PUBLIC DEBT
Learning objectives of this subtopic are:
1. To define what public debt is.
2. Identify sources of public debt
3. Classify different types of public debt
4. Determine the need for public debt
5. Effects of public debt
6. Management of Public Debt
7. Redemption of public debt
1.0 Meaning of public debt.
National debts are what a state owes to its own subjects or to the nationals of other countries. Public debt
is emerging to be the second major source of government revenue after taxation. Unlike for taxation,
public debt means the government has to pay interests and repay the principal to the creditors.
2.0 Sources of public debt
There are two main sources of public borrowings namely; -
Internal and
External.
2.1 Internal sources:
Government borrows from individuals, corporations, non-banking financial institutions, commercial
banks based in Kenya or from the central bank of Kenya. These local creditors lend to the government
through buying treasury bills or government bonds. Treasury bills and bonds are considered to be free
from default risks and therefore safe.
2.2 External sources:
Externally, the government borrows from other countries other than Kenya in the form of foreign capital
that enters the country either as private capital and/or public capital. Private foreign capital may take the
form of direct or indirect investments in Kenya. While public foreign capital may consist of bilateral
loans e.g. loans given by the British government in Sterling Pounds to Kenyan government, multilateral
loans (e.g. loans from IMF, World Bank, UNDP) and even at times Intergovernmental grants.
3.0 Classifications / types of public debts
Public debts are of various kinds and include the following:
3.1 Voluntary and compulsory debt.
Voluntary Debt is money taken by the government without any force or coercion. People lend it to the
government voluntarily. Actually all public debts are voluntarily. However, sometimes the government
compels the people to buy governments bonds e.g. in case of a war or a national emergency. These are
examples of compulsory debts.
3.2 Funded and unfunded debts
Funded debt is a long term debt for a definite period. The interest rate to be paid, with terms and
conditions of repayment are clearly stated in the debt instrument (certificate). In order to repay the debt, a
debt fund is created in which some money is deposited every year by the government. The debt is repaid
out of this fund on maturity.
Unfunded debt is for a short period usually less than a year. In this case, the government does not create
any separate fund from which the loan could be repaid. Therefore such a debt is repaid out normal
budgetary allocations or current receipts often by floating additional bonds in the market. For this reason
unfounded debts are also referred to as floating debt.
3.3 Productive and unproductive debt.
Productive (reproductive) loans are debts that are fully covered by assets of equal or greater value and the
source of the interest payment is obtained from income those investments e.g railways, oil pipeline,
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, airports, power generation plant etc. therefore a debt considered as productive when it is applied to
finance an income generating investment and ultimately both its interest payments and principle
repayment are obtained from the profits or surplus from such investments.
On the other hand, am unproductive debt does not increase the productive capacity of the economy as it
does not backed by any existing assets e.g. loans taken by the government for covering the budget deficit
or to help during war, famine, earthquake, flood and famine victims etc. would not bring additional
revenue to the government and are therefore referred to dead-weight debts.
3.4 Redeemable and irredeemable debt
Redeemable debt is a loan that is repayable by the government after a fixed period of time. The interest
on such a loan is paid by the government regularly e.g. quarterly, semi-annually or even annually. At
maturity the government pays back the total principal amount to its lenders. To repay the loan’s principal,
the government either creates a fund in which a fixed amount is deposited every year or raises the amount
through additional taxation.
Irredeemable debt is a loan that its principal amount is not refundable. However, for such a loan the
interest is paid regularly for life e.g. compulsory debt acquired by government during a time of war may
be non-redeemable with the lender only receiving interest.
3.5 Internal and external debt
Internal debt is money raised by the government from individuals, institutions etc. within the country
while external debt is that raised from persons or institutions residing outside the country such as the
IMF, World Bank etc.
4.0 Need for public debt
The reasons most government have for public borrowing includes the following:
4.1 Deficit budget
The government borrows when it is running on a deficit budget. The budget gap could be closed by
raising the existing tax rates or levying new taxes. However, tax measures take a long time to translate
into public revenue. Revenue could be obtained quickly by giving a particular date for the subscription of
a loan, the government obtain revenue immediately and meet its requirements or obligations immediately
and this is the reason why governments prefer debt to other sources of revenue like additional taxes.
4.2 War
To finance war campaigns, the government would borrow from the public. During a war, the
government’s expenditure increases many times to fund armaments, soldier’s upkeep and other military
logistics. War increased spending can be met by raising public loans on a large scale rather than through
taxation.
4.3 Natural calamities
Natural calamities like earthquakes, floods, famine etc. tend to occur when the government has exhausted
its normal budgetary resources. The related increase in government expenditure to provide relief to the
victims necessitates quick funding and that usually results in large scale public borrowing by the
governments.
4.4 Economic development
Both developed and developing countries borrow to fund their economic development budgets. However,
developing countries do not have sufficient resources to finance their capital projects plans because their
economics are still small.
Developing countries borrow for the development of agriculture, industry, power, transport,
communication etc. Developed countries also still borrow to modernize their existing infrastructure like
roads, railways, powers, etc.
