My Notes

What is Public Debt? Meaning ↓

Public debt or public borrowing is considered to be an important source of income to the government. If revenue collected through taxes & other sources is not adequate to cover government expenditure government may resort to borrowing. Such borrowings become necessary more in times of financial crises & emergencies like war, droughts, etc.

Public debt may be raised internally or externally. Internal debt refers to public debt floated within the country; while external debt refers loans floated outside the country.

The instrument of public debt take the form of government bonds or securities of various kinds. Such securities are drawn as a contract between the government & the lenders. By issuing securities the government raises a public loan & incurs a liability to repay both the principal & interest amount as per contract. In India, government issues treasury bills, post office savings certificates, National Saving Certificates as instrument of Public borrowings.

Classification / Types of Public Debt ↓

Government loans are of different kinds, they may differ in respect of time of repayment, the purpose, conditions of repayment, method of covering liability. Thus the debt may be classified into following types.

1. Productive and Unproductive debts

i. Productive debt:-

Public debt is said to be productive when it is raised for productive purposes and is used to add to the productive capacity of the economy.

As Dalton puts, productive debts are those which are fully covered by assets of equal or greater value.

If the borrowed money is invested in the construction of railways, irrigation projects, power generations, etc. It adds to the productive capacity of the economy and also provides a continuous flow of income to the government. The interest and principal amount is generally paid out of income earned by the government from these projects.

Productive loans are self-liquidating. Generally, such loans should be repaid within the lifetime of property. Thus, such loans does not cause any net burden on the
community.

ii. Unproductive debt:-

Unproductive debts are those which do not add to the productive capacity of the economy.

Unproductive debts are not necessarily self-liquidating. The interest and the principal amount may have to be paid from other sources of revenue, generally from taxation, and therefore, such debts are a burden on the community.

Public debt used for war, famine relief, social services, etc. is considered as unproductive debt.

However, such expenditures are not always bad because they may lead to well being of the community. But such loans are a net burden on the community since they are repaid generally through additional taxes.

2. Voluntary and Compulsory Debt ↓

i. Voluntary debt:-

These loans are provided by the members of the public on voluntary basis. Most of the loans obtained by the government are voluntary in nature. The voluntary debt may be obtained in the form of market loans, bonds, etc.

The Government makes an announcement in the media to obtain such loans. The rate of interest is normally higher than that of compulsory debt, in order to induce the people to provide loans to the government.

ii. Compulsory debt:-

A compulsory debt is a rare phenomenon in modern public finance unless there are some special circumstances like war or crisis. The rate of interest on such loans may be low. Considering the compulsion aspect; these loans are similar to tax, the only difference is that loans are rapid but tax is not.

In India, compulsory deposit scheme is an example of compulsory debt.

3. Internal and External Debt ↓

i. Internal debt:-

The government borrows funds from internal and external sources. Internal debt refers to the funds borrowed by the government from various sources within the country.

Over the years, the internal debt of the Central Government of India has increased from Rs.1.54 lakh crore in 1990-91 to Rs.13.4 lakh crore in 2005-06.

The various internal sources from which the government borrows include individuals, banks, business firms, and others. The various instruments of internal debt include market loans, bonds, treasury bills, ways and means advances, etc.

Internal debt is repayable only in domestic currency. It imply a redistribution of income and wealth within the country & therefore it has no direct money burden.

ii. External debt:-

External loans are raised from foreign countries or international institutions. These loans are repayable in foreign currencies. External loans help to take up various developmental programmes in developing and underdeveloped countries. These loans are usually voluntary.

An external loan involves, initially a transfer of resources from foreign countries to the domestic country but when interest and principal amount are being repaid a transfer of resources takes place in the reverse direction.

