Chapter8: Public Debt BBA 8 th Semester Bakhtar University

Introduction The ultimate aim of “Public Finance”, unlike business finance, is the maximum social welfare.  Govt starts from public expenditures and afterwards make plan for public revenues.  The functions of govt went on increasing with the passage of time after 19 th century..  More functions resulted in more public expenditures.

Meaning of Public Debt The term ‘public debt’ refers to the borrowings undertaken by public bodies. In broader sense it includes all sorts of obligations of a govt and in narrow sense it includes only the loans raised by the govt externally.  The govt may obtain loans from banks, business organizations and even individuals.

Cont… Public debt is normally in the form of bonds or treasury bills if the loan has been acquired for a short period. The maturity is normally less than one year at the time of issue and consists of treasury bills and borrowings from the banking sector. Then there is permanent or funded debt whose maturity is of more than one year.

Cont… Some obligations are called as floating debt which do not have any specific maturity but some part of it may be payable according to predetermined terms and conditions.  Include provident funds, small savings, reserve funds and deposits etc.

Causes of Public Debt Collecting revenue and spending it. It is not always possible that the receipt may exactly match the expenses.  To meet deficit the govt raises debts. Unforeseen and sudden developments, the govt is forced to borrow.  Like war, floods, earthquakes etc.

Cont… To bring about economic stability.  Intervention of the govt in economic affairs. For accelerating the process of capital formation and economic growth.  The govt has to borrow and invest funds in various development projects.

Classification of Public Debt Various types of loans because of number of factors like purpose of the loan, period, the terms and conditions etc.  1. Internal and External  2. Productive and Unproductive  3. Redeemable and Irredeemable  4. Funded and Unfunded  5. Voluntary and Compulsory

Internal and External Internal: Raised within the country  Does not affect the economy of a country because resources of the country are transferred from people to the govt. External: Raised in a foreign country either from govt or foreign nationals or institutions.  Affects the economy because their repayment requires the transfer of a part of national income abroad.

Productive and Unproductive Productive: Used for creating income yielding tangible assets so that it is made self-liquidating.  Construction of railways, generation of power, establishment and expansion of heavy industries etc. Unproductive: Used for purposes which do not yield any income.  Financing a war, floods etc.

Redeemable and Irredeemable Redeemable: The debts for which the govt is committed to repay at an appointed date.  The govt makes arrangement for payment of interest and principal amount..it means that the interest against such loan is paid at the determined time period while principle amount is paid once the time period of the debt is over.

Irredeemable: No such commitment from the govt.  The govt pays the interest rate and no commitment for the repayment of principal

Funded and Unfunded Funded Debts: Which are redeemable after a year or so.Funded debts is a public loan for whose repayment govt sets up a separate fund. Every year govt deposits a specific amount in this fund. When the time period of the loan is matured, its repayment is made by govt through this fund..

Unfunded Debts: Repayable within a year. On the other hand, the unfunded debt is the debt for whose repayment govt does not establish any specific fund. The interest against such loan is paid through the daily routine income of the govt.Whenever the govt has to pay to pay the principle amount it raises new debt from the market.

Voluntary and Compulsory Broadly speaking, all public debts are voluntary in nature.  Individuals and institutions are invited to purchase govt securities and bonds.  The govt does not put pressure on the people for purchase of its bonds etc. But during emergency like war or rising prices the govt may even force people to buy govt securities.

The Effects of Public Debt on the Economy Does not substantially affect the resource allocation but affects national income, investment and employment opportunities.  When spent on the purchase of capital goods, production increases, the national income rises which increases investment and level of employment.

Cont… If not used for the developmental purposes, it increases the govt expenditure in a sense that the govt additionally has to pay the interest expense as well.