Principle of Public Debt Management and Debt Repayment

As discussed, over a period of time, public debt has assumed greater significance in the economic policy formulation of any nation. Public debt brings with it the resources required for planning economic success. However, it is not without cost.

As we already know, public debt poses an enormous burden on an economy. Hence, the management of public debt occupies an important position in the decision-making process of economists, policy-makers, politicians etc.

J. M. Buchanan defines “public debt management, as such, is defined to include that set of operations which must be performed by the treasury department in “maintaining” a national debt. That is to say, debt management takes place even when no debt is being created and no old debt is being retired, in net terms.”

In simple terms, Public debt management refers to the determination of objectives of public debt by the fiscal and monetary authorities, the size and composition of debt, the terms of the debt, the maturity pattern and interest rates, the redemption of debt etc.

Public debt holds profound importance for the social-economic and political health of an economy. Lal (1978) identifies the objectives of debt management as “The efficient functioning of the public debt management machinery warrants that public borrowing program should be so conducted, the securities should be so issued that the maturity mix- from non-marketable to marketable, from long-term to very short-term securities – should be so determined; the interest rates on the securities should be so fixed; the refunding, conversion and monetization of the debt should be so managed and finally for meeting the interest burden as well as the repayment of the principal …………………………………………………… without jeopardizing the development process in the under developed countries”.

Objectives of Public Debt Management:

• The first objective is to repay loans at the earliest. It means funding as much debt as possible.
• The second objective is to secure loans at low cost, i.e. minimization of the interest cost of the public debt.
• The third objective of public debt management is to meet the needs and interests of various classes of investors.
• The fourth objective is to ensure economic stability, mobilize savings, and promote economic growth and effective coordination between the economic activities of the government and of the central bank.

Principles of Public Debt Management

The following are the broad principles for the management of public debt:

● Low Interest Cost on Servicing Debt: The objective of debt management is to secure debt at a low cost, and interest on debt servicing should be minimum. Debt servicing forces government to raise taxes posing an additional burden on present and future generations. With ever-growing needs and increasing government activities, it is not easy to secure huge amounts of debt at a low cost.

Moreover, this objective is in conflict with the objective of price stability. Maintenance of low market interest rates may lead to inflationary pressures due to a rise in aggregate demand. Effective debt management requires a reconciliation of such conflicting objectives.

● Meeting the Needs of Investors: An effective debt management policy should aim at fulfilling the needs of various classes of investors. The structure, terms of debt, liability schedule, etc., should satisfy the largest number of the population. A balance must be maintained between various methods of debt repayment. Debt servicing through additional money can lead to inflation, whereas through additional taxes can lead to deflation.

● Coordination Between Monetary, Fiscal Policies and Public Debt Policy: The three policies play a significant role in ensuring the proper health of the economy. Hence the three must work in unison to ensure economic stability and economic growth.

● Funding of Short-term and Long-term Debt: The funding of short-term and long-term debt requires an increase in the rate of interest. But a rise in interest rate will negatively impact investment behaviour and can cause an economic downturn. Thus, funding operations must be carefully undertaken to ensure economic stability.

Repayment of Public Debt

It is to the advantage of any economy to pay off public debt as soon as possible as it poses a serious burden for the present and future generations. Timely redemption saves resources for private investment, preserves investor confidence, reduces the cost of debt management, saves the government from bankruptcy and thus ensures economic well-being.

The following are the important methods of public debt repayment:

● Refunding: Refunding of debt implies the issue of new bonds and securities by the government in order to replace the maturing bonds. Hereby, the government, through the issue of new bonds, gives an option to the existing bondholders to subscribe to new debt by surrendering the old. Thus, the money burden of debt is not relinquished and is accumulated owing to the postponement of debt repayment.

● Conversion: Under this method, existing loans are converted, before maturity, into new loans at an advantage in servicing charges, i.e. to move from high-interest debt to low-interest debt. Converting old loans into new ones at a lower rate of interest reduces the debt-servicing burden. Apart from reducing costs, conversion reduces the burden of interest on the taxpayers. The success of the conversion will depend on various factors such as efficiency in public debt management, creditworthiness of the government and maintenance of adequate stocks of securities etc.

● Surplus Budgets: Any excess of public revenue over expenditure can be utilized to pay off public debts. However, given the ever-increasing public expenditures, a surplus budget is a rare phenomenon. Moreover, the imposition of higher taxes or reduction in public expenditure to achieve a surplus budget can have dire consequences for the economy.

● Sinking Fund: The government creates a sinking fund for the purpose of debt repayment. The government sets aside a part of current public revenue every year in such a way that it would be sufficient to pay off the funded debt at the time of maturity. It is the best method of debt repayment as the burden of public debt is least felt, as the tax burden is spread evenly over the period of the accumulation of the fund.

● Terminable Annuities: The government issues terminable annuities to the bondholders that mature annually. Hereby, public debt is cleared off in annual instalments, and the debt burden is gradually reduced.

● Additional Taxation: It is perhaps the simplest method of debt repayment. Hereby, by imposing new taxes, the government generates additional revenues to pay off debt and interest. The method is criticised on the grounds that it leads to the transfer of resources from taxpayers to bondholders. It may also impose a burden on the future generation if new taxes are levied to repay long-term debts.