4. Short-Term, Medium-Term & Long-Term Debts ↓

i. Short-Term debt:-

Short term debt matures within a duration of 3 to 9 months. Generally, rate of interest is low. For instance, in India, Treasury Bills of 91 days and 182 days are examples of short term debts incurred to cover temporary shortages of funds. The treasury bills of government of India, which usually have a maturity period of 90 days, are the best examples of short term loans. Interest rates are generally low on such loans.

ii. Medium-Term debt:-

Long term debt has a maturity period of ten years or more. Generally the rate of interest is high. Such loans are raised for developmental programmes and to meet other long term needs of public authorities.

iii. Long-Term debt:-

The Government may borrow funds for medium term needs. These funds can be used for development and non-development activities. The period of medium term debt is normally for a period above one year and up to 5 years. One of the main forms of medium term debt is by way of market loans.

5. Redeemable and Irredeemable Debts ↓

i. Redeemable debt:-

The debt which the government promises to pay off at some future date are called redeemable debts. Most of the debt is redeemable in nature. There is certain maturity period of the debt. The government has to make arrangement to repay the principal & the interest on the due date.

ii. Irredeemable debt:-

Such debt has no maturity period. In this case, the government may pay the interest regularly, but the repayment date of the principal amount is not fixed. Irredeemable debt is also called as perpetual debt. Normally, the government does not resort to such borrowings.

6. Funded and Unfunded Debts ↓

i. Funded debt:-

Funded debt is repayable after a long period of time. The period may be 30 years or more. Funded debt has an obligation to pay fixed sum of interest subject to an option to the government to repay the principal. The government may repay it even before the maturity if market conditions are favorable. Funded debt is undertaken for meeting more permanent needs, say building up economic & industrial infrastructure. The government usually establishes a separate fund to repay this debt. Money is credited by the government into this fund & debt is repaid on maturity out of this fund.

ii. Unfunded debt:-

Unfunded debts are incurred to meet temporary needs of the governments. In such debts duration is comparatively short say a year. The rate of interest on unfunded debt is very low. Unfunded debt has an obligation to pay at due date with interest.

 

 

Government debt

There are several types of government debt securities as follows:

1. Government Debt Securities

1.1 Treasury Bills

Treasury bills are treasury securities having a maturity period of one year or less and sold in the primary market by auction at a discount from face value. Upon maturity the face value will be paid to the holder.

Treasury bills were first issued in Thailand in 1945, worth 50 million baht with a maturity period of 4 months. The issuance of treasury bills continued until 1990 and no treasury bill was issued since then. However, since 27th September 1999, the government has resumed issuing treasury bills until now.

At present, treasury bills typically have 28-day, 91-day, and 182-day maturity periods.

1.2 Debt Restructuring Bills

Debt restructuring bills are treasury securities having a maturity period of one year or less and sold in the primary market by auction at a discount from face value. Upon maturity the face value will be paid to the holder.

The issuance of debt restructuring bills is authorized under section 7 of the Emergency Decree Authorizing the Ministry of Finance to Raise and Administer Loans for the Financial Institutions Development Fund B.E. 2541. Debt restructuring bills were first auctioned in March 2001 and continued until 2007.

Debt restructuring bills have maturity period based on number of days, typically having a 182-day maturity period.

1.3 Government Bonds

Government bonds are debt securities issued by the government, having a maturity period of one year or longer. The primarily objectives are  to finance the budget deficit in each fiscal year or when the expenditures exceed the revenue,  to support social and economic development and to restructure public debt.

The first government bonds, worth 1 million pound sterling, were issued by the Royal Siamese Government in 1905 called “European Bonds 1905”, to raise fund from investors in London and Paris capital markets. The proceeds were used to finance railroad construction projects, strengthen treasury reserve, and finance other social services. These bonds were in bearer form having a 40-year maturity with a 4.5% coupon per annum.

The first domestic government bonds, called “Loan Bond B.E.2476”, were issued in 1933 during Phraya Manopakorn Nititada government. These bonds were issued according to the Domestic Loan Management Act B.E. 2476 of Baht 10 million, in which the sale was managed by the Ministry of Finance. The bonds were in bearer form having 10-year maturity with a 4.5% coupon per annum.

