Public Debt
• Role of Public Debt in Economic Development
• Loan and Taxes
• Compensatory Aspect of Debt Policy
• Intergeneration Equity and Shifting of burden to Prosperity: The Concept of Pigou, Bowen-Davis-Koff
Hypothesis, the Concept of Modigliani and Musgrave
• The Concept of Debt Trap and its Consequences
• Effects of Public Debt and Management of Public Debt
Government Borrowing or Public Borrowing or Debt
Government borrowing is an important source of public revenue. We know that there are mainly two sources
of revenue – tax revenue collected through taxation and non-tax revenue collected through except taxation.
Among them public debt or borrowing occupies significance place in the modern time.
Public debt or borrowing is a term used for all short term and long-term borrowing of the government from
the people. But in the broad sense, public debt is the revenue of the state or government. Because the
government finances its expenditure from its income. The income of the government consists of public
revenue and public debt or tax revenue and non-tax revenue.
Role of Public Debt in Economic Development
Up to the end of the eighteen and beginning of the nineteenth centuries the whole economic system
dominated by the classical philosophy or laissez-fair philosophy. The principle of private finance that the
expenditure should not exceed the income held currency was in practice. The state under the influence of
laissez-fair, was reflected in economic liberalization, its activities to the minimum duties of providing
protection and security to the citizens. Hence, the activities of the state were limited to performing only few
essential function that the state could be better known as a police state. Classical economics considering
form of government expenditure in economic field as unproductive. Because any spending by government
causes transfer of resources from private sector to public sector thereby causing reduction in output of
private enterprises and hence the aggregate national product will reduce. According to them that government
is best which is governed by least. Further they advocated the principle of balanced budget. In this regard,
the classical view about the public debt was very limited or narrowed. In their view, government can spend
more and borrowing from public if it fruitful than the private sector. Public debt or borrowing will be bender
to the economy because it may is volume additional taxation for the repayment of loans and interest on
borrowed funds and their additional taxation may advisedly effect the production. It might produce currency
deuteriation and price inflation.
The modern view of the public debt emerged with the failure of the classical philosophy and increasing role
of the government in the state. Credit goes to the Keynes who refused the classical philosophy and retired
government intervention in the economy and thus the role of public debt. Keynes argued that debt need not
necessarily be unproductive, inflationary and burdensome. Keynes believed that it may an important tool to
achieve full employment and to raise the level of national income. Because, in the under-employment
equilibrium condition, resources in the private sector may remain unemployed. In a situation, when
resources are unemployed on a large scale, government of these resources does not necessarily deprive the
private sector of anything. On the other hand, increased government spending by using idle men and
materials, is likely to raise the level of aggregate output and income. Keynes and his followers argued that
if debts are internally held, there is nothing to worry about their size. Debt involves merely a series oftransfer payments and they can out for the economy as a whole. Hence, the only concern, should be about
economic stability at high level of employment and income. Thus, the concept of annually balanced budget
replaced by the concept cyclical balance budget.
A.P. learner also emphasized the public debt as a functional finance. According to him it may be an
important instrument for capital formation. In is views government should borrow when it wants to make
people hold more hands in place of money. This action will raise the rate of interest by lowering the value
of bonds and will prove to be anti-inflationary. Similarly, in the period of falling aggregate demand and
shortage of funds for production investment government should lead to the private sector or increasing
government expenditure, borrowing from central bank to retire debt held by the public. Thus, the desirability
of public debt should be judged in term of its effect, on aggregate demand and the government should not
be disturbed over the size of the debt. He also argued it will not create problem because there is always open
the door of central bank of borrow and to create new money, for the government. In this way, Learner
proved public debt as establisher instrument for the government.
The post Keynesian economist who modifies the classical theory of public debt as brought about by
Keynesian economist. They emphasized transfer and management aspects as well as the interrelationship
between public debt and money supply. It cannot be denied that internally held public debt involves a series
of transfer payment in the form of taxes and debt service payments and for the economy as a whole, they
cancel out. But a large volume of public debt cannot be dismissed as of no consequences. Many economists
argued that public borrowing today constitutes burden for the future.
