Public Debt

Meaning :

Public debt refers to the loans raised by government from within or outside the country. Every govt. has to borrow when its expenditure exceeds its revenue. The borrowing or taking loans by the govt Is known as public debt.

Comparison between Public and Private Debt  :

1. Compulsion :- The government can compel the people or institution in a country to lend funds to it in case of war, economic crises or any other emergencies but no private individuals can force or compel another private individual to lend them money

2. Repudiation :- Under abnormal conditions the govt. can refuse the payments of loan taken by it from people but the private individuals cannot do so under any circumstances.

3. Time Period :- The government can borrow from public for longer periods because it is a permanent institution and people have faith in it. Private individual can barrow for short period of time due to risks involved on the part of the lender.

4. Rate of interest :- Because of its high credit worthiness government can borrow at lower rate of interest but it is not so in case of private borrower who has to pay a very high rate of interest because risk is involved in it.

5. Sources :- The government can take loan within the country and also from abroad but a private borrower can borrow only from within the country.

6. Mode of Payment :- The government repays its loan by taxiing the people but in case of private debt the borrower has to repay loan out of his own saving.

7. Effect on the economy: - Public debt makes its effect on production distribution of income and wealth in country but private loans make no such effects due to its micro nature.

Need for public debt :

In recent times government have been barrowing huge sums both internally and externally for the following reasons.

1. Deficit budget: - The government may borrow to cover budgetary deficit on account of large expenditure incurred on administration and for financing unforeseen events like floods famines epidemics.

2. To finance war: - Modern wars are very costly they cannot be financed unwarily through taxation thus public debt becomes necessary.

3. Natural calamities :- Natural calamities like earthquake, flood, famines etc. lead to increase in government expenditures in order to provide relief to the victims. It necessitates huge public barrowing by the government.

4. Economic development :- Public debt is considered a very important tool for the development of a country. Both developed and developing countries borrow for economic development. Developing countries do not have sufficient resources to finance their plan they therefore borrow not only from within the country but also from foreign sources for the development of agriculture, industry, power, transport communication etc. Developed countries also borrow to modernized their infrastructure facilities like roads, railways power plant etc.

5. To finance Public enterprise :- Every country whether a socialist economy or missed economy runs certain public enterprises like railways, postage and telegrams, power work et. Which require large funds The government can meet them only through public borrowing rather than by taxation.

6. To check economic stability :- Government borrows to stabilize, to control inflationary conditions. The govt. borrows to take away excess money supply from the public. Since public borrowing is voluntary. This is a better method then raising taxes. Because loans from public do not increase the cost of production. Public borrowing also helps to lift the economy from depression. During a depression ideal funds lying with the bank govt. borrows in order to spend on public work programmers.

7. To provide foreign exchange :- In case of deficit in the balance of payment. Foreign exchange is needed to correct it. In such a condition government borrow from foreign countries as well as from international financial institution in the form of foreign exchange..

8. Soft Revenue option :- With increase in public expenditure government needs a lot of fund. Taxation is a source of income for the government but it cannot be increased at a very high rate to meet the expenses because it pinches a lot to the people. Therefore many a limes government chooses soft loan option of meeting its increasing expenditure by raising loans and thereby saving itself from public opposition.

Sources of Public debt :

There are 2 main sources.

(1)Internal (2) external

(1) Sources of internal debt :- It refers to govt. loans floated in capital markets within the political boundaries of the country . the main sources of internal borrowing are:

i) Individuals.

ii) Banking & non-banking institutions.

iii) Central Bank.

Sources of external debts:-

It refers to govt. loans floated in foreign capital market. The main sources are.

i) Foreign governments.

ii) International Monetary agency like world bank IMF, International finance corporation international development association.

Structure or classification of Public debt :

(1) Internal & external debt

(2) Productive & unproductive debt:-

Productive debt is defined as a loan, which is used for project which yields an income to the government like railways, construction, irrigation, power etc.

Unproductive debt is defined as that loan which does not yield any income to the govt. like debt for natural calamities and to finance war etc. this debt is also known as dead weight debt.

