PUBLIC DEBT

GROUP 1

WHAT IS PUBLIC DEBT?

The debt is in the form of promises by the treasury to pay to the holders of these promises a principal sum and in most instances interests on that principle
Philip E. Taylor

Objectives Of Public Debt

To cover budget deficit Rapid expansion in the state s function In times of depression To curb inflation To finance development plans To finance public enterprises Creation of social over head capital To have better allocation of resources Expansion of education and health To finance war

Classification of Public Debt

Internal Refers to the public loans floated within the country Payment of interest does not reduce the net income External Refers to the obligation of the borrower country to foreign government Interest payment reduces the net income of the debtor country by transferring a part of it s income abroad Unproductive

Productive

Those which are used for the projects which yields an income to the Govt. Not considered as a burden upon Govt. And tax payers

those which are incurred for financing war and for giving relief in times of flood, drought etc considered as dead weight upon the Govt.

Redeemable Those for which the Govt. Promises to pay off at some future date

Irredeemable Loans for which no such promises are made

Govt has to pay the interest and the capital Govt. Pays interest regularly both on some future date Funded Unfunded

Those that are redeemable after a year or are not paid at all

Those that are paid-off within a year

Voluntary individuals and the institutions are invited to purchase Govt. bonds

Involuntary Govt. exercise it s pressure for getting loans

Effects of Public Debt

Effect on consumption Securities when bought out of Present income > reduction in money avaliable for consumption Securities bought out of past savings or idle savings > no direct effect on present expenditure Govt. Spending welfare schemes/public undertakings no effect on consumption

Effect on production Funds Spent on Securities bought by withdrawing money from industrial concerns direct effect on private investment Public undertaking no adverse effect Unproductive uses adverse effect Securities from idle funds no adverse effect Securities from bank deposits may have an adverse effect

Effect on distribution Rich people > buy securities > burden of tax to pay debts > falls on poor classes > Increases inequalities of incomes Debt used for Economic welfare > equal distribution of income Effect on cost of production Funds used supply of raw materials/facilities reasonable rates - producers Promoting R&D subsidies also Fall in cost of production

Effect on investment Crowds out private investment However, Bonds With no special privileges/static interest-> non competitive -> no crowding out of private investment Sold to banks with excess reserves -> no crowding out

Effect on National Income Govt. expenditure incurred on capital > increased production > rise in employment > rise in national income Effect on liquidity government securities > highly negotiable and liquid form > increases availability of liquid assets Stiff credit times Banks Increase reserves by quick disposal of bonds Psychological effect Influences business behavior People alarmed High national debt

> loss of confidence > curtail investment

Effect of foreign loans on the economy External borrowing leads to import of capital goods, increase in supply and increase in income reduces demand of indigenous goods in the present but increases output in future

Factors affecting Effects of Public Debt

Factors on which the effect of public debt depend: 1. Source of Borrowing investors/foreign institutions etc 2. Purpose of Borrowing - Borrowing for wasteful expenditure is indefensible 3. Amount of Loans Obtained - Larger the loan, greater profit, more palpable effect on economic system

Internal and External Public Debt

Public Debt 2 major kinds Internal External Internal debt
Govt borrowings Sources within the country

External debt Govt borrowings Foreign countries or international institutions

Internal Debt

Borrowings from sources within country Repayable domestic currency Income & wealth redistribution of - no direct money burden Temporary and Permanent in nature Temporary loans also include non-negotiable non-interest bearing securities issued to international institutions such as International Monetary Fund(IMF)

Internal Debt in India

Sources
Individuals Banks Business firms

Internal Debt of Central Govt has increased from

1990-91 - Rs. 1.54 lakh crore 2005-06 - Rs. 13.4 lakh crore

Components of Internal Debt in India

Various components of Internal Public Debt in India
Market Loans Bonds Treasury Bills Special Floating and other loans Special Securities Ways and Means Advances Securities against small savings Compensation Bonds etc

External Debt
EXTERNAL DEBT
External debt Govt borrowings Foreign institutions and nations IMF, IBRD, friendly nations

COMPOSITION OF EXTERNAL DEBT

Major forms of borrowings include
Outright grants, Loans repayable in rupees Loans repayable in foreign currencies External loans - the issue of non-negotiable from IMF Cash grants Commodity grants Special credits from countries like Canada, Denmark

Net Increase In External Debt

YEAR

GROSS EXT BORROWING

REPAYMENT

NET INC IN EXT PUB DBT

1990-81 1990-91 2000-01 2007-08

1728 5339 17328 17452

447 2158 9823 8341

1281 3181 7505 9111

Burden of Public Debt

Two kinds of burden Internal External INTERNAL BURDEN OF PUBLIC DEBT Direct money burden Indirect money burden Direct real burden Indirect real burden

BURDEN OF EXTERNAL PUBLIC DEBT Direct money burden Indirect money burden Direct real burden Indirect real burden

Public Debt Management

Aims
Method of borrowing should not have adverse effect upon economy Reduce inflation or deflation Make available the needed funds

Objectives
Sub-serve Economic Policy of Govt. Advantageous to Govt. No adverse effect on money market

Principles
Interest cost must be minimum Satisfaction of investors Funding of short and long term debt Must coordinate with fiscal and monetary policy Maturity distribution & kinds of debt holders

Redemption of Public Debt

Various methods of redemption of PD, are (i) Sinking Funds: Fund - created out of general revenue pays off loans Portion of current revenue country sets aside annually When sum accumulated = principal, debt paid in one go (ii) Terminable Annuities: Country pays fixed instalments, for a period of years Instalments are called annuities (iii) Utilization of Surplus Budget: In case of surplus budget use for reduction of debt burden Unlikely for a debtor country In event of surplus too small for significant effect on debt (iv) Redemption by the Purchase of Government Stock: Govt - purchase of its own stocks in the market reduce debt Bought by fresh borrowing at low rates Also by the utilization of surplus revenues.

(v) Conversion: convert a loan bearing a high rate of interest into another with a lower rate of interest Exchange of new debt for old If loan was taken was ROI was high, conversion can help reduce interest payments (vi) Capital Levy: Introduction of a special debt redemption Impossible to reduce burden of war debt by previously suggested means Special tax onaccumulated wealth/capital of the people Progressive rate money raised pay off war debts at a progressive rate and with the money thus raised pay off all the war debts. Dalton in his book 'Public Finance' Writes: (vii) Surplus Balance of Payments: Reduce imports/increase exports Use surplus BOP to pay lower debt burdens (viii) Writing off loans: Request creditor nations to write off loans

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