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Subject ECONOMICS

Paper No and Title 9: Public Finance and Policy in India

Module No and Title 28: Trends in Public Debt

Module Tag ECO_P9_M28

ECONOMICS PAPER No. 9: Public Finance and Policy in India

MODULE No. 28: Trends in Public Debt
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TABLE OF CONTENTS
1. Learning Outcomes
2. Meaning of Public debt
3. Classification of public debt
4. Sources of public debt
5. Trends in Public debt
6. Burden of Public Debt
7. Methods to Reduce the Burden of Public Debt
8. Summary

ECONOMICS PAPER No. 9: Public Finance and Policy in India

MODULE No. 28: Trends in Public Debt
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1. Learning Outcomes

 After studying this module, you shall be able to

 Understand the meaning and classification of public debt
 Learn about the sources of public debt
 Analyse the trends of public debt
 Comprehend the burden that public debt creates
 Recognize the methods to reduce the burden of public debt

2. Meaning of public debt

Debt of the government is known as Public debt. It refers to the borrowings of the
govt from individuals, organisations, financial institutions and foreign countries. The
govt resorts to borrowings when the revenue collected through taxes and other
sources is not sufficient to cover expenditures. Hence, public debt is one of the tools
to cover deficits in the budget. In short, public debt refers to “compulsions of govts,
particularly those evinced by securities, to pay sums to the holders at some future
date”. These borrowed funds are utilised for development and non-development
activities. Additionally, debt is a stock, which is to be paid at the end of a year.

Local, state and federal govts all borrow money to pay for large projects, such as new
govt buildings, schools or for funding, etc. This forms the public debt, because, it is
money that public organisations be obligated to pay for which the burden of paying
rests with taxpayers ultimately. Borrowing is a flow variable, in a year. This debt can
take the form of many types of loans to the govt. Moreover, borrowing adjusted with
servicing of debt (return of debt and interest payment) is also sometimes mentioned
as net borrowing
Over the years, the public debt of Central Govt and that of State Govt has increased
substantially.

3. Classification of public debt

Government loans are of different kinds and may differ with respect to time of
repayment, the purpose, conditions of repayment, method of covering liability etc.
The various kinds of public debt are:

ECONOMICS PAPER No. 9: Public Finance and Policy in India

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I. Internal and External Debt

a) Internal Debt
Borrowings of the govt within the country or public loans floated within the country
are called internal debt. The numerous internal sources from which the govt borrows
include individuals, banks, business firms and others. Market loans, bonds, treasury
bills, and ways & means advances, etc. are examples of instruments of internal debt.
An internal debt may be either voluntary or compulsory. Internal debt implies a
redistribution of income and wealth within the nation and it, therefore, has no direct
money burden.

b) External Debt:-

Borrowings of the govt, from abroad, is known as external debt. Multilateral

borrowings, bilateral borrowings, loans from World Bank, Asian Development Bank,
etc. form the external debt. These external loans help to engage in a variety of
developmental programmes in both developing and underdeveloped countries. These
loans are usually voluntary. Initially, the external loan involves a relocation of
resources from foreign countries to domestic country, but when interest and principal
amount are repaid, there is transfer of resources in the reverse direction.

II. Short Term, medium Term and Long - Term Debt:-

a) Short-Term Debt

Loans for a period of less than one year are known as short - term debt. For example:
the treasury bills are issued to raise funds for a period of 91 days and 182 days by the
Reserve Bank of India (RBI), on behalf of the govt. Such loans have a very low rates
of interest. Hence, to cover the temporary deficits in budget short - term loans are
taken.

b) Medium-Term Debt

A medium term debt is normally ranges 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. The
interest rates on medium term loans are reasonable. These are preferred to meet
expenditure on health, education, relief work etc.

c) Long-Term Debt

ECONOMICS PAPER No. 9: Public Finance and Policy in India

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Loans exceeding a period of 5 years are long - term debt. These are mainly in form of
issue of bonds. Generally, these long-term debts are required for the purpose of
retreatment of debts and also for development projects.

III. Productive and Unproductive Debt

a) Productive Debt

A productive debt is raised for productive purposes and is used to add to the
productive capacity of the nation. These debts are long - term in nature and are
utilised on development activities such as infrastructure development like roadways,
railways, airports, seaports, telecommunications, power generation etc. These
infrastructural development leads to revenue generations which are then used to pay
the principal amount and interest of the productive debts, i.e.; these debts are self-
liquidating in nature.

b) Unproductive Debt

An unproductive debt is one, which does not yield any income and does not add to
the productive assets of the country. Examples include the debts utilised for transfer
payments in form of subsidies such as old age pension, special incentives to weaker
sections etc. Moreover, unproductive debts are a net burden on the economy and the
govt has to resort to additional taxation for its servicing and repayment.