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Learning objectives of this subtopic are:
1. To define what public debt is.
2. Identify sources of public debt
3. Classify different types of public debt
4. Determine the need for public debt
5. Effects of public debt
6. Management of Public Debt
7. Redemption of public debt
1.0 Meaning of public debt.
National debts are what a state owes to its own subjects or to the nationals of other countries. Public debt
is emerging to be the second major source of government revenue after taxation. Unlike for taxation,
public debt means the government has to pay interests and repay the principal to the creditors.
2.0 Sources of public debt
There are two main sources of public borrowings namely; -
Internal and
External.
2.1 Internal sources:
Government borrows from individuals, corporations, non-banking financial institutions, commercial
banks based in Kenya or from the central bank of Kenya. These local creditors lend to the government
through buying treasury bills or government bonds. Treasury bills and bonds are considered to be free
from default risks and therefore safe.
2.2 External sources:
Externally, the government borrows from other countries other than Kenya in the form of foreign capital
that enters the country either as private capital and/or public capital. Private foreign capital may take the
form of direct or indirect investments in Kenya. While public foreign capital may consist of bilateral
loans e.g. loans given by the British government in Sterling Pounds to Kenyan government, multilateral
loans (e.g. loans from IMF, World Bank, UNDP) and even at times Intergovernmental grants.
3.0 Classifications / types of public debts
Public debts are of various kinds and include the following:
3.1 Voluntary and compulsory debt.
Voluntary Debt is money taken by the government without any force or coercion. People lend it to the
government voluntarily. Actually all public debts are voluntarily. However, sometimes the government
compels the people to buy governments bonds e.g. in case of a war or a national emergency. These are
examples of compulsory debts.
3.2 Funded and unfunded debts
Funded debt is a long term debt for a definite period. The interest rate to be paid, with terms and
conditions of repayment are clearly stated in the debt instrument (certificate). In order to repay the debt, a
debt fund is created in which some money is deposited every year by the government. The debt is repaid
out of this fund on maturity.
Unfunded debt is for a short period usually less than a year. In this case, the government does not create
any separate fund from which the loan could be repaid. Therefore such a debt is repaid out normal
budgetary allocations or current receipts often by floating additional bonds in the market. For this reason
unfounded debts are also referred to as floating debt.
3.3 Productive and unproductive debt.
Productive (reproductive) loans are debts that are fully covered by assets of equal or greater value and the
source of the interest payment is obtained from income those investments e.g railways, oil pipeline,
Page 1 of 5
, airports, power generation plant etc. therefore a debt considered as productive when it is applied to
finance an income generating investment and ultimately both its interest payments and principle
repayment are obtained from the profits or surplus from such investments.
On the other hand, am unproductive debt does not increase the productive capacity of the economy as it
does not backed by any existing assets e.g. loans taken by the government for covering the budget deficit
or to help during war, famine, earthquake, flood and famine victims etc. would not bring additional
revenue to the government and are therefore referred to dead-weight debts.
3.4 Redeemable and irredeemable debt
Redeemable debt is a loan that is repayable by the government after a fixed period of time. The interest
on such a loan is paid by the government regularly e.g. quarterly, semi-annually or even annually. At
maturity the government pays back the total principal amount to its lenders. To repay the loan’s principal,
the government either creates a fund in which a fixed amount is deposited every year or raises the amount
through additional taxation.
Irredeemable debt is a loan that its principal amount is not refundable. However, for such a loan the
interest is paid regularly for life e.g. compulsory debt acquired by government during a time of war may
be non-redeemable with the lender only receiving interest.
3.5 Internal and external debt
Internal debt is money raised by the government from individuals, institutions etc. within the country
while external debt is that raised from persons or institutions residing outside the country such as the
IMF, World Bank etc.
4.0 Need for public debt
The reasons most government have for public borrowing includes the following:
4.1 Deficit budget
The government borrows when it is running on a deficit budget. The budget gap could be closed by
raising the existing tax rates or levying new taxes. However, tax measures take a long time to translate
into public revenue. Revenue could be obtained quickly by giving a particular date for the subscription of
a loan, the government obtain revenue immediately and meet its requirements or obligations immediately
and this is the reason why governments prefer debt to other sources of revenue like additional taxes.
4.2 War
To finance war campaigns, the government would borrow from the public. During a war, the
government’s expenditure increases many times to fund armaments, soldier’s upkeep and other military
logistics. War increased spending can be met by raising public loans on a large scale rather than through
taxation.
4.3 Natural calamities
Natural calamities like earthquakes, floods, famine etc. tend to occur when the government has exhausted
its normal budgetary resources. The related increase in government expenditure to provide relief to the
victims necessitates quick funding and that usually results in large scale public borrowing by the
governments.
4.4 Economic development
Both developed and developing countries borrow to fund their economic development budgets. However,
developing countries do not have sufficient resources to finance their capital projects plans because their
economics are still small.
Developing countries borrow for the development of agriculture, industry, power, transport,
communication etc. Developed countries also still borrow to modernize their existing infrastructure like
roads, railways, powers, etc.
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