a state borrows money for spending it on the
construction of canals, railways, factories, etc, it is then able to repay
the loan from these self-liquidating projects.
Debt: A debt which is not covered by any
real assets is called deadweight debt.
Debt invested on wars or prevention of war is a deadweight debt.
Debt: Funded debts are long-term debts.
The government continues paying the annual interest on such loans but
makes no promise to pay the principal sum to the lender on any specified
date. The examples of funded
debts are long-term government stocks, war loans and console.
or Unfunded Debt: Floating or unfunded
debt comprises of short-term loans. It
is payable to the lender with interest on or before a fixed date.