Public Debt | Types | Similarities & Difference

Public debt is the financial obligation which a government owes to its citizens or to the nationals or organizations of other countries.

Public debt is a source of public revenue but differs from other sources because the government pays interest and repays the principal to the creditors.

Types of Public Debt

Voluntary & Compulsory Debts:

This type of debt is taken by the government without any force or coercion. People lend to the government voluntarily. In fact, all public loans are voluntary.

However, sometimes the government compels the people to buy government bonds in case of a war or national emergency. When this obtains, it is known as compulsory loan.

Funded & Unfunded Debts:

Funded debt is a long term debt for a definite period. The interest rate to be paid, also the terms and conditions of repayment are clearly stated in the debt instrument (certificates).

In order to repay the debt, a debt is created in which some money is deposited every year by the government. Unfunded debt on the other hand, is for a short period of less than a year.

Such a debt is repaid out of current receipts often by floating additional bonds in the market. This is known as floating rate.

Redeemable & Irredeemable debts:

Redeemable debt is that debt which is repayable by the government after a fixed period of time. The interest on this loan is paid regularly half-yearly or annually.

When the debt matures, the principal is paid back to the lenders. Irredeemable debt is that whose principal is not refunded.

However, interest is paid regularly on such a debt for the period of its duration. Debt incurred during a war may be irredeemable.

Productive Debt & Unproductive debt:

Productive or reproductive loans are debts which are fully covered by assets of equal or greater value and the source of the interest is the income from the ownership of the assets such as the railways and irrigation works.

Thus a debt is productive when its amount is spent to finance a project which in long run brings revenue out of which interest is paid on the debt.

Unproductive loan does not increase the productive capacity of the economy because it is not backed by any existing assets.

Loans taken by the government for covering the budget deficit or to help in time of war, famine, earthquake, floods, are unproductive debts.

Internal &External Debt:

Internal debt is that debt which is raised from individual and institutions within the country. Internal sources are, purchase of public bonds, treasury certificates, treasury bills etc.

External debt is a debt resulting from borrowing from persons or institutions outside the country. Such institution may includes foreign governments, private foreign institutions and international organizations like International Development Association, International Monetary Fund (IMF), International Bank for Reconstruction and Development (IBRD), International Finance Corporation (IFC), African Development Bank (ADB) etc.

Similarities and Difference between Public & Private Debt

Similarities are:

  • Purpose of borrowing is the same with consumption and investment.
  • Both attract interest and are repayable.

Differences are:

Compulsion:

The government can compel the people to lend to it, in time of war, economic crisis and other emergency, defiance may invite legal action. This is not applicable in private debt.

Cancellation:

The government may cancel the repayment of public debt under certain circumstances. This is not so easy for private debt.

Durability:

Public debt last longer than private debt. Government is an institution and last forever. Therefore lenders have faith in it than private borrower, who can only borrow on short terms basis because of risk.

Level of interest rate:

The government can borrow at lower interest rate because of its credit rating. The private borrower pays higher interest.

Source of repayment:

Public debt can be repaid by taxing the people while private debt is often paid from personal savings, sale of assets or even borrowing from others.

Purpose (productive and unproductive):

Public debt is usually for productive purposes but private debt can also be for unproductive purposes e.g. taking a traditional title.

Welfare:

Government borrows to spend on products that promote social welfare but private debt is for personal motives e.g. profit maximization.

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