Principles of Public Debt Management

Principles of Public Debt Management:

Following are the principles of public debt management.

The Interest Cost of Servicing Public Debts must be Minimized:

According to this principle, the government must be in a position to create and redeem public debts, but at a minimum interest cost. This should be an important objective of public debt management. The interest cost of servicing public debt should be kept minimum because the government has to impose additional taxes or the rates of existing taxes have to be raised for the payment of interest cost. If the interest cost is minimum, the government will have to impose a smaller amount of additional taxes and vice versa. And hence, the smaller amount of taxes will have fewer adverse effects on the various economic incentives, i.e., the willingness to work more and save more.

The interest cost can be minimized; if the Central Bank of the country is induced to keep the interest rate low by means of its monetary operations, i.e., by means of bank rate policy, etc. When interest rates are low in the market, the government would be able to sell its bonds carrying lower interest rates and thus would be able to raise loans at low-interest costs.

But such an interest rate policy may create inflationary pressure, especially when the economy is already operating under full employment conditions. Therefore, a low-interest debt policy contributes to inflationary pressure which may create economic instability, when the economy is at full employment.

Satisfaction of the Needs of Investors:

There are some who argue that public debts should be managed in such a way that the needs of the investors with regard to the types of government securities and the terms of issues are satisfied.

A government may find it difficult to manage public debts if the investor’s needs are not satisfied. For instance, if the government desires to fund its short-term debt into a long-term debt, it will have to offer attractive terms on the long-term securities such as higher interest rates on them, or the government may offer to the security holders to convert long-term securities into cash without any loss for the purchase of new securities issued by the government. In such a case the general liquidity of the public debt remains more or less the same.

But when the public debt management does not satisfy the needs of the investors, there may be disturbances in the security markets on account of the sale of securities, the bondholders may cash their securities for one purpose or the other. But, if the interest of the investors is kept on the high side, the cost of public debt to the government may become high. Therefore, there are some who argue that public debt should be reduced as it matures. But, if it is serviced out by the issue of a new currency, it would create inflation, and if it is serviced out through additional taxation, it would be deflationary in its effects. Hence, both these situations should be avoided by a proper balance between the methods adopted to repay the public debt.

Funding of Short-Term Debit into Long-term Debt:

It has also been argued that public debt management should help to find as much of the short-term debt into long-term debt (especially into very long-term debt such as British Consols which never matures) as far as possible. But, the funding operation should be done in such a way that the economic stability is not disturbed. However, the advantages offered by this policy are not very great because the private short-term debt would exist and complicated the monetary management.

This policy would tend to raise the long-term rate of interest because the demand for long-term funds will have to be increased, this will also increase the budget expenditures in the future. Simultaneously, it would reduce the short-term interest rates because the demand for short-term funds will fail. But this undue rise in the long-term interest rates may cause a decline in the rate and volume of private investment, resulting in recession and unemployment. Hence, the funding operations must be undertaken in such a way that there is no undue rise in the long-term interest rates which may adversely affect the rate and volume of private investment. If however, there is a need for reducing private investment, the government may fund the short-term debt into long-term debt.

If the short-term interest rates are low, this may induce an outflow of short-term capital into other countries, where the short-term interest rates are high. This may not be in the interest of the country. Hence, the funding of short-term debt into long-term debt should be done in such a way that it satisfies the investor’s needs.

Public Debt Policy must be Co-ordinated with Fiscal and Monetary Policy:

The Coordination of public debt policy with fiscal and monetary policy is essential to maintain economic stability and promote economic growth. For instance, if the government forces the Central Bank to follow a low-interest rate policy in order to keep the cost of interest payment on public debt low, it may create inflationary conditions and may result in economic instability. Hence, such economic instability should be avoided by proper coordination between the public debt policy and monetary policy.

The public debt policy along with the fiscal and monetary policy must be operated in such a manner that all three policies contribute to economic stability and growth. Hence, the repayment of public debt, the conversion of existing debt, and the terms on which the new securities are sold should contribute to growth and stability.

Maturity, Distribution, and Kinds of Debt Holders:

If a large proportion of the total debt is short-term debt and a high proportion of the total debt is held by banks, there can be a high degree of liquidity, which may contribute to an inflationary pressure at a time when an anti-inflationary policy may be desirable. Thus, the high liquidity of debt makes the control of inflation difficult. Also, the purchase of such debt will not be quite effective as an anti-deflationary device. The highly liquid debt, held by individuals, can be used as an anti-deflationary device by raising the price of securities, thereby including people to convert them into cash for increasing their aggregate expenditure.

It is thus, obviously, from the study of these principles that it may not be possible to achieve all the objectives of public debt management. For instance, the policy of keeping the interest rate low may contribute to an inflationary condition, while the funding of short-term debt into long-term debt may cause recession and unemployment. Hence, public debt must be managed in such a way that the greatest economic advantage is secured or the least economic disadvantage is suffered.