IV. Compulsory and Voluntary Debt

a) Compulsory Debt

Normally, the govt does not obtain loans through compulsory means and can obtain
such loans from banks, financial institutions and large corporate firms at the time of
war or major disaster, i.e., only when it is not possible to obtain voluntary debt.
Example includes the Compulsory Deposit Scheme in India.

b) Voluntary Debt

Generally, public loans such as market loans, bonds etc. are voluntary in nature and
constitute voluntary debt. People invest in voluntary debts for liquidity and
profitability. The rate of interest of voluntary debt is normally higher than that of
compulsory debt.

V. Redeemable and Irredeemable Debt

a) Redeemable Debt

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Loans which the govt promises to pay off at some date in future are called
redeemable debts. These loans have a fixed maturity period and the govt has to make
arrangements to repay the principal and interest on that due date. These loans are
repaid out of the revenue receipts of the govt or by raising further loans.

b) Irredeemable Debt

Loans for which no promises are made by the govt regarding the exact date of its
repayment are called irredeemable debts. Such debts have no maturity period but the
govt may pay interest regularly. Normally, govt does not resort to such borrowings.

4. Sources of public debt

The sub-components of internal and external debt are:

I. Internal Debt
a) Market loans
b) Bonds
c) Treasury bills
d) Special securities issued by RBI
e) Ways and Mean Advances ( To meet the short term expenditure)
f) Special floating and other loans (These represents India's contribution towards
share capital of international financial institutions like IMF, World Bank,
International Development Agency and so on. )
g) Securities against small savings

II. External Debt

a. Bilateral borrowings
b. Multilateral borrowings
c. Loans from international organizations like IMF, World Bank etc.

III. Other Internal Liabilities:

a. Small savings (Relief Bonds 1987, Kisan Vikas Patras, Indira Vikas Patras, etc.)
b. Provident Funds
c. Reserve funds and deposits
d. Other accounts (Postal Insurance & Life Annuity Fund etc.)

I. INTERNAL DEBT

The internal debt forms a major part of public debt of the central Government of
India (GOI).
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The following are the various components of internal debt.

a. Market Loans
These have a maturity period of 12 months or more and are generally interest bearing.
The govt issues such loans almost every year. These loans are raised in the open
market by sale of securities or otherwise. Market loans and open market operations
require identification of ‘real’ stakeholders.

b. Bonds
The govt also obtains funds through the issue of bonds such as National Rural
Development Bonds. These provide medium-term to long-term funds to the govt and
the maturity period ranges from 3 years to 10 years period.

c. Treasury Bills
A major source of short-term funds for the govt is obtained by issue of treasury bills.
At present, govt issues 91 days and 364 days treasury bills. The treasury bills are
purchased by commercial banks and others.

d. Special Floating and Other Loans

These are representation of India's contribution towards share capital of international
financial institutions like International Monetary Fund (IMF), the World Bank, and
International Development Agency and so on. These funds are non-negotiable and
non-interest bearing securities. The GOI is liable to pay the amount at the call of
these institutions. Accordingly, it is a short-term debt upon the GOI.

e. Special securities issued by RBI

The govt can obtain temporary loans for a period of maximum 12 months from the
RBI by issue of special securities, which are non-negotiable and non-interest bearing.
Such securities provide short-term funds to the govt.

f. Ways and Mean Advances

The GOI obtains ways and means advances from the RBI to meet its short period
expenditure. These debts are purely temporary in nature and are usually repaid within
three months.

g. Securities against small savings

Since 1999-2000, under the new accounting system, the national small savings (NSS)
have been converted into the central govt securities. Consequently, there has been a
sharp increase in internal debt & a corresponding decline in small savings.

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II. EXTERNAL DEBT

External debt refers to the liabilities of the Indian Govt, both central and state, public
sector, private sector and financial institutions to overseas parties. The GOI, in the
past, has raised foreign loans from U.S.A, U.K, France, U.S.S.R, Japan, etc. The
external debt comprises of:

a. Multilateral borrowings
A Multilateral Loan is a kind of loan that involves a number of lenders and a single
borrower. The lenders are most financial institutions or banks. Multilateral loan is a
common type of loan that is taken countrywide.

b. Bilateral borrowings

A Bilateral Loan is a kind of loan that involves a single borrower and a lender. The
lenders are usually banks or other financial institutions.

c. Loans from IMF, World Bank, etc.