(3) Redeemable & Irredeemable debt :

Redeemable debt refers to that loan which govt. promises to pay off at some future date. The interest on this loan is paid by the government regularly half yearly or annually. When the debt matures the govt. pays back the principal amount to the lender.

Irredeemable debt is that loan in which the principle amount is never returned by the government although the interest is paid regularly for the period of its duration.

(4) Short term and long term debt.:-

Short term debt is defined as that debt which may mature within a period of 3 to 4 months. This debt is like treasury bills & advances from central bank. Interest on such loans is generally low.

Long term loans are repaid in a long period say roughly after 10 years or more. Usually such debt bears a higher rate of interest.

(5) Funded and Unfunded debt :-

Funded debt is a long term debt whose payment is made at least after a year. In order to repay a debt fund is created in which some money is deposited by the government and the debt is paid out of this fund at the time of maturity.

Unfunded debt is for short period or less than a year. The govt. does not create any separate fund to repay the debt. Treasury bills are unfunded debt.

(6) Voluntary & compulsory debt :-

Voluntary debt is defined as that debt which is paid without any legal enforcement in this the people voluntarily or willingly subscribe to govt. loans. In fact ,all public loans are voluntary.

Compulsory debt are those debt which are forcibly taken by the government. Such loans are taken only during wars and national emergencies.

(7) Marketable and Non-Marketable debt.

Marketable debt is defined as one in which the securities are negotiated in open market. for example, all types of securities sold in the secondary market

Non- Marketable loans are such loans where securities cannot be sold in the stock exchange market, for example, PPF,PF,NSC etc.

(3) Gross debt and Net debt:-

Gross debt consists of the total amount of all the debt out standing at any time

Net debt is balance amount of gross debt after exclusion of sinking fund and other assets meant for repayment of debt.

Debt Redemption or Debt Management :

Redemption of public debt means repayment of debt. Public debt is to be repaid by the government within the time limit fixed for its repayment. The various methods of debt redemption are.

(1) Repudiation of debt :- it means refusal to pay a debt all together. The government refuses to pay the interest as well as the principle amount. This method of debt redemption is not practical because the government reputation may be at stake the consequences of this method may be dangerous. Debt repudiation is not popular in modern times. Russia did so in 1971.

(2) Debt conversion :- In this method the debt with high interest rate is converted into new debt when the market rate of interest falls. The government borrows at low rate of interest and repays the past debt even before it matures. The lender is free to take his money back or get his loan converted into a fresh loan. However conversion can be successfully carried out ,if the credit of the good.

(3) Budgetary surplus A policy of surplus budget may be followed annually for clearing of public debt gradually instead of creating a fund for its repayment on maturity. But in recent years due to rapidly increasing public expenditure ,surplus budget is a rare phenomenon

(4) Terminal annuities: - under this method the physical authorities clear off. Part of public debt on the basis of terminal annuities into equal annual installments including interest along with the principle amount. This is the easiest method similar to sinking fund. According to this method ,the burden of debt goes on diminishing and by the time of maturity ,it is already fully paid off.

(5) Refunding:- In this method. There is issue of new bonds and securities by the government in order to repay the matured loans. refunding is the process by which the maturing bonds are replaced by new bonds .A major drawback of this method is that the govt. would be tempted to postpone its obligations of debt redemption and the total burden of debt would continue to increase in future.

(6) Sinking fund :- In this system the government establishes a separate fund known as sinking fund. A fixed amount of money is credited by the government to this fund every year. By the time one debt matures. There is enough amount in fund to pay off loans along with the rate of interest. In practice sinking funds are not accumulated, Government do not create such fund if even if they create they utilize it for the other purposes whenever they are in need of funds.

(7) Capital levy :- It refers to a very heavy tax on property and wealth. It is a once for all taxes imposed on the capital assets above the certain value. in fact capital levy is advocated immediately after the war to repay the unproductive war debts.

(8) Reduction of rate of interest : sometimes the govt. takes statuary decision to reduce the rate of interest. Payable on its public debt. The creditors are forced to accept the reduced rate of interest. This method is normally used by the govt. during financial crisis.

(9) Additional provision of taxation :- In this method new taxes are imposed to collect revenue. It is a method of redistribution of income by transferring it from the tax payer into the hands of bonds holders.

