PUBLIC DEBT

Written by:

1. ELEMIDE AYODEJI OLUWASEUN
2. AYODELE KEHINDE JOHN
3. DEBORH U. OMOAREGBA
4. BASHIRAT AJIBADE
5. BAMIDELE OLUSEGUN THOMAS

Introduction:

Governments borrow to meet her fiscal and monetary needs, as when estimated revenue falls below or is exceeded by estimated expenditures. Many national governments incur such debt because of an unwillingness to limit spending or increase taxes for fear of the political consequences.The largest public debts are incurred to meet emergencies, such as war debts that arise when it is difficult to finance the extended activities of the government by new or increased taxes, or when the government must borrow abroad to finance the war effort. In 2020, the value of government debt worldwide was $87.4 US trillion, or 99% measured as a share of GDP. Government debt accounted for almost 40% of all debt (which includes corporate and household debt), the highest share since the 1960s. The rise in government debt since 207 is largely attributable to the global financial crisis of 2007-2009, and the COVID-19 pandemic. The ability of government to issue debt has been central to state formation and to state building as well linked to the rise of democracy, private financial markets, and modern economic growth. DEFINITION OF PUBLIC DEBT “The debt is the form of promises by the Treasury to pay to the holders of these promises a principal sum and in most instances interest on the principal. Borrowing is resorted to in order to provide funds for financing a current deficit.”– Philip E.Taylor “The receipt from the sale of financial instruments by the government to individuals or firms in the private sector, to induce the private sector to release manpower and real resources and to finance the purchase of these resources or to make welfare payments or subsidies”.–Carl S.Shoup Public debt, also referred to as government debt, represents the total outstanding debt (bonds and other securities) of a country’s central government. It is often expressed as a ratio of Gross Domestic Product (GDP). Public debt is an important source of resources for a government to finance public spending and fill holes in the budget. Public debt as a percentage of GDP is usually used as an indicator of the ability of a government to meet its future obligations. According to Prof. J.K. Mehta, “Public debt is comparatively modern incident and it would come in practical form with the development of democratic governments”. In 2020, the value of government debt worldwide was $87.4 US trillion, or 99% measured as a share of GDP. Government debt accounted for almost 40% of all debt (which includes corporate and household debt), the highest share since the 1960s. The rise in government debt since 2007 is largely attributable to the global financial crisis of 2007-2009, and the COVID-19 pandemic. The ability of government to issue debt has been central to state formation and to state building. Public debt has been linked to the rise of democracy, private financial markets, and modern economic growth. Thus, Public debt is how much a country owes to lenders outside of itself. These can include individuals, businesses, and even other governments. The term “public debt” is often used interchangeably with the term sovereign debt. Regardless of what it’s called, public debt is the accumulation of annual budget deficits. It’s the result of years of government leaders spending more than they take in via tax revenues. Key Takeaways • Public debt is the amount of money that a government owes to outside debtors. • Public debt allows governments to raise funds to grow their economies or pay for services. • Politicians prefer to raise public debt rather than raise taxes. • Public debt is part of the national debt and when the national debt reaches 77% or more of gross domestic product (GDP) the debt begins to slow growth. Classification of Public Debt Public debts’ classificationsare as follows: – 1. Internal and External Debt 2. Productive and Unproductive 3. Redeemable and Irredeemable Loans 4. Funded and Unfunded Debt 5. Voluntary and Compulsory 6. Short, Medium, Long-Term Loans Internal and External Debt When the government raises revenue by borrowing from within the country, it is called internal debt. And where government borrows from the rest of the world, it is the case of external debt. It needs not to confuse public debt with gross external debt. That’s the amount owed to foreign investors by both the government and the private sector. Public debt impacts external debt, but they are not one and the same. If interest rates go up on the public debt, they will also rise for all private debt. That’s one reason most businesses pressure governments to keep public debt within a reasonable range. Productive and Unproductive Productive and Unproductive (Purpose of loans): Loans on Projects yielding income (Construction of plants, railways, power schemes, etc.) are called productive debt. Loans on loan non-income yielding projects are called unproductive loans (war, famine relief, etc.) Redeemable and Irredeemable Loans Redeemable and Irredeemable loans (Promise to repay): Redeemable debts refer to the loan which the government promises to pay off (principal plus interest) at some future date. Irredeemable debts are those, the principal amounts of which are never returned by the government but pays interest regularly. Funded and Unfunded Debt Funded and unfunded debt (Provision for repayment): Funded debt is long-term or ‘definite period’ debt. A proper agreement and terms and conditions of repayment