Public Debt - Classification Types of Public Debt Borrowing

What is Public Debt ? Meaning ↓

Public debt or public borrowing is considered to be an important source of income to the government. If revenue collected through taxes & other sources is not adequate to cover government expenditure government may resort to borrowing. Such borrowings become necessary more in times of financial crises & emergencies like war, droughts, etc.

Public debt may be raised internally or externally. Internal debt refers to public debt floated within the country; While external debt refers loans floated outside the country.

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The instrument of public debt take the form of government bonds or securities of various kinds. Such securities are drawn as a contract between the government & the lenders. By issuing securities the government raises a public loan & incurs a liability to repay both the principal & interest amount as per contract. In India, government issues treasury bills, post office savings certificates, National Saving Certificates as instrument of Public borrowings.

Classification / Types of Public Debt ↓

Government loans are of different kinds, they may differ in respect of time of repayment, the purpose, conditions of repayment, method of covering liability. Thus the debt may be classified into following types.

1. Productive and Unproductive debts

i. Productive debt :-

Public debt is said to be productive when it is raised for productive purposes and is used to add to the productive capacity of the economy.

As Dalton puts, productive debts are those which are fully covered by assets of equal or greater value.

If the borrowed money is invested in the construction of railways, irrigation projects, power generations, etc. It adds to the productive capacity of the economy and also provides a continuous flow of income to the government. The interest and principal amount is generally paid out of income earned by the government from these projects.

Productive loans are self liquidating. Generally, such loans should be repaid within the lifetime of property. Thus, such loans does not cause any net burden on the
community.

ii. Unproductive debt :-

Unproductive debts are those which do not add to the productive capacity of the economy.

Unproductive debts are not necessarily self liquidating. The interest and the principal amount may have to be paid from other sources of revenue, generally from taxation, and therefore, such debts are a burden on the community.

Public debt used for war, famine relief, social services, etc. is considered as unproductive debt.

However, such expenditures are not always bad because they may lead to well being of the community. But such loans are a net burden on the community since they are repaid generally through additional taxes.

2. Voluntary and Compulsory Debt ↓

i. Voluntary debt :-

These loans are provided by the members of the public on voluntary basis. Most of the loans obtained by the government are voluntary in nature. The voluntary debt may be obtained in the form of market loans, bonds, etc.

The Government makes an announcement in the media to obtain such loans. The rate of interest is normally higher than that of compulsory debt, in order to induce the people to provide loans to the government.

ii. Compulsory debt :-

A compulsory debt is a rare phenomenon in modern public finance unless there are some special circumstances like war or crisis. The rate of interest on such loans may be low. Considering the compulsion aspect; these loans are similar to tax, the only difference is that loans are rapid but tax is not.

In India, compulsory deposit scheme is an example of compulsory debt.

3. Internal and External Debt ↓

i. Internal debt :-

The government borrows funds from internal and external sources. Internal debt refers to the funds borrowed by the government from various sources within the country.

Over the years, the internal debt of the Central Government of India has increased from Rs.1.54 lakh crore in 1990-91 to Rs.13.4 lakh crore in 2005-06.

The various internal sources from which the government borrows include individuals, banks, business firms, and others. The various instruments of internal debt include market loans, bonds, treasury bills, ways and means advances, etc.

Internal debt is repayable only in domestic currency. It imply a redistribution of income and wealth within the country & therefore it has no direct money burden.

ii. External debt :-

External loans are raised from foreign countries or international institutions. These loans are repayable in foreign currencies. External loans help to take up various developmental programmes in developing and underdeveloped countries. These loans are usually voluntary.

An external loan involves, initially a transfer of resources from foreign countries to the domestic country but when interest and principal amount are being repaid a transfer of resources takes place in the reverse direction.

4. Short-Term, Medium-Term & Long-Term Debts ↓

i. Short-Term debt :-

Short term debt matures within a duration of 3 to 9 months. Generally, rate of interest is low. For instance, in India, Treasury Bills of 91 days and 182 days are examples of short term debts incurred to cover temporary shortages of funds. The treasury bills of government of India, which usually have a maturity period of 90 days, are the best examples of short term loans. Interest rates are generally low on such loans.

ii. Long-Term debt :-

Long term debt has a maturity period of ten years or more. Generally the rate of interest is high. Such loans are raised for developmental programmes and to meet other long term needs of public authorities.

iii. Medium-Term debt :-

The Government may borrow funds for medium term needs. These funds can be used for development and non development activities. The period of medium term debt is normally for a period above one year and up to 5 years. One of the main forms of medium term debt is by way of market loans.

5. Redeemable and Irredeemable Debts ↓

i. Redeemable debt :-

The debt which the government promises to pay off at some future date are called redeemable debts. Most of the debt is redeemable in nature. There is certain maturity period of the debt. The government has to make arrangement to repay the principal & the interest on the due date.

ii. Irredeemable debt :-

Such debt has no maturity period. In this case, the government may pay the interest regularly, but the repayment date of the principal amount is not fixed. Irredeemable debt is also called as perpetual debt. Normally, the government does not resort to such borrowings.

6. Funded and Unfunded Debts ↓

i. Funded debt :-

Funded debt is repayable after a long period of time. The period may be 30 years or more. Funded debt has an obligation to pay fixed sum of interest subject to an option to the government to repay the principal. The government may repay it even before the maturity if market conditions are favourable. Funded debt is Undertaken for meeting more permanent needs, say building up economic & industrial infrastructure. The government usually establishes a separate fund to repay this debt. Money is credited by the government into this fund & debt is repaid on maturity out of this fund.

ii. Unfunded debt :-

Unfunded debts are incurred to meet temporary needs of the governments. In such debts duration is comparatively short say a year. The rate of interest on unfunded debt is very low. Unfunded debt has an obligation to pay at due date with interest.