Internal and External Debt
There are two sources of public borrowing internal and external. Internal borrowings are those borrowing
of the government which are borrowed from internally or with in the country. External borrowing included
all borrowing from external sources. In other words, internal borrowing borrowed from domestic market
where as external borrowing borrowed from international market.
Internal, sources of public borrowing are citizens, commercial banks and other financial institution in the
money market and the central bank. External sources of public borrowing are the foreign individuals and
bank of foreign countries, foreign governments and international financial institutions. Thus, loans floated
within the country are called internal borrowing and those floated outside the country are called external
borrowing.
Different forms of borrowing have different effect in the economy. Here is general fading that an internal
borrowing is better than an external borrowing. Because the borrowing from external will have the foreign
centrals in the country's economy. So, it will be danger for political and economic independence.
1. Borrowing from individual – Reduce the purchasing power of the people and their past saving, which
may result in the reduction of affective demand in the economy.
2. Borrowing from NBFI – Individual savings or Pvt. Saving divested from private sector to
government by which the fall in the capital formation and deficiency of capital in Pvt. Investment.
3. 4. Borrowing from commercial banks – leads to the creation of additional purchasing power.
Borrowing from central banks – Also leads to rapid increase in the purchasing power and more
inflation than the borrowing from commercial banks.
So, the government should choose the sources of borrowing more carefully. Since, under internal borrowing,
borrowing takes place with in the country, the availability of total resources does not raise. Simply theresources transfer from bond holders individual and institutions to the public treasury and government can
spend it for public purposes. Similarly, payments of interest for repayment of principle would transfer
resources from tax payers to bond holders. So, it has no dived net money burden as such
External debt, on the other hand, leads to a transfer of wealth from the lender nation to the borrower nation.
Which the loan is made through the external borrowing the resources available to the borrowing nation
increases. However, when the external debt is repaid, there would be transfer of resources from the debtor
to the creditor countries. Causing a decline in total resources of the debtor country. To cover the interest
and repayment of the principle of external debt debtor government has to reduce its expenditure in the future
or to reduce private spending by increasing taxation, then cutting the use of resources at home.
Loan and Taxes
Loans or debt and taxes are the two different sources of government revenue. But the nature of these two
sources are different that is former has to be repaid with interest, the latter are not. Taxes are collected from
the public without any promise or commitment on the part of the government to provide the tax payers any
services, much less the commitment of paying them bank to the tax payers, but public loans are taken by
government from the banks institution and individuals on the explicit understanding given in writing that
these shall be repaid on maturity while interest shall be paid regularly-half-yearly or yearly as stipulated in
the terms of the loans.
Sometimes, the government faces the problem whether resources mobilize through taxes or by raising loans.
Heavy taxation as well as reckless borrowing may ruin the financial structure and may being misfortunes to
the community as a whole. The general principle followed in financing public expenditure is that the normal
or ordinary and recurrent expenditure should be financed out of taxes while non recurrent and productive
expenditures should be met out of loans. This principle has to be analyzed. The government should raise as
much as taxation annually as the nation can bear, to defray extra ordinary or abnormal expenditure, as for
as possible from this source. The great advantage of tax, as compared with a loan is that the former never
leaves any charge behind it in the form of repayment of principle to disturb subsequent budgets.
• Taxation is a burden on the current income, while borrowing implies curtailment of further power of
spending.
• Taxes come from the annual incomes and involves curtailment of present enjoyments while a loan come
from saving and reduces the available funds for the production in the private sector.
• Tax is compulsory contribution while loan is generally voluntary. The pressure of a tax is immediate
while that of loan is imposed on future.
• The burden of heavy taxation may not be equitable, but the burden of loans is diffused over a long
period.
• The aim of taxes may reduce excess expenditure while the aim of loan to increase income in the future
which may increase the expenditure in the presence for war finance and the recovery of the economy
from war effects public debt is most convenient alternative to taxation. Similarly, for long term projects
for economic development methods of financing by debt is useful than the tax financing. There are three
reason which the tax is inferior than debt.