with the percentage of interest payable are declared. They are used for the creation of permanent assets. Unfunded debt is for a short term and for an indefinite period. It is paid through the income received from other sources. These are used for meeting current needs. Voluntary and Compulsory Voluntary and compulsory (On the basis of legal enhancement): Voluntary debt is the debt that is paid by any legal enforcement. Whereas compulsory debt is legally forced in nature. Here people have no option but to repay the debt. Short, Medium, Long-Term Loans Short, Medium, Long-term loan (Time duration): Short term loans are usually incurred for a period varying from three months to one year. Usually, governments get such loans from the central bank by using treasury bills. These loans are calls ‘ways and means advances. Medium Term loans are those which are obtained for more than one year but less than ten years. Methods of Repayment of Debt The methods of repayment of public debts are highlighted thus: 1. Repudiation 2. Refunding 3. Conversion of Loans 4. Sinking Fund 5. Capital Levy 6. Surplus Budget 7. Buying up Loans Repudiation It means refusal to pay a debt by governments. This method was followed by the USA after the civil war and by the USSR after the 1917 Revolution. This method is undesirable and has not been used recently anywhere in the world. Repudiation shakes the confidence of the people in public debt and many provoke retaliation from creditor countries. Refunding Refunding is the process of replacing maturing securities with new securities. In some cases, the bonds may be redeemed before the maturing date when the government intends to rearrange the maturity of outstanding debts or when the current rate of interest is low. Generally, short-term borrowings are made in anticipation of tax collections for meeting current expenditure. However, the excessive burden of new expenditure does not permit the retirement of the debt by means of revenue newly raised or by means of long-term borrowing.Thus, there is the necessity of refunding the loans by old lenders and renewing the loans at a lower rate of interest for future periods. The drawback of this method is that the government is tempted to postpone its obligation of debt redemption. This leads to a continuous increase in the burden of public debt in the future. Conversion of Loans It is a special type of refund. Conversion of existing securities into new securities before maturity. It is generally resorted to reducing the burden of debt by converting high-interest loans into low-interest loans. According to Professor Dalton, the conversion does not reduce the burden of public debt on the state; because a reduction in interest rates reduces the ability of the creditors to pay taxes which may mean a loss of income to the government thereby reducing its capacity to repay loans. Sinking Fund A sinking fund is a special fund created for the repayment of public debt. There is a theoretical justification for creating this fund because it imposes a requirement on the government to pay the old debts regularly. According to this method, the government sets aside a certain amount out of the budget every year for this fund. The balances in the funds are also invested and the interest accruing on them is also credited to the fund. The sinking fund is of two types: 1. Certain sinking fund here, the governments credit a fixed sum of money annually. 2. Uncertain sinking fund the amount is credited when government secures a surplus in the budget. The one danger of this method is that the government may not wait till the end of the period of maturity and utilize the fund for some other purpose than the one for which the fund was created originally. The practice of sinking funds inspires confidence among lenders and the enhancement of the creditworthiness of governments. Capital Levy Capital levy is a special type of “once for all” tax on capital imposed to repay war debts. All capital goods are taxed above a minimum level of assets possessed by residents of the country. Simply, a capital levy refers to a very heavy tax on property and wealth. This tax was levied immediately after the First World War. This method has been advocated by economists like David Ricardo, Pigou, and Dalton. Professor Dalton has suggested that capital levy is a method of debt redemption with the least real burden on society. It is useful on account of its deflationary character. Surplus Budget Quite often, the surplus budget may be used to clear the public debt. But in recent times due to the ever-increasing public expenditure, a surplus budget is a rare phenomenon. Buying up Loans Buying up Loans: Governments redeems debt by buying up loans from the market. When Is Public Debt Good? In the short run, public debt is a good way for countries to get extra funds to invest in their economic growth. Public debt is a safe way for people in other countries to invest in another country’s growth by buying government bonds. This is much safer than foreign direct investment. That’s when people from other countries purchase at least a 10% interest in the country’s companies, businesses, or real estate. It’s also less risky than investing in the country’s public companies via its stock market. Public debt is attractive to risk-averse investors since it is backed by the government itself. When used correctly, public debt can improve the standard of living in a country. It allows the government to build new roads and bridges, improve education and job training, and provide pensions. This