Debt Trap : It refers to a phenomenon where the government of a country has to raise fresh loan just in order to pay the interest charged on the earlier loan borrowed by govt. and it is very difficult to repay to the amount. The govt. is trapped in vicious circle of borrowing.

Burden of public debt :

It tells both internal & external debt may be direct money burden, indirect money burden, direct real burden and indirect real burden.

i. Direct Money Burden :- It refers to the amount of money to be raised to meet the revenue requirements. In case of internal public debt there is no direct money burden because in this case money changes hands only. But in case of external debt money burden is heavy.

ii. Indirect money burden :- When govt. spends the loans it result in the creation demand for certain commodities as a consequences the prices of goods and services rise imposing additional burden on the society.

iii. Direct Real burden :- It is in the form of reduction in economic welfare and this strains and stresses tax payers.

iv. Indirect Real burden :- The indirect real burden of a debt is also felt through the ultimate effects on production when the govt. imposes taxes to repay loans and interest it discourages the willingness of the tax payers to work more & save more, thus it adversely affect the production in a country and the indirect real burden of a tax will be heavy.


1 Mobilization of resources: - Public borrowing is very helpful in implementing 5 year plans and various other projects. with the help of borrowing govt. can easily make various types of plans to mobilizes the resources efficiently.

2 Increase in the productive capacity :- With increase in barrowing productive capacity of a country can easily be increased. Borrowing is very much helpful in using capital intensive techniques to increase the productive capacity of a country.

3 To promote Investments: - Public borrowing helps in promoting investments, borrower fund can be utilized for strengthening infrastructure and promoting economic development of country.

4 Developmental expenditure: - Barrowing can be used to meet the developmental expenditure like roads, communication system, railways telecom, finance etc.

5 Obtaining foreign exchange:- Borrowing in the form of foreign exchange can be used to meet developmental activities. For development purpose govt. tries to acquire money capital, raw material from foreign countries. It can then only be possible if we have good stock of foreign exchanges with us.


1) Inflationary impact :- With increase in the public borrowing money supply in the market also increases which increases the prices of the commodity.

2) Additional tax burden :- To repay the old loans. Government has to impose new taxes on people which will be extra tax burden on the people and it pinches a lot.

3) Adverse effect on saving and in vest anent :- for the repayment of loan when govt. imposes new taxes on the people there will be adverse effect on saving and investment b/c more saving & more investment means more tax.

4) Effects on distribution of income :- Public debt may sometime effect distribution of income among people. Govt. raises loans from higher income group people and the return of it is also given to them only. Thus rich becomes richer and poor becomes poorer.

5) Unproductive debt:- a part of the loan taken by the govt. is used to meet the non developmental expenditure which never helps in increasing the production in the country. Thus it is called dead weight debt which is very difficult to repay.

6) Debt servicing burden :- The annual interest paid by the govt. in lieu of debt increase is known as debt servicing burden. There is very large increase in debt servicing burden in every country in modern times which has very dangerous consequences.

Questions :
1. What is public finance? Explain its nature and scope?

2. Explain the sources of public revenue.

3. Define taxation? Explain its nature or explain important characteristics of it.

4. Explain the objectives of taxes.

5. Explain the cannons of taxation.

6. Explain the merits/demerits of direct & indirect taxes.

7. Differentiate between direct & Indirect taxes.

8. define proportional, progressive. Regressive and digressive taxation.

9. What is Public expenditure? Explain any two types of public expenditure.

10. Give the reasons for the growth of public expenditure in recent times.

11. Define public debt.

12. Explain the reasons for borrowing by the government.

13. Explain any 4methods of debt redemption.

14. Explain the adverse effects of public debt.

15. What is fiscal policy? Explain its objectives.

16. show how fiscal policy can be used to achieve economic statrlity, economic growth & equity.

17. Define govt. budget. Explain its needs and importance.

18. Explain any 4 Types of budget.

19. Distinguish between revenue, fiscal & primary.

20. What is deficit financing? Explain its objectives.

21. What is the effect of deficit financing on an economy.

22. Explain the compulsion of India in using deficit financing.


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  4. Useful info about public debt subject of economics faculty banking and finance department 4th year.

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