III. OTHER INTERNAL LIABILITIES

The govt does not include these liabilities under Public Debt. However, the govt is
liable to make repayment of these liabilities.

a. Small Savings

In recent years, small savings have increased in the economy due to rising money
income.
A number of small savings instruments were launched by the GOI recently. These
include 9% Relief Bonds 1987, Kisan Vikas Patras, Indira Vikas Patras, etc.

b. Provident Funds

Provident funds are divided into 2 categories:-

1. Employee Provident Funds (which are meant for employees)
2. Public Provident Funds (which are meant for general public)

Deposits in Public Provident Funds are repayable only after 15 years.

c. Other accounts

ECONOMICS PAPER No. 9: Public Finance and Policy in India

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Other accounts include Postal Insurance and Life Annuity Fund, Income Tax Annuity
Deposit, Borrowings against Compulsory Deposits, Special Deposit of Non-
Government Provident Fund and Outstanding Amount.

d. Reserve Funds and Deposits

These are divided into two categories:-

1. Interest bearings and
2. Non-interest bearings.

These include depreciation and reserve funds of Railways, Deposits of Local Funds,
Departmental and Judicial Deposits, Department of Post, Telecommunication, Civil
Deposits, etc.

5. Trends of public debt

Public debt in India has been growing at an alarming rate for past few decades. India
faces difficulty in the financing of economic development because of the under
developed nature of the economy and institutional credit deficiencies. Hence, the govt
has to play an important role in stimulating the rate of capital formation and in
promoting the economic development of the economy. Thus, public debt is used by
the govt as a means for mobilising the resources.

TABLE 1:
PUBLIC DEBT OF THE CENTRAL GOVERNMENT OF INDIA

Internal Total Public

External Debt
Liabilities Debt
Year As a per As a per
(Rs. (Rs.
cent of cent of (Rs. crore)
crore) crore)
total total
1980-81 79.86
public 44817 20.14
public 11298 56115
1990-91 89.97
debt 28303 10.03
debt 31525 314558
2000-01 94.35 3
11025 5.65 65945 1168541
2010- 94.41 96 5.59 2898799
11 27367 16204
The above tables indicate the 54 growth of the public 5 debt of the GOI.
The Central govt's debt has increased by over 51 times between 1980-81 and 2010-
11, from Rs. 56,115 crores to Rs. 28,98,799 crores.

The main reason for increase in internal public debt in India during the above said

ECONOMICS PAPER No. 9: Public Finance and Policy in India

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period was the requirement of funds for financing various developmental

programmes, as both tax and non-tax revenues were inadequate to finance the govt
expenditures. The external public debt in India also increased significantly, as it was
utilised to make import payments and to solve the balance of payment problems.

Out of the total public debts, the internal liabilities share increased from 79.6 per cent
in 1980-81 to about 90 percent in 1990-91. It went up further to 94.3 percent in 2000-
01, and has floated around that range in 2010-11, as well. On the other hand, the
external debt as a percent of total debt has shown a decline from 20 per cent in 1980-
81 to 10 percent in 1990-91 and then it fell down to about 5.6 percent in 2010-11
(Table 1).

TABLE 2:
TOTAL PUBLIC DEBT OF THE CENTRAL GOVERNMENT AS A PER
CENT OF GDP

Internal Liabilities

Internal Other Total Externa Total

Year Debt Liabilities Internal l Debt Public
Liabilities Debt

1980-81 21.23 9.60 30.83 7.77 38.60

1990-91 27.04 22.65 49.69 5.53 55.22
2000-01 38.23 14.21 52.44 3.13 55.57
2010-11 39.50 14.90 54.40 2.30 56.70
Source: Economic Surveys, various issues

In 1980-81, the total outstanding debt of the Central Govt was 38.6 percent of GDP.
Out of which, the Internal debt was 30.8 percent and the External debt was 7.7 per
cent. The total debt went up to about 55 percent in the next decade. It remained
almost the same, even in the year 2000-01 and then it went up further to 56.7 percent
in 2010-11. The internal debt jumped from about 50 percent in 1990-91 to 52 percent
in 2000-01 and further to 54.4 percent in 2010-11. The external debt, on the other
hand, declined from 5.5 per cent to 3.1 percent and then to 2.3 percent of GDP in the
respective years.

The tremendous rise in total public debt in India during 1980-81 to 2010-11 provides
an alarming signal to the Indian economy. There is an urgent need to manage public
debt in India. However, we cannot ignore the fact that public debt is essential for the

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functioning of the govt and the economy. According to Global Development Finance
Report 2009, India is ranked as 7th largest debtor country in the world.
However, the govt has now withdrawn from investment and foreign direct investment
(FDI) and foreign portfolio investment (FPI) can, in general, be a substitute for
borrowings.

