Redemption of Public Debt

Redemption of Public Debt:

Redemption means repayment of loans. All government loans, except permanent investments in self-supporting industries, should be repaid promptly. In order to assure the control of debts and their orderly retirement provision of repayment should be made when debts are issued. Government too frequently finds excuses for postponing the repayment of their debt, therefore, every precaution should be taken to assure their punctual repayment.

Advantages of Debt Redemption:

(1) It saves the government from bankruptcy.

(2) It discourages extravagant expenditure of the government.

(3) It maintains the confidence of the lenders.

(4) It would be easy for the government to float loans in the future.

(5) It reduces the cost of debt management.

(6) It saves posterity from the burden of debt when it is redeemed at an early stage.

(7) When government loans are repaid, the resources may be directed toward private investment. Hence, a climate for private investment is created.

(8) Repayment of loans may act as a deflationary measure.

Methods of Debt Repayment:

Let us now discuss the various methods of debt repayment.

Repudiation:

Repudiation means the refusal to pay a debt by the government, as was done by the Soviet Government in 1917 which repudiated Czarist debts, it was also done by some states in the U.S.A. before the civil war (1961-65), which repudiated the debts owed to the English Citizens.

Repudiation shakes the confidence of the people and banks in the government and hence, it may find it difficult to raise new loans in the near future. It is inequitable and discriminatory because it affects only one class of property owners, i.e., the class which purchases government securities, while it leaves others unaffected. If all contracts regarding the payments to property owners are repudiated simultaneously, no discrimination is involved, but if all contracts are repudiated, this may bring social revolution, the effects of which may be harmful to all classes of people.

If an external debt is repudiated it may create a number of grave difficulties for the repudiating country, such as economic blockade, military action, etc., which may be resorted to by the foreign governments to collect the debt. Moreover, it is not wise to follow a policy of repudiation of public debt as it is considered immoral and dishonest.

Refunding:

If a government sells its bonds to pay its floating obligations, the debt is said to be funded. Refunding is the process by which the maturing bonds are replaced by new bonds. Sometimes bonds may also be redeemed before the maturity date, if the current rate of interest is low or when the government intends to rearrange the maturity of outstanding debts. But, the refunding is undertaken mainly with a view to meeting maturity requirements. Usually, the short-term debt incurred to meet current expenditure is cleared off later on by obtaining and raising fresh funds through the sale of long-term bonds to the public, so that the short-term loans are replaced by long-term loans.

A major drawback of this method is that the government would be tempted to postpone its obligation of debt redemption, and hence, the total burden of the debt would continue to increase in the future.

Conversion:

Conversion of public debt means the exchange of new debts for old ones. In this method, the loan is actually not repaid, but the form of debt is changed. The process of conversion consists of generally converting or altering a public debt from a higher to a lower rate of interest. A government might have borrowed at a time when the rate of interest was high. Now when the rate of interest has fallen, at that time, it may convert the old loans into new ones at a lower rate of interest, in order to minimize the burden of the debt on the State. Moreover, lower interest rates on public loans would mean a less unequal distribution of income.

However, conversion can be successfully carried out, if the credit of the government is good and its stock is above par. It thus necessitates efficient management of public debt.

Dalton, however, is of the view that debt conversion does not really relax the debt burden. Because, a reduction in interest rate reduces the ability of the bondholders to pay taxes, which may cause a reduction in public revenue, thereby reducing the government’s capacity of redeeming the loans.

However, the terms of refunding and conversion are, unfortunately, often used interchangeably without any distinction. Refunding is, essentially, the postponement of debt payment while conversion is the re-arrangement of interest rates or details other than the postponement of debt maturities. Refunding and conversion may be combined in a single operation, which may be called either refunding or conversion.

Actual Repayment:

While the first three methods are not concerned with the actual repayment of loans, the following measures may be taken for the repayment of public debt. Here the question is whether loans should be repaid slowly or quickly. However, this depends upon the wealth and income of the borrowing country, particularly, in the case of an external loan. The greater the wealth and smaller the debt, the faster it can be paid off.

(a) Sinking Fund- A device that has been developed for the regular retirement of debt, is the sinking fund, or a fund into which a certain amount of revenue is deposited each year for the repayment of outstanding debt. The fund is used for the purchase of outstanding debt, which is generally in the form of securities, and the ultimate retirement of loans as they fall due. Originally sinking funds are accumulated until debts matured, but now they may be used to retire debt as far as funds are available.

Dalton, however, was of the view that sinking fund, should be made out of the current revenue of the treasury and not out of loans, etc. A sinking fund, which is built up through fresh loans, may not be called a true sinking fund.

In practice, sinking funds are not accumulated from year to year. But some funds are earmarked each year for the payments of some part of the debt in the same year.

Thus, properly managed sinking funds provide a means of orderly debt retirement. But this is a slow process of repayment of debt and suffers from the defect that the government in its financial difficulties may use the funds for other purposes.

(b) Surplus Revenues- A policy of surplus budget may be followed annually for clearing off public debt gradually instead of creating a fund for its repayment on maturity. But in recent years, due to rapidly increasing public expenditure, a surplus budget is a rare phenomenon. Moreover, a surplus budget during a period of deflation would be an unwise act of the government, hence, the policy of surplus budget cannot be followed during a depression, and therefore, loans may not be repaid in such a situation.

(c) Terminal Annuities- A government may issue terminal annuities, a part of which matures every year according to serial order announced or decided by the lottery system so that the debt can be cleared every year and consequently the burden of interest is also reduced to that extent every year. Thus, it is the method of repayment of loan installments. According to this method, the burden of debt goes on diminishes annually and by the time of maturity, it is already fully paid off.

(d) Capital Levy.