Classification of Public Debt

What is Public Debt?

Public debt is defined as a specific amount that also consists of liabilities borrowed by the government from the public for various public needs and developments. Government can borrow this debt from the public, banks, other financial institutions, and even from foreign countries. The debt borrowed from other foreign countries is known as external debt; whereas, debt borrowed from the same country is known as internal debt. The debt can be short, long, or medium-term. Therefore according to their use and their nature, they are classified into various types. 

Classification of Public Debt

Public debt is classified based on various parameters such as duration, type of payment, promises, funds, etc. Below is the detailed classification of public debt:

1. Productive and Unproductive Debt

Upon the basis of the purpose of the loan, the public debt is classified as Productive and Unproductive Debt.

Productive Debt

Productive debt is also known as Reproductive Debt. When public debt is used for income-earning enterprises it is known as productive debt. When government bodies raise loans for increasing the productive power of the economy of the country it is often known as productive debt. These types of loans are invested by the government for irrigation, water, railway projects, etc. When the government spends the money raised from such debts on productive purposes, it increases the revenue of the government from which it can easily pay the interest on the debt.

For example, the Government takes a loan to start a new factory that will provide employment opportunities for citizens as well as increase the revenue and income of the government. This loan will help the government to increase its income and maintain the economic condition of the country by providing employment opportunities for the citizens.

Unproductive Debt

Unproductive Debt is defined as a type of debt that does not involve any type of productive assets for the country, making it difficult for the government to repay such debts. This type of debt does not add any significant value to the economy of the country. It is also known as Dead Weight Debt. Unproductive types of loans are taken for tasks such as war, and expenditure on the administration of the public. 

For example, the Government takes loans for building their offices. Building this office will not affect the economy of the country as well as it will not benefit the citizens on a large scale. In certain situations, when the loan taken is very high and accordingly the money is not used for things that are not required leads to more problems.

2. Voluntary and Forced Debt

The public debt that is taken from the people is classified as voluntary and forced debt.

Voluntary Debt

When the government and organisation of a country are democratic, the government raises loans for the country. When government takes a loan from the people, voluntarily, the type of loan is known as Voluntary Debt. When the financial condition of the people and government is okay, people are willing to provide the government with debts for the country. The rate of interest payable on these loans is more than that of the interest payable on forced debt.

For example, Government takes loans from the citizens along with their own will to provide them with a house or flat system for living. In such conditions, even the citizens agree and provide the loan to the government.

Forced Debt

When the government takes loans from people forcefully without their will, especially during natural calamities, disasters, or wars. Such types of loans are known as Forced Debt. Forced Debts are borrowed when the economic condition is not proper. During such periods even if people are facing financial issues or are not willing to provide the government with such loans, they are forced to provide the government with debt. The rate of interest payable on these debts is also low.

For example, in 1964, the Indian government decided to take forced debt from the public under the Compulsory Deposits Scheme. However, it was scrapped at a later date due to stiff public opposition.

3. Internal and External Debt

When loans are taken within or outside the country, they are classified as Internal or External Debt.

Internal Debt

When debt is being taken by the country from its residents, financial institutions, or through other methods, it is known as Internal Debt. Taking internal debt can be voluntary or forced. Internal debts are controllable and can be estimated easily. The sources of internal debt include domestic financial institutions such as commercial banks, etc. The interest rate for such internal debt is also less as compared to external debt. However, these debts do not increase the total availability of resources within the country.

For example, the Government wants to start a new small infrastructure-related project. For this government takes a loan that is public debt from the country’s National Bank for a certain amount of time. 

External Debt

When debt is being taken by the country from other foreign countries, then the type of debt is known as External Debt. External debts are difficult to estimate. These debts are taken from international banks or financial institutions in other countries. When a huge investment or loan is required that cannot be provided within the country then the government goes for external debt. The interest rate on such debts is quite high, making it a less suitable source of borrowing money than internal debt. Besides, external debt can also pose a threat to the country’s economic and political independence. 

For example, during a time of crisis, inflation, or recession, to maintain the economy of the country, the government takes a large debt from the World Bank.

4. Funded and Unfunded Debt

When debts are taken according to the period or duration, they are classified as funded and unfunded debts.

Funded Debts

The debts for which the government opens a separate fund to repay it, are known as Funded Debts. Funded Debts are secured, have fixed interests, and follow principles. The creditors that hold the bond have rights only for interest. The government has more time for such debts to return. This type of debt is used particularly for long-term or lengthy use by the government; therefore, is also known as Long-term Debt. 

For example, convertible bonds, debentures, long-term notes payables, etc.

Unfunded Debts

When debts are funded for a very short period, such as three months or six months, and the government has not prepared any separate fund for its repayment, they are known as Unfunded Debts. These are the types of debts that are redeemable within a single year. The government has less time to return the funds as compared to funded Debts. The government repays the principal amount of such debts by taking additional loans from the market; therefore, they are also known as Floating Debt.

For example, treasury bills are the most common example of unfunded debts. As treasury bills are used for a specific short period. These bills are paid within less than one year.

5. Redeemable and Non-redeemable Debt

When public debts are based on the feature of maturity, they are classified as redeemable and non-redeemable.

Redeemable Debt

When government promises to return the principal amount of money borrowed after a predetermined time period, the type of debt is known as Redeemable Debt. The government pays interest on such debts on a regular basis. Besides, to repay redeemable debts, the government of a country sets up a sinking fund and every year credits a fixed amount in it, and once the date of the debt expires, it pays the principal amount from this fund. This type of debt requires less time to return, and government works according to the date given while borrowing the money.

For example, The municipal corporation takes a public debt for a short period for certain development in the village. The government bodies take less time to return such debts.

Non-redeemable Debt

When the government never returns the principal amount of the money borrowed, it is known as Non-redeemable Debt. However, the government pays the interest on such debts permanently. This type of debt causes a permanent burden on the taxpayers, making it an undesirable type of public debt.

For example, Government takes public debt from the citizens for the implementation of a large project that requires more time. During such loans, the government does not makes promises it return it within the specific given time. It requires more time than redeemable debts.

6. Short-term, Medium-term, and Long-term Debt 

According to the period, debts are further classified as short-term, medium-term, and long-term debts.

Short-term Debts

When public debts are taken for a very short period such as three to nine months, they are known as Short-term Debts. These debts have a very small rate of interest as compared to medium and long-term debt. Within a less period, the returns are given to the people. Therefore this type of loan is majorly preferable for the citizens.

For example, Treasury Bills, Ways and Means Advances (WMA), etc.

Medium-term Debts

When public debts are taken by the government with a maturity period of two to three years, they are known as Medium-term Debts. Medium-term debts have an intermediate amount of interest. 

For example, Debt taken by the government to finance relief works is taken for a period of two to three years.

Long-term Debts

When public debts are taken for a very long term and are repayable after ten or more than ten years, they are known as Long-term Debts. Long-term debts mainly have a high rate of interest. These debts are majorly used for financial help in wars, education, and accidental calamities.

For example, Loan/debt taken by the government for developmental purposes.