Public debt: meaning, types, burden and methods of repayment

Economic Theory and Public Finance · Unit IV · Topic 15 of 17 · 5 min read

Why governments borrow, the classification of public debt, its burden, and the methods of redemption from sinking funds to conversion and refunding.

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On this page

1. Meaning
2. Why governments borrow
3. Types of public debt
4. Burden of public debt
5. Methods of repayment (redemption)
6. Public debt and fiscal responsibility in India
How this is examined

Cases checked to exist. Read the judgment before quoting a holding.

Every case cited here has been checked to exist — the citation resolves and names the right parties. The propositions attributed to each case have not been verified line by line against the judgment. Case names link through to the full judgment: read it before quoting a holding in an examination answer, and never carry a proposition from notes into court on trust.

The examinable core. Public debt is borrowing by the government, internally or abroad. Give the reasons for borrowing, the types in pairs (internal and external, productive and unproductive, short and long-term, funded and unfunded, and so on), the burden, and the methods of repayment. “What is Public Debt? Explain the methods of repayment of public debt” was set in October 2023.

1. Meaning

Public debt is the total amount owed by the government to lenders inside and outside the country, arising from loans it has raised. Dalton: public debt arises when a public authority borrows. It is a capital receipt when raised and a liability to be repaid with interest.

In India, the Union borrows on the security of the Consolidated Fund of India within limits Parliament may fix by law (Article 292); States borrow within India under Article 293, and need the Union’s consent while any loan from the Union is outstanding. The RBI manages the market borrowing of both as their debt manager.

2. Why governments borrow

To cover a budget deficit when taxes are insufficient.
To finance development projects with long gestation (dams, railways, power).
To meet war and emergencies (natural disasters, pandemics).
To fight depression by spending idle savings (Keynesian functional finance).
To control inflation by absorbing surplus purchasing power.
To finance public enterprises.
To bridge temporary gaps between receipts and payments within a year.

3. Types of public debt

Internal and external. Internal debt is raised within the country from individuals, banks, insurance companies and the central bank; it is a transfer within the economy. External debt is borrowed from foreign governments, international institutions (World Bank, Asian Development Bank) and foreign markets; it brings in foreign exchange but must be repaid in it.
Productive (reproductive) and unproductive (dead-weight). Productive debt is spent on assets that yield income to repay it, such as railways and power projects. Unproductive debt is spent on war, relief or current consumption and leaves no asset; Dalton called it dead-weight debt.
Short-term, medium-term and long-term. Short-term debt (under a year) is mainly treasury bills, issued in India for 91, 182 and 364 days. Long-term debt is dated securities (government bonds) of five to forty years.
Funded and unfunded (floating). Funded debt is long-term, repayable after a long period or at the government’s option, often with a fund set aside for it. Unfunded or floating debt is short-term, repayable within a year.
Redeemable and irredeemable. Redeemable debt has a fixed date of repayment. Irredeemable debt has no such date; the government pays interest indefinitely (British consols).
Voluntary and compulsory. Most loans are voluntary; compulsory loans are forced on citizens, as with compulsory deposit schemes.
Marketable and non-marketable. Marketable debt (treasury bills, dated securities) is traded; non-marketable debt (small savings, provident funds, certain special securities) is not.

4. Burden of public debt

Internal debt. A.P. Lerner’s view: “we owe it to ourselves”, so there is no net burden on the nation as a whole. But there is a direct money burden of transfer from taxpayers to bondholders, which may be regressive if taxpayers are poorer than bondholders, and a real burden of disincentive from higher taxes to pay interest.
External debt. A real burden: goods and services must be exported to service it, lowering domestic consumption; failure risks a balance of payments crisis, as in India in 1991.
Burden on future generations. If borrowing finances consumption, future generations inherit the debt without assets. If it finances productive capital, they inherit the assets as well.
Crowding out of private investment through higher interest rates.
Debt trap: when interest payments are financed by fresh borrowing, debt grows faster than income.

5. Methods of repayment (redemption)

Sinking fund. Money is set aside every year from revenue into a fund which, with accumulated interest, is enough to repay the loan on maturity. Dalton regarded it as the most orderly method. In India most States maintain a Consolidated Sinking Fund with the RBI, into which they contribute a share of outstanding liabilities each year.
Conversion. An old loan carrying a high rate of interest is replaced by a new loan at a lower rate, reducing the interest burden. Goschen’s conversion of British consols in 1888 is the classic case. Possible only when market rates have fallen.
Refunding. Maturing bonds are repaid out of fresh borrowing (rolling over). It postpones repayment rather than achieving it.
Surplus budget. Revenue in excess of expenditure is used to retire debt.
Terminal annuities. The debt is repaid in equal annual instalments covering principal and interest, so it disappears at the end of the term.
Purchase of securities in the market (buy-back). When bond prices are low the government buys back its own securities. The RBI also conducts switches, exchanging short-dated securities for longer ones to smooth the repayment profile.
Capital levy. A one-time heavy tax on capital to wipe off debt, discussed after the First World War (Dalton supported it) but rarely used.
Additional taxation earmarked for repayment.
Repudiation. Refusal to repay. It destroys the credit of the State and is used only after revolutions (the Soviet repudiation of Tsarist debt in 1918).
Inflation reduces the real value of debt, but is an unfair and harmful way of reducing it.
Repayment of external debt requires export surpluses or foreign exchange reserves.

Keep the two halves apart. “Types” and “methods of repayment” are different lists. Funded debt is a type; a sinking fund is a method. Mixing them is the commonest error in this answer.

6. Public debt and fiscal responsibility in India

The Fiscal Responsibility and Budget Management Act, 2003 requires the Union to reduce its deficits and debt and to lay fiscal policy statements with the Budget. The N.K. Singh Committee (FRBM Review Committee, 2017) recommended using the debt-to-GDP ratio as the main anchor of fiscal policy, with a ceiling of 60 per cent for general government (Centre and States together). Deficits and their financing are treated in types of deficits and deficit financing.

How this is examined

As a 10-mark essay: “What is Public Debt? Explain the methods of repayment of public debt” (October 2023). The syllabus heading is “Public debt — types and its repayment”, so both halves can be asked together. Write the meaning with Articles 292 and 293, the types in pairs, and at least eight methods of redemption. A paragraph on burden is useful if the question says “critically”.

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