• Collecting resources through taxation will be inadequate.
• Adverse effects on ability to work save and invest.
• It reduces consumption thus reduces effectively demand.
Similarly, the major disadvantages of debt financing are the obligation to pay a fixed rate of interest and
the principle. There no such obligation in taxation. Public debt therefore increases the inequality in thesociety. But tax can minimize the inequality. However, the proper utilized public debt can benefit the
weaker section through increased output and employment. For curbing inflation taxation is better than
debt.
Conclusion:
1. As far as feasible and practicable current expenditure should be met out of the annual receipts and with
the increase in expenditure taxation should also increase.
2. 3. When there is non-recurring expense of a large amount, it should be financed through borrowing.
When the abnormal expenditure is expected to last for a number of years tax structure should be adjusted
to meet it.
Compensatory Aspects of Debt Policy
The shifting of the debt to posterity of, Debt burden and posterity (future generation)
There are different views of the different economists whether the burden of public debt shift to the future
generation or not. In this regard, the classical economists have stated that through debt finance, it is the
present generation which suffers a loss of resources. The future generation will suffer if the present
generation reduces it saving in order to meet the debt finance and there by leaves a smaller amount of capital
resources for the future. This will reduce the productive capacity of the coming generations and they will
accordingly lose. In reality, however current financing requires resources today itself (especially in the care
of war) consequently, the present generation has either to curtail its consumption or saving are reduced, the
future generation has to suffer on account of reduced, inheritances of capital assets. The present generation
may shift the burden of debt on the shoulders of posterity because it does not reduce its consumption.
According to the classical view, large borrowing today will leave smaller stock of capital goods to future
generation. It means lower output and consumption for them. The burden of public debt is thus shifted to
future generations in the form of relatively greater curtailment of savings and real investment compared to
the tax financing of public outlay. This view is to be found in the second edition of Pigou and public finance,
though its essential had been set out long before in Ricardo.
Ricardo-Pigou views of public debt and posterity summarized by Shoup as “If the government expense is
financed by taxation the first generation hands onto the second nothing but tax receipts; it by bond issue,
the first generation bequeaths the bonds to the second generation, but along with them, a tax liability
represented by the annual charge on the debt for interest, and if bonds are not perpetuities for redemption
or amortization. The members of the second generation, like those of the first, pay the interest to themselves
and hence cannot gain by holding bonds rather than their forebear’s tax receipts. The welfare of the second
generation depends not on whether it inherits tax receipts or government bonds. But on what it inherits in
the way of real stock of capital and this latter inheritance depends on the section of the first generation to
the taking away of real resources by the government.”
Thus, in the case of tax the first generation will cut consumption move and investment less. While in the
case of borrowing first generation may feel itself richer with bonds together with an undefined future tax
obligation. This feeling of being richer may cause this generation to cut consumption less and saving more.
This means that the second generation inherits smaller stock of capital goods and this constitutes the burden
of debt on future generation.(However, the traditional views discussed above has been opposed by the economists including Buchanon
Bowen-Davis-Kopf, Musgrave, Modigliani and others)
Bowen -Davis Kopf hypothesis defines burden in terms of the cut in life time consumption of different
generation of taxpayers. In their view, at any period of time society consists of revenue generation of the
people. Therefore, the total burden of public expenses is the reduction in the life time consumption of each
generation of tax payers. Under debt finance first generation can shift part of the needed cut in consumption
to future generation such as second and third. The latter generation (i.e II and III) were not present at the
time of debt financing but would be present at the time of debt servicing. When the debt is retired generation,
1st consume the proceeds but 2nd and 3rd would pay tax for debt servicing. In other words, other generation
increases their consumption while the decrease occurs in the consumption of newer generation. Thus, the
burden of debt in terms of “the total consumption of private good foregone during the life time of
generation” falls on the generation alive at the time the loan is repaid. Thus, in their view, the discounted
life time consumption reduced by the existence of debt service. In the whole analysis there is no reference
to any curtailment in the rate of investment.