At present, government bonds are issued with different names, e.g. government bonds, special-issue government bonds, debt restructuring government bonds and debt management government bonds.

Interest payments of government bonds are made at regular intervals throughout the life of the bonds, normally twice a year. Upon maturity, the principal of face value will be paid along with the last interest payment.

1.4 Government Savings Bonds

Government savings bonds are debt securities sold, as an investment or savings alternative, to individuals and non-profit institutions such as foundations, the Thai Red Cross Society, and the National Council on Social Welfare of Thailand.

Interest payments of government savings bonds are made at regular intervals throughout the life of the bonds, normally twice a year. Upon maturity, the principal of face value will be paid along with the last interest payment.

2. State-Owned Enterprise Bonds (SOE Bonds)

State-owned enterprise bonds have a maturity period of one year or longer issued by state-owned enterprise (an enterprise in which the state holds for more than 50% of total capital) seeking funds for the state enterprise’s projects.

State-owned enterprise (SOE) bonds can be divided into two types: guaranteed and non-guaranteed by the Ministry of finance (MOF). For both types of SOE bonds, the MOF selects underwriting institutions by auction. An institution offering the lowest total costs will be selected as the underwriter of the SOE bonds.

Interest payments of SOE bonds are made at regular intervals throughout the life of the bonds, normally twice a year. Upon maturity, the principal of face value will be paid along with the last interest.

3. Bank of Thailand Bonds (BOT Bonds)

Bank of Thailand bonds are debt securities issued by the Bank of Thailand  and used primarily for conducting monetary policy, managing liquidity and interest rate in financial market  in order to stabilize economic growth and setting benchmark interest rate  that helps enhance corporate debt  market development.

The first BOT bonds were issued in 1987 having 6-month maturity.  After that they had been continually issued until 1997 (except 1989, 1992, 1993 and 1994) with various maturity periods of 1 month, 3 months, 6 months, 1 year and 2 years. In 1997, the Bank of Thailand had  been issuing bonds with maturities of 35 days, 42 days and 49 days before it temporarily stopped issuing the bonds since then.  Since 2003, the BOT has resumed issuing the BOT bonds  until now.

Nowadays, the BOT bonds can be divided into 4 categories as follows:

3.1 Zero Coupon Bonds

The zero coupon bonds, issued by the BOT, are debt securities  with maturity period  ranging from 3 to 364 days at a discount from face value. Upon maturity the face value will be paid to the holder.

3.2   Fixed Rate Bonds

The fixed rate bonds, issued by the BOT, are debt securities having maturity period longer than 1 year with fixed-rate interest. Interest payments are made at regular intervals throughout the life of the bonds. Upon maturity, the principal of face value will be paid along with the last interest payment.

3.3  Floating Rate Bonds

The floating rate bonds, issued by the BOT, are debt securities having maturity period longer than 1 year, which the bonds bear a floating coupon rate  based on BIBOR (Bangkok Interbank Offered Rate).   Interest payments are made at regular intervals throughout the life of the bonds with the rate set before the start date of each interest-earning period. Upon maturity, the principal of face value will be paid along with the last interest payment.  The first 3-year BOT floating rate bonds were issued in 2007 with the rate based on 6-month BIBOR minus 0.20 paying twice a year and the first interest was paid at a rate of 4.41094% per annum.

3.4    BOT Savings Bonds

The BOT savings bonds are debt securities paying fixed interest in every payment period throughout the life of the bonds at the rate set by the BOT. Upon maturity, the principal of face value will be paid along with the last interest payment.  The first BOT savings bonds were issued in 2007 having maturity period of 4 and 7 years.  The BOT bonds are issued according to the Bank of Thailand Regulation (SorKorNgor. 57/2554) on the Issuance of Bank of Thailand Bond.  <<click for BOT Regulation (in Thai version)>>

The BOT bonds having maturity period of 1 year or less, longer than 1 year as well as the BOT floating rate bonds are sold in primary market by   auction according to the Bank of Thailand Regulation (SorKorNgor. 3/2550) on sale method, eligible bidder, tender arrangement, allocation and settlement of the Bank of Thailand Bond. <<click for BOT Notification (in Thai version)>>