encourages people to spend more now instead of saving for retirement. This spending further boosts economic growth. When Is Public Debt Bad? Governments tend to take on too much debt because the benefits make them popular with voters. Increasing the debt allows government leaders to increase spending without raising taxes. Investors usually measure the level of risk by comparing debt to a country’s total economic output, which is measured by GDP. The debt-to-GDP ratio gives an indication of how likely the country is to pay off its debt. Investors usually don’t become concerned until the debt-to-GDP ratio reaches a critical level. The World Bank has said the tipping point is 77% or more. When debt approaches a critical level, investors usually start demanding a higher interest rate. They want more return for the greater risk. If the country keeps spending, then its bonds may receive a lower credit rating. This indicates how likely it is that the country will default on its debt. As interest rates rise, it becomes more expensive for a country to refinance its existing debt. In time, income has to go toward debt repayment, and less toward government services. Much like what occurred in Europe, a scenario like this could lead to a sovereign debt crisis. In the long run, public debt that’s too large causes investors to drive up interest rates in return for the increased risk of default. That makes the components of economic expansion, such as housing, business growth, and auto loans, more expensive. To avoid this burden, governments need to carefully find that sweet spot of public debt. It must be large enough to drive economic growth but small enough to keep interest rates low. Measuring government debt Government debt is typically measured as the gross debt of the general government sector that is in the form of liabilities that are debt instruments.  A debt instrument is a financial claim that requires payment of interest and/or principal by the debtor to the creditor in the future. Examples include debt securities (such as bonds and bills), loans, and government employee pension obligations. International comparisons usually focus on general government debt because the level of government responsible for programs (for example, health care) differs across countries and the general government comprises central, states, constituencies, local governments, wards and social security funds.  The debt of public corporations (such as post offices that provide goods or services on a market basis) is not included in general government debt, following the International Monetary Fund’s Government Finance Statistics Manual 2014 (GFSM), which describes recommended methodologies for compiling debt statistics to ensure international comparability. The gross debt of the general government sector is the total liabilities that are debt instruments. An alternative debt measure is net debt, which is gross debt minus financial assets in the form of debt instruments.Net debt estimates are not always available since some government assets may be difficult to value, such as loans made at concessional rates. Debt can be measured at market value or nominal value. As a general rule, the GFSM says debt should be valued at market value, the value at which the asset could be exchanged for cash.  However, the nominal value is useful for a debt-issuing government, as it is the amount that the debtor owes to the creditor. If market and nominal values are not available, face value (the undiscounted amount of principal to be repaid at maturity)is used. A country’s general government debt-to-GDP ratio is an indicator of its debt burden since GDPmeasures the value of goods and services produced by an economy during a period (usually a year). As well, debt measured as a percentage of GDP facilitates comparisons across countries of different size. The Organization for Economic Co-operation and Development (OECD) views the general government debt-to-GDP ratio as a key indicator of the sustainability of government finance. Why Do Governments Accumulate Debt? An important reason government borrow is to act as an economic “shock absorber.” For example, deficit financing can be used to maintain government services during a recession when tax revenues fall and expenses rise (for unemployment benefits, say). Government debt created to cover costs from major shock events can be particularly beneficial. Such events would include a major war, like World War II; a public health emergency like the COVID-19 pandemic; or a severe economic downturn as with the financial crisis of 2007-2008. In the absence of debt financing, when revenues decline during a downturn, a government would need to raise taxes or reduce spending, which would exacerbate the negative event. While government borrowing may be desirable at times, a “deficits bias” can arise when there is disagreement among groups in society over government spending. To counter deficit bias, many countries have adopted balanced budget rules or restrictions on government debt. Examples include the “debt anchor” in Sweden; a “debt brake” in Germany and Switzerland; and the European Union’s Stability and Growth Pact agreement to maintain a general government gross debt of no more than 60% of GDP. Effects of Public Debt: A peculiar profile of public borrowing is its voluntary nature, as con¬trasted to the compulsory features of taxation. When the govern¬ment offers its securities to the public, persons are free to purchase them. If subscribed in the government bonds, there is nolossof net dimi¬nution in