Modigliani considers that debt financing by the government will necessarily lead to reduced capital stock
with the future generation. According to Musgrave “The burden of debt finance is both a critique of
borrowing and an argument in favor of borrowing.” It is a critique because financing by debt may shift
burden to future generation and an argument in favor, it may be used to secure inter generation equity by
passing on part of the cost of capital ayes to the future.
Conclusion:
Classical or Pigou's view– Inter generation transfer of debt burden – debt burden rests largely with the
present generation which creates the debt and that it may be shifted to future generation only if the present
generation reduces its rate of saving as a result of the debtor creation activity.
Modern or Buchanan – Derris 's view - the traditional view that the present generation bears the burden of
public debt, since individual, who purchase government bonds do so on a voluntary basis. They do not
realize present burden because they are merely post poring present consumption to the future, when they
will redeem their securities. Meanwhile these individuals earn interest compensation on their bonds.
According to him, the financial (Monitory) contributions of taxes by subsequent generations to maintain or
taken the debt created by an earlier generation contribute an inter temporal burden transfer to the later
generation.
BDK hypothesis state that reduction in capital formation is the only way of transferring burden to the future
in inter generation approach or when generation do not overlap. But when generation overlap in time this is
not necessary condition that is no references to any curtailment in the rate of investment.
Management of Public Debt
Public debt management refers to the debt policy designed to achieve certain objectives and actual
implementation of this policy. According to abbot “Public debt management is concerned with the decision
of forms of public debt, in terms of which new bonds are sold, maturity debt is redeemed or refunded, the
proportion of in which different forms of public debt should be issued the pattern of maturity of debt and
its ownership etc.” why public debt management? Because an increase and decrease in debt has its own
effect on the working of economic system. Debt policy may also serve to formulate national economic
policy. The economic development may in wage and discourage with the change and utilizes of debt. Toimplement the planning policy, it is necessary to know the debt policy and it gives knowledge of the actual
amount of requirement for the implementation of a certain policy. How to manage the public debt.
According to traditional philosophy, debt management consists of raising the necessary debt at the cheapest
interest cost and paying it off as early as possible. But with the emergence of welfare state, various
objectives are being considered as the cornerstones of sound debt management policy of course, every
government is still interested in keeping the interest cost of its debt at the minimum possible but when this
objectives conflicts with other, it may be sacrificed. Other important objectives, attracting the attention of
the authorizes, include analytical or stabilization objectives, economic growth and refunding.
A.R. Prest has elaborated on two main issues of inquiry in regard to public debt management.
1. Minimizing interest charges through proper and efficient debt management.
2. Minimizing administrator, cost: A funded long-term debt is much easier to administer than short
term securities involving frequent conversions.
Public debt management policy should be well co-ordinate with the monetary and fiscal policies to secure
national objectives. In the period of depression borrowing should be from banks and during inflation
borrowing should be from the public.
General principle should be followed while managing public debt i.e.
• Minimization of interest cost of public debt.
• Satisfaction of the lender or investor in bonds and securities.
• Undoing of short-term debt into long term debt.
• Must be coordinates with fiscal and monetary policy.
• Proper adjustment of maturity.
It is important to note that the various debt management activities will inevitably exert economic effects on
the three functional areas of economic activity, allocation, distribution and stabilization.
• Debt management and distribution – directly related even it involves indirect taxation.
• Stabilization – In inflation situation – creation of debt of central bank will be inflating but whether there
in the situation of unemployment and full employment.
Debt Trap: Definition and Consequences in Developing Countries
A debt trap is a situation where a borrower, typically a developing country, becomes unable to repay its
debts due to an accumulation of interest and principal payments. This creates a vicious cycle where the
borrower needs to borrow more money to service the existing debt, ultimately leading to further debt
accumulation and economic instability.
Consequences of Debt Trap in Developing Countries:
1. Reduced spending on essential services: As debt service consumes a significant portion of government
budgets, less money is available for essential services like healthcare, education, and infrastructure
development. This can exacerbate poverty, inequality, and hamper overall economic growth.