6. Burden of public debt

Public debt puts a burden on the economy on account of repayment of principal
amount and interest. Both internal as well as external debts carry a burden on the
economy.

 To repay public debt, the govt may increase taxes or reduce public expenditure.
This leads to increase in tax burden, which adversely affects the growth and
development of India. Higher taxes may demotivate the tax payers to work hard for
higher incomes. This may have an adverse effect on productive activities in the
country.

 The servicing of internal debt involves transfer of income from younger

generations to older generations and from active to inactive enterprises.

 Internal debt may indirectly affect private investment. It involves huge interest
payments. Therefore, lesser funds are available with the govt for development
activities such as infrastructure. Lack of infrastructure development discourages
private investment, which affects economic growth.

 Higher interest burden also leads to availability of lower funds towards

activities for social development such as health, education, family welfare, etc.

 Excessive govt borrowings leads to loss of liquidity in the economy. It forces

the interest rates to go up and public investment is crowded out as there is less
liquidity in the economy and the interest rates are too high. The investment suffered
and there is deceleration in the growth.

 Though, external debt is initially beneficial for the country as it increases the
resources availability of the country, but its repayment and servicing creates a
monetary load on the debtor country. The degree of load depends upon the rate of
interest and loan amount.

 There is also a loss of economic welfare i.e. increased taxation leads to

sacrifice of the consumption of goods and services.

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 There is also a problem of Debt Trap as certain countries borrow heavily from
external sources. Quite often, these funds are utilised for non-development and
unproductive purposes. Every so often, countries which are highly indebted borrow
funds to repay its earlier debts. These heavy borrowings to repay earlier debts put
already highly indebted countries in an external debt trap.

Counties affected by 2010 crisis are European nations such as Portugal, Italy, Spain
and Ireland. Also, Dubai debt crisis did have an effect on International community.

The paying off the external debt puts a liability on foreign exchange reserves of a
nation. International crisis, often lead to a contagion (spreading) effect. This means, if
one country is affected, the other countries are also affected. Internal debt is
considered less burdensome as compared to external debt.

7. Methods to reduce the burden of public debt

The steps that can be taken to reduce the public debt are:

 The revenue expenditures, like govt’s wasteful expenditures and subsidies need
to be reduced so that they can be met out of the revenue receipts of the govt. This
way the govt's net borrowings are used only for productive purposes.

 There is a need to encourage more foreign investment.

 Disinvestment of sick public sector units.

 There is a need for the proper monitoring of public expenditures. Moreover, a

special department should be set up for the same.

 There is an urgent need for creating consolidated sinking fund (CSF) to break
the vicious cycle of burden of debt and repayment.

ECONOMICS PAPER No. 9: Public Finance and Policy in India

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8. Summary

 Public debt refers to the govt debt. It refers to govt borrowings from individuals,
financial institutions, organisations and foreign countries.

 Internal debt is the public debt available within the country; while external debt
refers loans outside the country. External debt has two components: public and
private. Public debt is therefore (i) internal debt + (ii) external public debt. Internal
debt is always understood as internal public debt.

 Loans ranging for a period of less than 1 year are short - term debt, medium term
debt is normally for a period above one year and up to 5 years and loans for a period
beyond 5 years are long - term debt.

 The debts, which are productive for the economy are known as productive debts,
similarly the debts, which do not benefit the economy, are unproductive.

 Usually, the debts taken by the govt are voluntary in nature and are known as
voluntary debts. Whereas in times of wars or crisis there is a mandatory loan taken
by the govt known as compulsory debt.

 The debts, which the govt promises to pay at a future date are known as redeemable
and irredeemable is vice-versa. It does not have a maturity period.

 The core reason for a significant increase in internal public debt in India during
1980-2010 was the requirement of funds for financing numerous developmental
programmes as both tax and non-tax revenues were very inadequate to finance them.

 The external public debt in India increased significantly during 1980-2010, as it was
utilized to make import payments & solve balance of payment problems.

 Public debt, both internal and external, places a burden on the nation because of
paying of principal amount and interest.

 To reduce public debt there is a need to reduce the revenue expenditures. Increased
foreign investments, disinvestments of the sick units in the public sector, proper
monitoring of public expenditures and creation of consolidated sinking fund (CSF)
are the other methods that can be used for reducing debt.

ECONOMICS PAPER No. 9: Public Finance and Policy in India

MODULE No. 28: Trends in Public Debt