their wealth, as occurs when they pay taxes. In exchange for liquid cash, they receive bonds or other securities which bear interest and which will ultimately be paid off. The government in turn receives money for meeting its expenditure, but incurs a liability for the payment of interest and the repayment of principal in the future. The economic effects of a government programme financed by borrowing are different from the effect of a similar programme financed by taxation. This is partly because the lending of money to the gov¬ernment is purely voluntary and partly because the making of such loans does not reduce the personal wealth of the lenders but merely changes its form. A major consequence of these types of funds mobi¬lization is that borrowing, on the whole, is likely to have a less contractionary effect upon aggregate demand, than raising an equiva¬lent amount by way of taxation. Hence a programme of expenditure financed by borrowing is likely to have a greater net expansionary effect upon the economy than a programme of the same magnitude financed by taxation. 1. Effect of Borrowing upon Consumption: In the case of borrowing, curtailment of consumption spending is likely to be slight, i.e.high marginal propensity to consume, except in wartime borrowing programmes in which substantial pressure is applied to individuals to reduce consumption and buy bonds. Hence compared with taxation, public debts do not have any serious effect on the level of current consumption. In the case of individuals, their consumption pattern is set by their current income. Loans are advanced out of saving, whereas taxes are paid out of income. Under certain conditions, there is greater possibility of an increase in the spending on consumption, due to government borrowing. The bond holders regard their bonds as wealth and a source of income. Moreover, by holding government bond, their li¬quidity position is not very much effected because bonds can be converted into cash at any time. Hence there will be a tendency to increase spending on consumption. 2. Effect of Borrowing on Saving and Investment: The floating of public debt influences saving and investment through the interest rate mechanism. Floating of public debt will raise the rate of interest. Since savings are interest elastic, creation of public debt will raise savings. Investment expenditure of the bond holders are influenced through the claim effect on investment. That is through increase or decrease in interest rate. When bonds are issued, the ratio of money supply to debt supply will be reduced and as a result rate of interest will increase. As a result, the effect of public debt will be, reduced investment expenditure. On the other hand, when bonds are purchased by the government from the open market, or when government repay public debt, the ratio of money supply to debt supply increases and the rate of interest declines. This will lead to an increase in investment. The overall effect on the economy de¬pends largely on the way in which the investment is made in the public sector, compared with what could have been achieved in the private sector. The effect of public debt on investment also depends on the method of raising loans. Suppose if the government borrows from commercial banks and central bank of a country, it will increase the money supply or purchasing power and hence the funds available for investment will not be reduced. However, if the government bonds are subscribed by the public and financial institutions, out of funds meant for investment, then automatically investment expenditure will be curtailed. 3. Effect of Borrowing on Production: In general, government borrowing results in enhancing the productive capacity of the economy. If the borrowed money is used by the government to finance developmental projects, it will generate in¬come and employment opportunities. Such investments strengthen the capital base of the economy and help to increase the production of goods and services. Moreover, the government will be able to re¬pay the debt and interest charges in future without much difficulty. Whereas, if the public purchases government bonds, by selling their shares or debentures, invested in private industrial concerns, it will create an adverse effect on private investment. However, when the borrowed money, as stated above is used for highly productive activities, overall production is not affected badly. Likewise, if the public subscribe government bonds by withdrawing their bank de¬posits, it will adversely affect the lending capacity of commercial banks and thereby private investment activities. However, if public debt is purchased by the individuals, utilizing their idle funds, it will not adversely affect private investment. Whereas borrowing resorted to meeting current expenditure or for financing a war, would result in the diversion of resources from productive activities to wasteful ex¬penditure flows. 4. Effect of Public Debt on Distribution: Borrowing leads to transfer of resources from one section of the community to another section. If this transfer takes place from the rich to the poor, the inequality in the distribution of income and wealth would be reduced and as a result the economic welfare of the com¬munity will be enhanced. On the other hand, if the transfer of wealth takes place from the poor to the rich, the disparity in the income distribution will be aggravated. Usually, government bonds are subscribed by the richer income group. Whereas, the burden of taxation imposed for financing debt service and repayment of public debt, falls on the poor section. There¬fore generally public debt has a tendency to increase economic in¬equality. Whereas suppose the public debt is mobilized through the small savings of lower income group. Correspondingly debts are serviced and repaid through taxation imposed on the richer income group. Then public debt will not result in increased income inequality. Hence, loan finance can be used as a means to redistribute income be¬tween different segments of the society. 