2. Limited investment in productive sectors: Debt-burdened countries often struggle to invest in
productive sectors like agriculture, manufacturing, and renewable energy. This hinders job creation,
economic diversification, and long-term development prospects.
3. Vulnerability to external shocks: Developing countries with high debt levels are more vulnerable to
external shocks like global economic crises, natural disasters, and rising interest rates. These shocks can
further exacerbate existing debt problems and lead to debt distress or defaults.4. 5. Loss of economic sovereignty: When countries become heavily indebted to external creditors, they
may face pressure to implement austerity measures and structural adjustments dictated by lenders. This
can lead to a loss of economic sovereignty and decision-making power.
Increased risk of political instability: Debt-induced economic hardship and social unrest can increase
the risk of political instability and violence in developing countries. This can further deter investment
and undermine long-term development efforts.
Examples of Debt Traps in Developing Countries:
Zambia: In 2020, Zambia became the first African country in more than two decades to default on its
sovereign debt. This was due to a combination of factors, including high levels of borrowing, declining
copper prices, and the COVID-19 pandemic.
Sri Lanka: Sri Lanka is currently facing a severe debt crisis, with its foreign exchange reserves depleted
and its currency significantly depreciated. This has led to shortages of essential goods and widespread
protests.
Lebanon: Lebanon has one of the highest debt-to-GDP ratios in the world, exceeding 180%. This has contributed to a severe economic crisis, including a banking sector collapse and hyperinflation.
Addressing the Debt Trap Challenge:
Debt restructuring: A comprehensive approach to debt restructuring, including debt relief, debt swaps, and maturity extensions, is crucial for alleviating the burden on developing countries.
Improved debt management: Developing countries need to improve their debt management practices, including strengthening transparency, accountability, and risk assessment frameworks.
Increased international cooperation: The international community needs to play a more active role in addressing the debt crisis through coordinated efforts, including debt relief programs, concessional financing, and support for long-term development initiatives.
By addressing the debt trap challenge, we can help developing countries break the cycle of poverty and achieve sustainable economic development.
Is Nepal facing debt trap?
Whether Nepal is facing a debt trap is a complex and debated issue. There are concerns and arguments on both sides of the debate:
Arguments for Nepal facing a debt trap:
• Rapidly increasing debt levels: Nepal's debt has doubled in recent years, reaching around 2 trillion
Nepalese Rupees (approximately USD 15 billion) in 2018-19.
• Large share of external debt: A significant portion of Nepal's debt is external, primarily from
China. This makes the country vulnerable to external shocks and fluctuations in currency exchange
rates.
• Concerns over transparency and accountability: There have been concerns about the transparency
and accountability of some of the debt projects, particularly those financed by China.
• Projects with low economic viability: Some analysts argue that certain projects, like the Pokhara
airport, are economically unviable and may struggle to generate enough revenue to service the debt.
• Limited fiscal space: The increasing debt burden limits the government's ability to spend on essential
services and invest in productive sectors.Arguments against Nepal facing a debt trap:
• Low debt-to-GDP ratio: Nepal's debt-to-GDP ratio is still relatively low compared to other
developing countries, standing at around 39% in 2022.
• Room for further borrowing: With a low debt-to-GDP ratio, Nepal still has some room to increase
its debt burden within sustainable limits.
• Diversification of debt sources: Nepal has diversified its debt sources, reducing dependence on a
single creditor like China.
• Commitment to economic reforms: The government has implemented various economic reforms to
improve transparency, accountability, and fiscal management.
• Strong economic growth: Nepal has experienced relatively strong economic growth in recent
years, averaging around 7% per year.
Current situation:
While Nepal's debt situation is a cause for concern, it is not yet at the level of a full-fledged debt trap.
However, it is crucial for the government to continue implementing sound economic policies, manage debt
levels responsibly, and ensure transparency and accountability in its borrowing practices. Diversifying debt
sources and focusing on projects with high economic feasibility will also be important to avoid falling into
a debt trap in the future.
