What is public debt?

When revenue is not sufficient to finance



spending, state borrows from various

sources.

Amount of funds borrowed by the state
plus other financial liabilities is called
public debt
 Public debt and private debt
o Similarities:

1) Like private debt, the public debt may

also be incurred either for consumption
or for investment purposes.
2) There is interest rate on both private and
public borrowings.
 Public debt and private debt
o Differences:

1) A private economic unit cannot borrow

internally, that is to say, it cannot borrow

from itself. However, the government

usually borrows internally, that is, from its

own subjects and from within the country

 Public debt and private debt
o Differences:

2) Unlike private debt that can be repaid out

of earnings or accumulated assets or by
borrowing from other sources, the public
debt can also be repaid by printing
currency
 Public debt and private debt
o Differences:

3) Unlike private debt that affect individual

borrower, public debt has a profound effect

on various dimensions of the economy such

as income distribution, capital formation,

unemployment and economic growth

 Classification of public debt
o Public debts can be classified according to
the sources of funds, activities being
financed or time within which debts have to
be completely repaid
o If government borrows domestically, it is
referred as internal debt, but when it
borrows from abroad, it is external debt
 Classification of public debt
o If the government borrows to finance
productive activities (education, energy,
infrastructures) it is productive debt, but
when it borrows to finance unproductive
issues such as HIV/AIDs campaign, it is
unproductive debt
 Classification of public debt

o Public debts incurred to be repaid within

a short period of time (5 years) are
called short term debts while public
debts incurred to be repaid after a long
period time (at least 10 years) are called
long-term public debts
 Why public debt?
o Inadequate tax revenues: a country borrows
when tax revenue is less than expenditure
o To reduce tax burden: borrowing could be an
alternative to heavy taxation
o To overcome natural calamities: a country
may borrow to finance disasters (floods,
hunger, wars, etc)
 Why public debt?

o To correct balance of payment deficit:

external debts can correct deficit in B.O.P
o Dept serving: government can take new
loan at lower interest rate to repay
previous loan carrying higher interest rate
 Why public debt?
o Modern governments borrow to achieve
specific objectives including those of
capital formation, economic growth and
economic stability. This can be done by
investing borrowed funds in various
development projects
 Methods of National Debts Redemption
i. Conversion: the government can get new
loan at low rate of interest and use it to
repay previous loan carrying high interest
rate
ii. Sinking fund: the government can create a
sinking fund and after sometimes use it to
repay the national debt
 Methods of National Debts Redemption
iii. Capital levy: this is a special tax imposed by
the government on rich people to repay the
debt
iv. Use of surplus budget: if the budget of the
government is surplus during a particular
year then this surplus can be used to repay
the debt
 Methods of National Debts Redemption

v. Printing money: unlike private debts,

government can issue currencies through
its Central Bank to repay its Debts
obligations. However, this approach is
not healthy to the economy because it
may cause inflation
 Burden of public debt

o If debt was internal, it will increase no

burden to the future generation. This is
because when the debt is paid off there
will be a transfer of income from one
group of citizens to the other (i.e.
repayment involves no capital outflow)
 Burden of public debt
• If debt was external and used for productive
purposes which eventually increased
production; the loan plus accrued interest can
be repaid out of the increased production. In
this case the debt will have no burden and
instead will make future generation better off
 Burden of public debt
• If debt was external and used for
unproductive purposes, future generation
will certainly bear a burden to pay the debt
because the level of their consumption will
be reduced by an amount equal to the loan
plus the accrued interest (repayment
involves capital outflow)
 Burden of public debt

o According to Taylor, if debt is owed to citizens or

governments of other societies, its payments
represent deductions from national product, and
standard of social welfare is also reduced.
Therefore, investment of funds borrowed from
abroad produces less net return to the borrowing
economy than would similar investment of funds
provided at home.
 Burden of public debt

• Pigous stated that Loans raised from foreigners

entail a burden represented in interest and sinking
fund on future generations in the borrowing
country. But interest and sinking fund on internal
loans are merely transfers from one set of people
in the country to another set, so that the two sets -
future generations - are not burdened at all - it is
the present generation that pays.
 Burden of public debt

• From these statements implication is that,

when a community is faced with the two
options, its choice determines the location of
the real burden of the debt. If it chooses
external loan, the burden is shifted to ``future
generations''; if it selects the internal loan,
the present generation will bear the sacrifice
Measures that can be used to reduce debt burden
o Strengthening tax system: the government
should reduce tax exemption and increase
efforts to control tax evasion and
avoidance
o Reduce public expenditure: Government
may cut down un-necessary expenditures
to avoid borrowing
Measures that can be used to reduce debt burden

o Borrowing for investment purpose: if

government borrows to increase capital
stock and productive capacity of a
country, then there will be no burden
 Sustainability of the National Debt
o is the ability of a country to repay its debt
obligations without requiring debt relief or
accumulating arrears. Tanzania manages its
debt in line with the National Debt Strategy
of 2002 and the Government Loans,
Guarantees and Grants Act No. 30 of 1974
as amended in 2004
 Sustainability of the National Debt

o The ratio of present value of the national

debt to gross domestic product should be
less than 50% (Debt/GDP x 100 < 50%)
o The ratio of present value of the national
debt to export should be less than 200%
(Debt/Export x 100 < 200%)
 Sustainability of the National Debt

o The ratio of present value of the

national debt to revenue should be
less than 300% (Debt/Revenues x
100 < 300%)
 Sustainability of the National Debt
• Suppose the present value of public debt of a
country Z is 35 trillion while its total final
output values 95 trillion, of which 15 trillion
is meant for export. If the government revenue
and expenditure are 13 trillion and 17
trillion, respectively. Analyze the Debt
Sustainability of this country and give
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