Public Debt and it’s Types

21/01/2021 0 By indiafreenotes

Public Debt refers to “Obligation of Government particularly those evidenced by securities, to pay certain sums to the holders at some future date.

In simple words, Public Debt can be defined as the amount of debt taken by government from internal as well as external sources to meet out its deficit. Government needs to borrow when current revenue falls short of public expenditure.

Government debt, also known as public interest, public debt, national debt and sovereign debt, contrasts to the annual government budget deficit, which is a flow variable that equals the difference between government receipts and spending in a single year. The debt is a stock variable, measured at a specific point in time, and it is the accumulation of all prior deficits.

Government debt can be categorized as internal debt (owed to lenders within the country) and external debt (owed to foreign lenders). Another common division of government debt is by duration until repayment is due. Short term debt is generally considered to be for one year or less, and long-term debt is for more than ten years. Medium term debt falls between these two boundaries. A broader definition of government debt may consider all government liabilities, including future pension payments and payments for goods and services which the government has contracted but not yet paid.

Governments create debt by issuing government bonds and bills. Less creditworthy countries sometimes borrow directly from a supranational organization (e.g. the World Bank) or international financial institutions.

  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.

The following points of distinction between internal and external debts are noteworthy:

  1. An internal loan may be voluntary or compulsory, but an external loan is normally voluntary in nature. Only in the case of a colony, an external loan can be raised by compulsion.
  2. An internal loan is controllable and can be estimated before hand with certainty, while external loans are always uncertain and cannot be estimated so confidently. Its realisation is very much conditioned by international politics and foreign policies of the lending government.
  3. Internal loan is in terms of the domestic currency, while external loans are in terms of foreign currencies.

An important feature of external debt is, that usually foreign exchange resources of the borrowing country increase when the loans are received in terms of foreign currencies. But, when there is repayment of such loans, i. e., debt servicing charges, foreign exchange reserve is depleted to that extent.

Sometimes, however, external loans are repayable in the borrowing country’s domestic currency, so that foreign exchange resources are least affected. For instance, in the post-independence period India received loans from U.S.A. under P.L. 480, which were repayable in Indian rupees.

Since under internal debts, borrowing takes place within the country, the availability of total resources does not arise. Simply the resources are transferred from the bond-holders individuals and institutions to the public treasury, and the government can spend, these for public purposes.

Similarly, payment of interest for repayment of principal of internal loans would transfer resources from tax-payers to bond-holders. An internally- held public debt, thus, represents only a commitment to effect a certain transfer of purchasing power among the people within the country. It has, therefore, no direct net money burden as such. It amounts to only a redistribution of income in the community from one section to the other.

External debt, on the other hand, leads to a transfer of wealth from the lender nation to the borrower nation. When the loan is made through the means of external loans the resources available to the borrowing nation increase.

However, when a foreign loan is repaid or interest is paid on such loans, there would be a transfer of resources from the debtor to the creditor countries, causing a decline in total resources of the debtor country.

The Structure of the Internal Public Debt:

The structure of the internal public debt may be constituted by various types of loan instruments/obligations of the government. It may be classified as follows:

In particular, for instance, the government of India’s debt obligations includes:

(1) Dated and non-terminable Rupee loans consisting:

(a) Marketable long-term loans including the portion subscribed by the State Bank of India out of the rupee counterpart funds;

(b) Dated loans issued by the Government to the Reserve Bank of India in exchange for ad hoc Treasury Bills outstanding; and

(c) Miscellaneous debt such as the Prize Bonds issued in 1961.

(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 Account, Indira Vikas Patra, Kisan Vikas Patra.

(4) Other miscellaneous obligations of the Central Government constituting the internal public debt in India are: Compulsory Deposit Scheme, Gold Bonds, Public Provident Funds, and items of unfunded debts and special securities issued to the United States Embassy for the Rupee Counterpart funds since 1961, unclaimed balance of State Provident Funds, and other accounts such as General Family Pension Fund, the Hindu Family Annuity Fund, the Postal Insurance, Life Insurance, Life Annuity Fund, etc. and unclaimed balance in respect of three-year Interest-free Prize Bonds.

  1. 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., which yield a sufficient income to the public authority to pay out annual interest on the debt as well as help in repaying the principal in the long run.

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.

  1. 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.

  1. 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.

  1. Short-term, Medium-term and Long-term loans:

According to their duration, 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, generally, for covering temporary deficits in the budgets. Interest rates on such loans are generally low.

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.

Similarly, loans of medium-term (in between short-term and long-term) are floated by the government, bearing intermediate interest rates. For war finance, or to meet expenditure on education, health, relief work, etc., such loans are generally preferred.

  1. 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.