Burden of Internal and External Public Debt - Shifting of Burden

Introduction To The Burden of Public Debt ↓

Over the years, the public debt of the India's Central and that of State government has increased considerably during the planning period. The Government borrows funds by way of public debt to meet the various development and non-development expenses.

Table below indicates composition of public debt of the Central Govt. of India.

Apart from internal debt, there are also internal liabilities of the central government in the form of small savings of the public, provident funds, reserve funds & deposits of Government department.

Both internal and external debt carry a burden on the economy of nation.

The Burden of Internal Public Debt ↓

1. Internal debt trap

One of the bad effects of internal debt is the interest paid by the government. Such interest payments increase public expenditure and may become a cause for fiscal deficit. If internal public debt is not checked and kept within limits, it may take the country to the worst position called 'Internal Debt Trap'.

2. More burden on poor and weaker sections

Internal debt provides opportunities for the rich and higher middle class to earn a higher rate of interest from the state on their lending. At the same time the pobr suffer a lot due to the tax burden. The government levies taxes to repay interest on public debt. But the tax burden does not necessarily fall on the rich unless it is progressive in nature. In the case of indirect taxes, the burden is felt more by the poor than the rich.

3. Increasing interest burden

Public borrowing may become costlier for the government especially when it resorts to public borrowing by issuing bonds and debentures. Such bonds and debentures carry a high rate of interest to the extent of 15 percent. The impact of such interest payments may develop manifold and still worsen in the future if the government stick to the same policy of borrowing in the years to come.

4. Unjustified transfer

The servicing of internal debt involves transfers of income from the younger to the older generations and from the active to the inactive enterprises.

The government imposes taxes on enterprises and earnings from productive efforts for the benefit of the idle, inactive, old and leisurely class of bond holders. Hence work and productive risk taking efforts are penalised for the benefit of accumulated wealth. This adds to the net real burden of debts.

5. Indirect real burden

Internal debt involves an additional indirect real burden on the community. This is because the taxation required for servicing the debts reduces the tax payer's ability to work and save and affects production adversely. The government may also economise social expenditure thereby, reducing the economic welfare of the people.

Taxation will reduce the personal efficiency and desire to work. Thus there would be a net loss in the ability and desire to work. The creditor class will also not have any incentive to work hard due to the prospect of receiving interest on bonds. This would further cause a loss to production and increase the indirect burden of debt.

The Burden of External Public Debt ↓

External debt is beneficial in the initial stages as it increases the resources available to the country. But its repayment & servicing creates a burden on the debtor country.

1. External debt trap

The external debt creates direct money burden. This is because; it involves transfer of funds from the debtor country to foreign citizens. The degree of burden depends upon the interest rate, and the loan amount. The loans are normally to be paid in foreign currency. Therefore, the funds are mostly transferred from export earnings or by raising more funds from foreign markets. Borrowing by way of additional loans would put extra burden on the country. The situation may become so worse, that the country may be caught in the external debt trap. It may have to borrow from foreign markets to repay the interest amount and it would be very difficult to repay the principal amount.

2. Direct real burden

The external debt may also result in direct real, burden. The citizens of the debtor will have to suffer loss of economic welfare to the extent of repayment of principle amount and interest burden. The foreign currency earned through exports would have been utilized to import better goods and technology. Which would have increased the economic welfare of the citizens of the debtor country. But because of external debt repayment, they have to restrict their welfare which the imported goods would have provided. In other words, the citizens of debtor country are deprived of imported goods and service to the extent till the loans and interest amount is repaid.

3. Decline in expenditure to public welfare programmes

When the government spends a significant portion of its resources towards the payment of foreign debt it reduces the government expenditure to that extent which otherwise would have been spent for public welfare programmes.

4. Decline in the value of nation's currency

The repayment of external debt involves an increase in the demand for the currency of the creditor country. This will raise the exchange rate of the creditor country's currency, and aggravate the problem of foreign exchange crisis.

The creditor country may also be adversely affected if it is induced to import more from the debtor country. This may hinder the growth of their domestic industries and cause unemployment.

5. Burden of unproductive foreign debt

The magnitude of external debt burden depends upon whether the debt is incurred for productive purposes or for unproductive purposes. If it is incurred for unproductive purposes, it will create a greater burden and sacrifice on the citizens of the debtor country.

6. Political exploitation

In recent years, it was found that the lending countries who dominate international organisations like World Bank & international monetary fund use the lending opportunity as an instrument to exploit the borrowing countries economically & politically.

Shifting The Burden of Public Debt ↓

When resources for government expenditure are generated through taxation, the present generation bears the burden but when resources are generated through public debt, the future generation pays the interest & principal and thus bears the burden. Thus in the case of public debt the burden falls on the prosperity. Payment of such projects out of taxation would be unjustified as it would put burden on the present generation while benefit would accrue to the future generations. In future when the time for payment of interest & principal comes, the government will have to tax people to pay money to bond holders. The future tax payers will pay future bond holders. It would merely imply diversion of funds from one set of people to another within the country. However, it will involve direct real burden as the classes of tax payers & bond holders are likely to be different. The burden of taxation is likely to be heavy on general mass while the benefit will accrue to small rich class of bond holders.

Whether the burden of public debt is borne by future generations or not may also depend upon many factors. The loan raised for productive purposes may not create burden on future generation since it will create assets and will add to productive capacity of the economy. This would not only increase income for present generation but also for the posterity. If it is used for unproductive purposes or emergencies like war it will shift burden on future generation.

Whether the burden will shift or not also depends on whether the present generation pays off debts by sacrificing current consumption or investment. If it is done by reducing current consumption, future generation will not bear the burden. But if it is done by reducing investment the future generation will bear the burden.

If loans are short term it can be repaid by the current generation. This will not shift the burden. In case of long term loans shifting of burden will depend upon whether the loan is self liquidating or deadweight.

It may be concluded from the above analysis that shifting of the burden of public debt from present to future generations may be possible, but it depends of various factors.