Public debt is the total amount of debt borrowed by a government. It is when total liabilities of the Union Government needs to be paid from the Consolidated Fund of India (CFI). As of March 2021, India’s public debt as a percentage of gross domestic product (GDP) increased to 60.5% mainly due to the pandemic. In this article, we will study about the public debt which is important for the UPSC examination.

What is Public Debt?

• Public Debt is the total amount that includes external debt, internal debt and also total liabilities, borrowed by the government to meet its development expenses.
• It is to be paid from the Consolidated Fund of India. It can also refer to the overall liabilities of central and state governments. This is provided under Article 292 of the Indian Constitution.
• According to the Finance Ministry reports, in FY20, India's total debt burden as a percentage of GDP was 51.6 percent; in FY21, it was 60.5 percent.
• The debt-to-GDP ratio demonstrates the country's ability to repay its debt. The debt-to-GDP ratio is frequently used by investors to analyse the government's ability to service its debt. Increased debt-to-GDP ratios have fueled global economic crises.

Reasons For Borrowing/Public Debt

• The income generated is not sufficient to carry out the required expenditure.
• Presently the tax part of national income is less than 20%, hence there is a small share of taxes in the national income.
• There is greater reliance on indirect taxation and therefore most of the pressure falls on lower-class strata.
• Asymmetrical institutional setup for taxation for instance complex tax systems with greater tax evasion.
• There is a gross misuse of public funds due to corruption, wasteful projects, red-tapism etc.
• In order to accomplish various government schemes and plans financial resources are needed.
• Lately, the increase in Public Debt has been mainly due to the following reasons.
  • Total central government debt was increased in both absolute terms and as a percentage of GDP that fiscal due to bank recapitalization.
  • Due to the issuing of Ujwal Discom Assurance Yojana (UDAY) bonds, there has been an increase in liabilities of states which have increased during 2015-16 and 2016-17.
  • There is a small share of taxes in national income, most of which comes from indirect taxes.
  • Asymmetric taxation systems with high tax evasion because of increased loopholes in the tax system.
  • Misuse of public funds due to corruption, bribe, and red-tapism available and the work done is completed with great difficulty.

Classification of Public Debt

Internal Debt

• They are the public debt borrowed from within the country.
• Major sources of funds for internal debt include commercial banks and financial institutions.
• Here the government obtains finance by borrowing and not by creating de novo. It is rarely spent on goods and services.

External Debt

• It is when debt is taken from individuals and organizations living outside the country.
• Here borrowing is from commercial banks, governments or international financial organizations.

Productive Debt

• These are those debts that are used to generate income from sources such as railway, plans for electricity, plans of irrigation, etc.
• The income generated from such plans can be used for the payment of yearly interest and for the payment of principal. Such debts put pressure on the taxpayer and the government.

Unproductive Debt

Such debts are incurred on assets that do not generate income. In such debts at some point, there are losses of interest also.

Redeemable/Terminable Debt

These are those debts in which the government promises that they would pay back the debt on a fixed date later. These debts are also called terminable debts.

Irredeemable Debt/Perpetual Debt

• These are those debts that are done without any promise to be paid back later.
• When debts are not paid back on time then the governments decide on specific arrangements to pay back the debt such as whether such debts need to be paid back from the taxable income, etc.

Funded Debt

Such debts are long term in nature. Payment of these debts is to be done within one year or it can be possible, not to give any promise.

Unfunded debts

Such debts are given for three or six months and their time period is not more than one year such as treasury bonds, etc.

Short Term Debt

It is when the government takes debt for a short period. These debts are paid back within a year that is to be taken to complete the tenure of debts.

Long Term Debt

It is when the government takes debt for a long period of time. The period of giving it back is not fixed. In this type of debt, the giver got regular interest.

Advantages of Public Debt

• It increases the money supply that facilitates various industries in the country to increase production which in turn increases the national standard of life.
• It helps to counter various man-made (inflation, etc) and natural calamities (floods, landslides, etc).
• It is especially helpful for developing countries to allocate resources in various sectors of the economy.
• Equitable and suitable distribution of debts take place which promotes harmony and cooperation in public.
• Public debts are also regarded as secure sources of investment.
• It also helps in various non-economic benefits to nations such as better international relations between friendly nations.

