FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Public Debt

Updated on April 15, 2024
Article byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

What is Public Debt?

The public debt is the fund borrowed by a nation’s government. Governments borrow from people, banks, organizations, and other countries. It is an aggregation of all internal and external debt liabilities pertaining to a nation.

When the government runs into a budget deficit, it must borrow funds from various sources. In addition, governments borrow funds for public welfare schemes, wars, nuclear programs, and infrastructure projects. Public debt is also used for reviving dysfunctional public sector enterprises.

Key Takeaways

  • Public debt or sovereign debt refers to the outstanding loans borrowed by a government from individuals, financial institutions, companies, other nations, or international organizations.
  • The sovereign debt has a revenue effect on the economy. It influences the nation’s consumption expenditure. Sovereign debts also have an expenditure effect; acquired funds are used for specific funding purposes. They are not used to cover general expenses.
  • When a sovereign loan is taken for income-generating activities like developing irrigation facilities, it is considered a productive debt; funding a war with loans is considered an unproductive debt.

Public Debt Explained

The government often borrows money domestically or internationally to meet the nation’s financial needs. The loan could be for the short, medium, or long term. The public debt or the sovereign debt helps a government-run, build, and develop the country.

Public Debt Explained

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Public Debt (wallstreetmojo.com)

For example, governments take loans to cover budget deficits, infrastructure projects, wars, nuclear programs, public welfare schemes, or for the operation of public corporations. But if a country keeps borrowing excessively, the debts will pile up. Excessive debts are caused by the misuse of revenue, tax cuts, tax relaxations, low revenue from taxes, natural calamities, and disasters.

However, public debt burdens the national expenditure. On top of the principal amount, the government has to pay interest for the loans—installments are hefty. Further, for loan repayment, the public is taxed heavily. External debts can affect nations adversely—they restrict economic growth and development. Sometimes, countries take many years to clear their sovereign debt.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Types of Public Debt

Public debts are classified based on the source, the reason for borrowing, terms, and tenure:

#1 – Internal and External Debt

Internal debt is the loan acquired from the people, banks, or companies within the nation in the local currency. In contrast, external debt includes the funds borrowed in foreign currency from other countries or international organizations.

#2 – Productive and Unproductive Debt

When a sovereign loan is taken for income-generating activities like developing irrigation facilities, electricity plants, or roadways, railways, and bridges, it is considered a productive debt. However, funding a war with loans is considered an unproductive debt.

#3 – Redeemable and Irredeemable Debt

Loans with fixed future repayment dates or maturity dates are called redeemable debts. In comparison, loans without fixed repayment dates are called irredeemable debts. With irredeemable loans, governments are not required to pay regular interests.

#4 – Voluntary and Compulsory Loans

When the government issues debt securities to raise funds from individuals, firms, and financial institutions, it is considered a voluntary loan. On the other hand, debts that bind people to a compulsory contribution or mandate taxpayers to deposit a sum are considered compulsory loans.

#5 – Short-Term and Long-Term Debt

Sovereign loans that are repaid within one year are considered short-term debt. Long-term loans are paid back in ten years or more.

Examples

#1 – US

In May 2022, the US owed a public debt of $30.49 trillion. Since 2000, United States’ debt has been rising. It has become a major concern for the federal government.

This value includes intragovernmental debt owed to Social Security and public debts such as bonds and treasury bills. There is political strife between the Democrats and Republicans on how to manage indebtedness.

The government facilitated tax cuts and stimulus packages to aid people during the Great Recession and the Covid-19 Pandemic, but these measures led to a rise in US public debt.

#2 – India

In December 2021, India owed a public debt of ₹117633514.3 million. The sum is further divided into two—₹8168293.6 million is owed as external debt and ₹109465220.7 million as internal debt.

Effects of Public Debt

Sovereign debt affects a nation in the following ways:

#1 – Revenue Effect

When the government acquires funds by releasing government securities, citizens either reduce their expenses or save more to invest in such assets. It thus impacts the nation’s consumption expenditure. Consumption expenditure is the amount spent on goods and services for meeting the needs of individuals and communities.

#2 – Expenditure Effect

The expenditure of borrowed funds is different from that of the tax revenue. It is usually used for special purposes like infrastructure development, welfare programs, or meeting war expenses. Tax revenue, on the other hand, is used for regular expenses.

#3 – Other Effects

The sovereign debt also influences other national aspects—production, distribution, consumption, employment, cost of production, and investment.

Frequently Asked Questions (FAQs)

What are the sources of public debt?

Two sources of sovereign debts are as follows:
Internal: The government can borrow funds domestically in local currency from individuals, financial institutions, and private organizations.
External: The other way of acquiring funds is from foreign countries or international organizations. It could be an international financial institution, an economic forum, or a foreign donor.

What are the causes of public debt?

The government borrows funds for the following reasons:
1. To run public welfare schemes.
2. Infrastructure development.
3. To revive dysfunctional public corporations.
4. To meet the budget deficit.
5. To fund wars and nuclear programs.

What are the effects of public debt?

The public debt results in revenue and expenditure effects. The public debt, when acquired from individuals through the sale of government securities, impacts their consumption expenditure. Also, the proceeds from such loans are utilized for specific purposes.

What is the difference between public debt and private debt?

Sovereign debt is a loan acquired by a nation. Governments borrow from individuals, organizations, financial institutions, other countries, and international organizations. Treasury bills and government securities fall into that category. On the other hand, loans availed by private companies or individuals are called private debts. Personal loans, business loans, credit cards, and lines of credit are examples of private debt.

This has been a guide to What is Public Debt and its meaning. We discuss public debt types, effects, & examples from countries like US, & India. You can learn more about it from the following articles –