PUBLIC DEBT
MEANING:
The amount of public expenditure has increased over the years in view of the increasing activities of the government. It is not possible to meet the large public expenditure through traditional source of revenue, namely taxes. Therefore, the government is required to obtain additional revenue through borrowing. In modern times, borrowing by the government has become a normal method of government finance, along with other sources of public finance like taxes, fees, etc. Borrowing by the government leads to public debt. The total outstanding loans by the government go by the name of government debt or ‘public debt’. Public debt is the debt which the government owes to its subjects or to the nationals of other countries. In other words, public debt refers to the loans raised by the government from within the country or from outside the country. The government may borrow from individuals, business enterprises and banks, etc.
Structure (Types) of Public Debt
Public debt can be classified into various categories. They differ from each other in many ways. These differences are due to the markets in which the loans are floated, the rate of interest offered, the conditions of repayment of loans or the purpose for which loans are taken. The main forms or kinds of public debts are given below:
1. Internal and External Public Debt: Internal debt refers to the public loans floated within the country, i.e., the government borrows funds from the individuals and institutions located within the country.
External debt refers to the loans taken by the government from the individuals, institutions and governments of foreign countries as well as the loans taken from the international financial institutions like World Bank, IMF, etc. The payment of interest on internal debt does not pose much of a problem because it only causes redistribution of income within the country. But payment of interest on external debt and repayment of these loans may cause great hardships to the economy because the payment has to be made in terms of foreign currency, and this results in transferring a part of its income and wealth abroad. Consequently, a large amount of country’s limited foreign exchange earnings from exports is not available for its economic development.
2. Productive and Unproductive Debt: Loans may be used for productive purposes. Productive debt is the debt which is used by the government for directly productive purposes. It is used for the projects which yield an income, like development of railways, power projects, irrigation projects, establishment of industries, etc.
Unproductive debt is that debt which is used for undertaking projects which are not directly productive. It is incurred on those projects which do not yield any income such as financing war, controlling floods, epidemics, etc. Such debt do not add to the productive capacity of the economy. Consequently, these debts constitute a burden upon the government, and repaying the debt becomes difficult. That is why unproductive debt is known as deadweight debt.
3. Short-term and Long-term Debt: Public debt may be classified on the basis of the period for which government raises loans. Short-term debt is the debt which is raised for a short period of three to nine months. Treasury bills and advances from the central banks are the examples of short-term loans. Interest on such loans is generally low. On the other hand, long-term debt is that debt which is repayable after a long period, say five years or more. Such debts are raised largely for development purposes. They carry a higher rate of interest.
Public debt is also classified into funded and unfunded debt, voluntary and compulsory debt, redeemable and irredeemable debt and marketable and non-marketable debt.
Reasons for Borrowing by the Government
Public borrowing in modern times is necessary to meet various essential expenditures. The government may borrow for the following reasons:
1. To Meet Budgetary Deficit: The government sometime borrows to meet its current revenue expenditure. It may borrow because its current revenue falls short of its expenditure. Many a time, the revenue from taxation and other sources of revenue may fall short of its current expenditure. In such cases, the government requires short period loans to cover the gap between the current revenue and expenditure.
2. To Finance War: The government may borrow for defence of the country. Modern warfare is a very expensive proposition. It cannot be financed by taxation alone. Moreover, public loan is an easier method of collecting revenue than taxation.
3. Financing Development Plans: The government in the underdeveloped countries is expected to play an important role in promoting economic development. It may undertake development plans for this purpose. The government has to incur huge expenditure to undertake various developmental projects. The government in these countries cannot resort to heavy taxation because of the low taxable capacity of the people. Under such circumstances, public loans are the only way out.
4. To Provide Foreign Exchange: Underdeveloped countries need foreign exchange during the early stages of economic development to undertake high level of investment, to purchase capital equipments and raw materials from abroad and to cover the balance of payments deficit. Therefore, resources have to be obtained from abroad by way of foreign loans.
5. To Check Recession: The government in the developed countries have been borrowing to control recession so as to prevent the possibility of occurrence of depression.
6. Meeting Unforeseen Expenses: Sometime the country has to face some unforeseen contingencies such as floods, famines, tsunami, epidemics, etc. The government is required to undertake huge expenditure to meet such situations of crisis in the economy. Therefore, the government raises loans to meet large expenditure arising therefrom.
7. To Finance Public Enterprises: In countries like India, public sector has been assigned a major role in promoting economic development. The developmental activities undertaken by the public sector like expansion of basic and heavy industries, creation of economic and social infrastructure, etc., require huge funds. The government cannot provide such funds out of taxation alone. Therefore, it raises loans to meet the financial requirements of the public sector.
8. Soft Revenue Option: While public expenditure has been increasing sharply all over the world, the possibility of financing it through taxation is limited. Therefore, many a time, the government chooses the soft option of meeting its mounting expenditure by raising loans and thereby saving itself from the public opposition and criticism.
Methods of Debt Redemption
Redemption means repayment of a loan. Redemption of public debt, therefore, can be defined as repayment of public debt. All government debts need to be repaid. If the government fails to repay debt, its credibility will be lost and it may not be in a position to raise loans in future. Various methods are used by the government to redeem its debt.
1. Repudiation of Debt: Repudiation means refusal to pay a debt by the government. When the government repudiates public debt, it does not recognize its obligations to pay the loan.
2. Refunding: Refunding is the process by which the government raises new bonds to pay off the maturing bonds.
3. Debt Conversion: Conversion of public debt means exchange of new debt for the old debt. In this method, the loan is actually not repaid, but the form of debt is changed.
4. Budgetary Surplus: Sometimes the government is able to generate a surplus in its budget. It can also use this budget surplus to pay off its debt to the people.
5. Terminal Annuities: Under this method, the government pays its debt in equal annual instalments, which include interest as well as the principal amount of debt. The annual payments are called annuities.
6. Sinking Fund: Sometimes, the government establishes a separate fund, known as ‘sinking fund’, for the purpose of repayment of its debt. The government credits (deposits) certain amount of its revenue every year for the repayment of outstanding debt.
7. Statutory Reduction in the Rate of Interest: Sometimes, the government takes a statutory decision to reduce the rate of interest payable on its public debt. The creditors are forced to accept the reduced rate of interest in view of the statutory powers of the government.
8. Capital Levy: Capital levy refers to a very heavy tax on property and wealth. It is a once- for-all tax imposed on capital assets of a certain value .
9. Export Surplus: The method discussed above are used to repay internal debt. But external debt needs to be repaid normally in foreign exchange. It can be done by creating an export surplus.