Disadvantages of Public Debt

• There is increased misuse of the resources of the country as a large part of it is given as interests to foreign nations.
• There is a fear of going bankrupt in the near future especially in case of a global economic crisis.
• Extravagant spending can happen when resources are available easily. For instance, Greece had a debt to GDP ratio of 160% in 2009 due to extravagant spending.
• There can be international pressure and political interference in the domestic policies of the debtor nation.
• Increased burden of repayment on citizens in the form of increased taxation.
• Slower economic and weak economic development

Conclusion

Excessive public debt can lead to a higher premium in interest rate, this leads to a crowding effect where the amount of private investment in the economy and the overall growth of the economy is impacted. Although it stimulates aggregate demand in the short term but if not taken care of can lead to spiralling losses in the economy of a nation.

FAQs

Question: What is public debt?

Question: What are the types of public debt?

Question: How is public debt managed in India?

Question: What is the difference between public debt and fiscal deficit?

Question: Why is public debt important for an economy?

MCQs

1. What does internal public debt refer to?

a) Borrowing from foreign countries

b) Borrowing within the domestic market

c) Borrowing from international institutions

d) Issuing global bonds

2. Which entity manages India’s public debt?

a) Reserve Bank of India

b) Planning Commission

c) Ministry of Finance

d) SEBI

3. What is external debt?

a) Debt owed by private entities

b) Debt borrowed from foreign sources

c) Debt accumulated by state governments

d) Grants given by international bodies

4. Which of the following can lead to a higher public debt burden?

a) Budget surplus

b) Fiscal deficit

c) Increased foreign exchange reserves

d) Tax surplus

5. What is the primary risk of high public debt?

a) Increased foreign exchange reserves

b) Higher economic growth

c) Economic instability and inflation

d) Decreased fiscal deficit

GS Mains Questions and Model Answers

Q1: Analyze the impact of rising public debt on India’s economic growth and fiscal stability.

Answer: Rising public debt in India can have both positive and negative impacts. While borrowing helps finance large infrastructure projects and stimulate economic growth, high levels of public debt lead to fiscal instability. An increase in debt servicing costs diverts resources from developmental spending, leading to a reduced ability to invest in education, healthcare, and infrastructure. It also leads to inflationary pressure, a higher fiscal deficit, and increased borrowing costs. As a result, it reduces investor confidence and may hamper long-term economic growth.

Q2: Discuss the challenges of managing public debt in developing countries like India.

Answer: Developing countries like India face several challenges in managing public debt, such as a high fiscal deficit, low revenue generation, and dependence on external borrowings. Fluctuations in the global economy, such as changes in interest rates and currency exchange rates, make external debt servicing costly. High public debt also limits fiscal flexibility, leaving little room for governments to maneuver during economic crises. Additionally, rising interest payments on debt reduce the fiscal space available for public spending on infrastructure and welfare programs, further hindering growth.

Q3: Examine the relationship between fiscal deficit and public debt, and how it impacts economic policy in India.

Answer: The fiscal deficit is closely linked to public debt, as any shortfall in government revenue is met through borrowing, leading to increased public debt. A rising fiscal deficit indicates higher borrowing requirements, contributing to an accumulation of debt. This impacts economic policy by forcing the government to allocate a larger portion of its budget towards debt servicing, reducing spending on growth-enhancing sectors like infrastructure and social welfare. To manage this, the government may adopt austerity measures, raise taxes, or cut expenditures, which can have negative short-term effects on economic growth.

Previous Year Questions on Public Debt - Indian Economy Notes

1. UPSC CSE Prelims 2018:

Question: Public debt can be classified into which of the following categories?

A. Budgetary deficit and external debt

B. Internal debt and external debt

C. Revenue deficit and internal debt

D. Fiscal deficit and international debt

Answer: B

Explanation: Public debt is classified into internal debt (borrowed domestically) and external debt (borrowed from foreign sources).

2. UPSC CSE Mains 2017 (GS Paper 3):

Question: Discuss the implications of high public debt on India’s fiscal policy.

Answer: High public debt impacts fiscal policy by reducing the government’s ability to spend on development and welfare programs due to a higher share of the budget being allocated towards debt servicing. As interest payments on public debt rise, it leads to a higher fiscal deficit, further necessitating borrowing. This can cause a vicious cycle of debt accumulation, reduce fiscal space, and lead to economic instability. Additionally, high public debt can raise interest rates and crowd out private investment, limiting economic growth.

3. UPSC CSE Prelims 2017:

Question: Which of the following best explains fiscal deficit?

A. The difference between total revenue and total expenditure

B. The difference between capital and revenue deficit

C. The difference between the government's borrowings and public debt

D. The shortfall in a government’s income compared to its spending in a fiscal year

Answer: D

Explanation: Fiscal deficit refers to the difference between total government spending and its revenue (excluding borrowings) in a given fiscal year.