5. Other Effects of Public Debt: (a) Public debts in the form of government bonds are negotiable credit instruments. They are highly liquid form of assets. The investors can freely convert them into liquid cash at any time to meet their demand for money. Moreover, as far as financial insti¬tutions are concerned, it adds to the liquidity position of these institutions, because of its transparency in convertibility. (b) During times of inflation, when the government borrows from the people, the purchasing power in the hands of the public will be reduced. As a result, inflationary pressure in the economy will be reduced. On the contrary, during depression, when the borrowed funds are utilized for development projects, it will generate addi¬tional purchasing power, employment and income. Hence, dur¬ing depression, public debt can be utilized as an effective instru¬ment to curb deflationary fluctuations in economic activity. Hence, in modern times, public debt is used as an important instrument to bring about economic stability in the economy. In fact, one of the major objectives of government borrowing today is to strengthen the economy by freeing it from the evils of depres¬sions and also to build up the economy and stable economic growth. Owing to this reason, rapid increase in public debt need not be viewed with concern. CHALLENGES / CAUSES OF PUBLIC DEBTS These are causes of public debt which are given below: Government can borrow because it can possible that local income was not enough for their expenditure due to incidental expenditure government could have to borrow because it is not possible to increase the tax income at that point. Government can borrow finance arrangement of capital expenditure because current revenue will not be enough to fulfill the target. At the time of depression, when private demand is not enough then government borrows, the extra savings of people which is not in use and spends it to increase the effective demand and by this gives birth to extra income and employment in the society. These extra amounts from government taxes are supplementary to each other. 1. Small Share of Taxes in National Income After India got independence, there is an increase in national income four times more. In present, there is a part of tax less than 20% in the national income but this percentage in America is 22.42%, in Sweden 26.3%, in Australia 27.9%, in Nederland 29.2%, in England 30.4%, and in Nigeria 43.4%. Except this, in these countries, most parts of income from taxes got from direct taxes and in India, most part of the tax income is from indirect taxes. So, in this condition, fiscal policy cannot be able to help in the increase in the development of Economy. 2. Burden of Indirect Taxes In Nigeria tax system, there is a burden of indirect taxes that is not just. In the economy there is an inflation increase in indirect taxes that the complete tax arrangement has become imbalanced and unjust. Most of the pressure of taxes are from indirect taxes the lower class people who have to face as a comparison to rich section so this increase, economical problems in society. 3. Imperfect Tax System The Indian tax system is not working perfectly. In Nigeria, there is very high tax evasion because our tax system is full of error. According to Nigeria financial analysts, there is tax evasion of 30 to 35 percent, every year. Except this, the complete part of income tax is never collected. 4. Misuse of Public Income In Nigeria, there is a big part of public income misused. A big part is spent on undeveloped plans, except this, some plans are started on the basis of standard. A big quantity is spent on them even public got no gain from these. There is a big quantity spent on government departments where there is corruption, bribe, and red-tapism available and work is completed with very difficult. By this reason, there is a reduction in production. 5. Increasing Public Debt To fulfill the long-term plans in Nigeria, there is a big quantity of financial resources needed. To fulfill this public debt is to be taken as a help. And there is a regular increase in the pressure of it. Because of most of them depend on foreign debt, there is non-definite plans of economic development. Conclusion: There is no doubt a feeling among some people that interest payment on the national debt repayment is a drain on the nation’s limited economic resources. It is pure waste of our resources to use them to pay interest on the debt. This argument is wrong because interest payment on the debt — if domestically held —do not prevent a use of economic resources at all. It is, of course, true that if our debt is held by foreigners, we will suffer a loss of resources. In the case of domestically held (internal) debt, internal payment on the debt involves a transfer of income from Indian taxpayers to Indian bondholders of the same generation. Since, in most cases, taxpayers and bond¬holders are different entities, a large national debt inevitably involves income redistri¬bution effects. 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