What is debt trap? Explain its consequences in developing countries.
A debt trap occurs when a borrower, often a country or entity, becomes unable to repay borrowed funds and
ends up borrowing more just to meet its interest payments or refinance the existing debt. This cycle can lead
to a situation where the borrower becomes increasingly burdened by debt, with little ability to escape from
it.
In developing countries, falling into a debt trap can have severe consequences:
1. Economic Instability: High debt levels can lead to economic instability, causing fluctuations in
currency value, interest rates, and inflation. This instability can deter foreign investment and hinder
economic growth.
2. Reduced Public Spending: Governments may allocate a significant portion of their budget to debt
servicing, reducing the funds available for crucial public services like healthcare, education, and
infrastructure development. This impacts the overall well-being and development of the country.
3. Dependency on Creditors: Developing countries may become heavily reliant on external creditors,
which can lead to a loss of sovereignty. Creditors might impose conditions on loans, influencing
economic policies and priorities of the borrowing country.
4. Vicious Cycle: Borrowing more to pay off existing debt or cover interest payments can perpetuate the
debt trap. The cycle continues, often with higher interest rates or more stringent terms imposed by
lenders, making it even harder for the country to escape the trap.
5. Impact on Poverty: A significant portion of the population may suffer from the consequences of
reduced public spending, economic instability, and lack of development. This can lead to increased
poverty rates and worsened living conditions for many citizens.
Efforts to escape a debt trap often involve austerity measures, which can exacerbate social inequalities and
lead to public unrest. Additionally, relying on external assistance or restructuring debt may offer temporary
relief but can also prolong the cycle of indebtedness if underlying economic issues aren't adequately
addressed.1. Addressing a debt trap typically requires a combination of strategies including responsible borrowing and
lending practices, fostering economic growth, improving governance to prevent corruption and
mismanagement, and implementing policies that support sustainable development.
Nepal, like many other developing nations, faces challenges related to debt that have unique implications
within its socio-economic context:
Infrastructure Development and Financing: Nepal has substantial infrastructure needs, especially in
transportation, energy, and water resources. The country often relies on external borrowing to fund these
projects due to limited domestic resources. However, this reliance can lead to a debt burden if these
projects do not generate sufficient returns or face delays.
2. Economic Vulnerabilities and Dependence: Nepal's economy is susceptible to various factors,
including its landlocked geography, reliance on agriculture, political instability, and susceptibility to
natural disasters. These factors can hinder economic growth and make debt management more
challenging, especially if external shocks impact the country's revenue streams.
3. Bilateral and Multilateral Debt: Nepal has borrowed from various sources, including bilateral
agreements with countries like China and India, as well as multilateral institutions such as the World
Bank and the Asian Development Bank. Each source may have different terms, and bilateral debts might
carry geopolitical implications affecting Nepal's autonomy and foreign policy decisions.
4. Impact on Development Programs: High debt servicing requirements can significantly reduce the
government's ability to allocate funds to critical social sectors like healthcare, education, and poverty
alleviation programs. This could impede progress towards sustainable development goals and negatively
impact the well-being of Nepali citizens.
5. Hydropower Projects and Debt: Nepal's potential for hydropower generation is immense, and the
country has ambitions to develop this sector to meet its energy demands and even export surplus power.
However, financing large-scale hydropower projects often involves substantial borrowing, and delays
or cost overruns in these projects can exacerbate the debt situation.
6. Need for Sustainable Debt Management: To address the debt challenges, Nepal requires a
comprehensive strategy that focuses on sustainable debt management, revenue generation, economic
diversification, and reducing reliance on external borrowing. This could involve improving tax
collection systems, promoting private sector growth, and enhancing governance to ensure efficient use
of borrowed funds.
In Nepal's context, managing the balance between meeting development needs and avoiding a debt trap is
crucial. Prioritizing investments that yield sustainable economic returns, promoting transparency in
borrowing and spending, and diversifying the economy to reduce dependency on specific sectors can be
essential steps in addressing the country's debt challenges while fostering long-term growth and stability.