Classification of Public Debt

Classification of Public Debt:

Government loans differ from one another in many ways. The differences are due to the market, in which the loans are floated, the rate of interest offered, the conditions of repayment, or the purpose for which they are used. Different forms of kinds of public debt are given below:

(1) Internal and External Debts.

(2) Productive and Unproductive Debts.

(3) Redeemable and Irredeemable Debts.

(4) Funded and Unfunded Debts.

(5) Voluntary and Compulsory Loans.

Internal and External Debts:

Internal debt refers to the public loans floated within the country, while external debt refers to the obligations of the country to foreign governments or foreign nationals, or international institutions. The payment of interest on foreign debt reduces the net income of the debtor country by transferring a part of its income abroad, the payment of interest on internal debt has no such effect. The country’s national income is the same whether the interest on the internal debt is left with the taxpayers or is taken from them as taxes and paid out as interest on the internal loan. It is a roundabout way of taking money out of one’s pocket and putting it into another or the same taxpayer. Hence the payment of such interest does not affect the productive capacity of the country as a whole, but there may be indirect effects on production. However, foreign loans should not be considered as bad if they are used for productive purposes and even for war purposes, in the former case, they may be repaid out of income from where they are invested, and in the latter case, they may be helpful in saving the prestige of the country for which no sacrifice will be too great.

Productive and Unproductive Debts:

Loans may be classified into two groups, i.e., productive and unproductive. Productive loans are those which are used for those projects which yield an income to the Government. For instance, the loans may be used for the construction of railways, irrigation, and power projects and for the establishment of heavy industries such as iron and steel, cement, and fertilizers. The income derived from these projects may be enough to pay the yearly interest of the loan Incurred on these projects. Moreover, the principal and the interest both can be repaid out of the income derived from these projects. Besides, productive loans invested in capital goods industries will be helpful in increasing further production. Thus, productive loans should not be considered as a burden upon the Government and the taxpayers, on the other hand, unproductive loans are those which are incurred on those projects which do not yield and income. For instance, loans taken for financing war, and for giving relief in times of flood and drought may be considered unproductive. The special character of unproductive debt is that they have no existing assets, and hence they are considered dead weight upon the government.

Redeemable and Irredeemable Debts:

Redeemable loans are those loans for which the government promises to pay off at some future date. Those loans, for which no such promise is made, are called irredeemable loans. When a loan is redeemable the government has to make some arrangement for its repayment. If it is decided to pay it off from tax money and that is in most cases the best thing to do, fresh taxes have to be imposed for that purpose. Hence, in the case of redeemable loans, the government has to pay the interest and the capital both on some future date, but in the case of irredeemable loans the government may have to pay only interest regularly.

These loans are also known as terminable debts. However, redeemable loans may further be classified as short-term, medium-term, and long-term debts. Short-term debts may mature within a period of 3 to 9 months, for example, Treasury Bills. Interest rates on such loans are generally low. Long-term debts generally mature in ten years or more. Such loans usually bear a high rate of interest. Similarly, medium-term debts may mature between a period of short-term and long-term periods, say five years or more, and bear an interest rate that is lower than long-term.

Funded and Unfunded Debts:

Public debts have also been classified into funded and unfunded or floating debts. Funded debts are long-term debts. The payment of those may be made at least after a year or may not be made at all. In other words, funded debts are those that are redeemable after a year or are not redeemable at all. Unfunded debts are those that are paid off within a year. Treasury bonds are unfunded debts because they are for three to six months and are never for a longer period than a year. However, it should be noted that in the case of funded debt, the government’s obligation is to pay a fixed sum of interest to the creditor, subject to the option of the government to repay the principal. Hence, in the case of funded debt the creditor (bondholder) has no right to anything except the interest on the amount that he has credited to the government.

Voluntary and Compulsory Loans:

Generally, Government debt is of a voluntary nature, the individuals and the institutions are invited to purchase government bonds. However, compulsory loans are not common in modern times. But the government may have to exercise its pressure for getting loans during an emergency such as war, and during an inflationary period so that the volume of purchasing power in the hands of people may be reduced and the rising prices may be checked. In most cases, the loans floated by the Government are oversubscribed, because the government has much better credit than a private individual or a company, and that is why the rate of interest on government securities is lower than other types of securities. Government securities are known as the best securities for investment. However, if the rate of interest on government securities is very low then it may find it difficult to get loans voluntarily from the public and it may have to exercise its influence.