BOT savings bonds are sold in primary market to individuals and non-profit institutions via selling agents which are designated  for each particular issue. The first BOT savings bonds issued in 2007 were sold through 8 selling agents comprised of   Bangkok Bank pcl., Krungthai Bank pcl., Kasikorn Bank pcl., Citibank N.A.,  Siam Commercial Bank pcl., UOB Bank pcl.,  Standard Chartered Bank (Thai) pcl.,  and Hongkong and Shanghai Banking Corporation Ltd.

4. Financial Institutions Development Fund Bonds (FIDF Bonds)

Financial Institutions Development Fund (FIDF) bonds are debt securities issued by the FIDF for the purpose of rehabilitating and developing financial institutions in order to maintain stability in the financial system.

FIDF bonds were first issued in August 1996 to help financial institutions manage liquidity problems during the financial crisis.

At present, there are 2 categories of FIDF bonds as follows:

4.1 FIDF bonds specifically sold to the Bank of Thailand

4.2 FIDF Savings Bonds sold to retail investors by selling agents

 

 

 

What is Redemption ? Meaning

Redemption means repayment of a loan. Redemption refers to escaping from the burden of public debt.

Methods of Public Debt Redemption

Various Methods of Public Debt Redemption ↓

The various methods of public debt redemption are as follows :-

1. Sinking fund method

The Government creates a fund called sinking fund by accumulating a part of the public revenue every year for the repayment of debt. This is the most systematic and best method of debt redemption. The burden of debt is spread evenly over the period of accumulation of the fund. Sinking fund creates confidence among the lenders and increase the credit worthiness of the government.

2. Capital levy

A direct tax upon the capital of the tax payers is called capital levy. It will be generally imposed in times of emergencies. Dalton recommended this method very strongly. It was advocated as a method of liquidating the unproductive war debts. Debt redemption by imposing a very heavy taxation on property has been advocated. However, this method has raised objections as heavy taxes might lead to undesirable effects on the economy.

3. Conversion

Conversion is not repayment, it is only exchange of new debts for old. It is the process of converting or altering a loan with a given rate of interest into a loan at a lower rate of interest. This may take place at the time of maturity or before the time of maturity by the voluntary acceptance. The main advantage of conversion is that it reduces the interest burden of the state and relieves tax payers. For this purpose, the government had to maintain an adequate stock of securities for a smooth functioning of this method.

4. Refunding

Refunding implies the issue of new bonds and securities by the government, to repay the matured loans. The short term securities are replaced by long term securities. The owners of the old debt have the option of subscribing to new debt or opt for cash. Under this method, the burden of repayment of public debt is postponed to a future date.

5. Terminable annuities

The fiscal authority clears off a part of the public debt every year by issuing terminable annuities to the bond holders which mature annually. It is a method of redeeming debts by instalment. The burden of debt goes on diminishing annually and by time of maturity it is fully paid off.

6. Redemption by Purchase

In this case the government pays off debts by purchasing securities even before the maturity whenever it has surplus budget. However, surplus budget is a rare phenomenon in modern times.

7. Additional Taxation

The government imposes new taxes to get revenue to repay the principal and interes of the loan. This is the simplest method of debt redemption. If new taxes are levied to repay long term debts, the burden is imposed on future generation. This method causes a redistribution of income from the tax payers to the bond holders.

8. Surplus balance of payments

External debt redemption is possible only by accumulating foreign exchange reserves. Hence it is necessary to create a trade surplus by increasing exports and reducing imports. External debt can also be reduced by changing the terms of repayment. The loans raised must be used productively so that they are self liquidating posing no real burden on the economy.

Conclusion On Public Debt Redemption Policy ↓

The best redemption policy is to clear off internal and external debt annually so that there is no mounting burden of debt upon the present generation or on posterity. Proper and efficient management of public debt calls for active, participation policy which is inevitable for price stabilization.

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