● Capital Levy: It involves the imposition of a heavy tax on capital such as property and wealth. It is once- for all tax on capital assets and estates. It poses the least burden on society.

● Surplus Balance of Payments: The above methods were useful for the repayment of internal debt; however, repayment of external debt requires the accumulation of foreign exchange reserves. Hence a debtor country must ensure a favourable balance of payments by augmenting its exports and curbing its imports. Further, debt raised must be productively utilized so that it may become self-liquidating, posing no real burden on the economy.

Given the linkages between fiscal, monetary and public debt policies efficacy of public debt management is an important factor in the overall health of the economy. For countries where public debt has reached enormous levels, the governments must try to achieve a reconciliation of conflicting objectives apart from early and easy redemption of their public debt, which already poses a greater risk for their economies, as recently in the case of Greece’s economy’s fallout.

Read More in: Theory of Public Finance

1. Public Finance: Meaning, Nature & Scope
2. Role of Government in Economy
3. Role of Government in Mixed Economy: Public & Private Sector
4. Role of Government under Cooperation and Competition
5. Role of Government in Economic Development and Planning
6. Concept of Public Goods, Private Goods, and Merit Goods
7. Concept of Market Failure and Functions of Government
8. Market Failure and Functions of Government: Decreasing Costs
9. Market Failure and Functions of Government: Externalities
10. Market Failure and Functions of Government: Public Goods
11. Future Market: Meaning, Role & Uncertainty
12. Concept of Information Asymmetry
13. Theory of Second Best: Concept & Explanation
14. Problem of Allocation of Resources: Public & Private Mechanisms
15. Preferences: Meaning, Types & Problems of Preference Revelation
16. Preference Aggregation & Its Mechanism
17. Voting Systems, Direct Democracy, Representative Democracy, Leviathan Hypothesis & Arrow’s Impossibility Theorem
18. Economic Theory of Democracy: Concept & Explanation
19. Politico Eco Bureaucracy: Concept & Explanation
20. Rent-Seeking and Directly Unproductive Profit-Seeking Activities
21. Rationale for Public Goods: Concept & Explanation
22. Benefit Theory or Voluntary Exchange Theory
23. Lindahl Model: Concept, Equilibrium & Limitations
24. Bowen Model: Concept, Advantages & Limitations
25. Samuelson’s Model of Public Expenditure
26. Musgrave’s Model of Public Expenditures
27. Demand Revealing Schemes for Public Goods
28. Vickery-Clarke-Groves Mechanism
29. Groves-Ledyard Mechanism
30. Tiebout Model: Concept, Assumptions Equilibrium & Simple Tiebout Model
31. Theory of Club Goods
32. Keynesian Principles of Stabilization Policy
33. Difference Between Keynesian Economic Thought and Others
34. Role of Expectations and Uncertainty in Formulating Stabilization Policy
35. Intertemporal Markets Efficiency & Failure
36. Liquidity Preference Theory
37. Diamond-Dybvig Banking Model
38. Preference Shocks, Adverse Selection & Central Bank
39. Equilibrium Deposit Contract
40. Social Goods and Its Effect on Stabilization Policy
41. Effect of Infrastructural Facilities on Stabilization Policy
42. Effect of Distributional Inequality on Stabilization Policy
43. Effect of Regional Imbalances on Stabilization Policy
44. Wagner’s Law of Increasing State Activities: Explanation, Graph & Criticism
45. Peacock-Wiseman Hypothesis: Explanation, Graph & Criticism
46. Public Expenditure: Concept, Objectives, & Public vs Private Expenditure
47. Pure Theory of Public Expenditure
48. Structure & Growth of Public Expenditure in India
49. Trends, Lessons & Priorities in Public Expenditure in India
50. Social Cost-Benefit Analysis: Project Evaluation, Estimation of Costs & Discount Rate
51. Performance Based Budgeting and Zero Based Budgeting
52. Theories of Tax Incidence: Concentration Theory, Diffusion Theory & Modern Theory
53. Tax System and Its Principles
54. Equity Principle and Efficiency Principle of Taxation: Meaning, Explanation & Examples
55. Ability to Pay and Benefits Received Principle of Taxation
56. Theory of Optimal Taxation: Excess Burden & Distortions of Taxation
57. Deadweight Loss of Taxation: Causes, Measurement & Example
58. Concept of Equity & Efficiency in Economics
59. Trade-Off Between Equity and Efficiency: Meaning & Example
60. Theory of Measurement of Dead Weight Loss
61. Double Taxation: Meaning, Desirability, Forms & Solution
62. Solution to Problem of Double Taxation: Intra-Country & International
63. Double Taxation Avoidance Agreement (DTAA) and Indian Policy
64. Classical View on Public Debt
65. Compensatory Aspect of Public Debt Policy
66. Public Debt or Borrowings: Concept, Need, Sources & Types
67. Concept of Public Debt or Public Borrowings
68. Need for Public Debt or Public Borrowing
69. Sources of Public Debt
70. Classification of Public Debt
71. Burden of Public Debt: Meaning, Types & Explanation
72. Debt Through Created Money or Deficit Financing
73. Public Debt (Public Borrowings) and Inflation (Price Level)
74. Crowding Out of Private Investment and Activity
75. Principle of Public Debt Management and Debt Repayment