Debts come in different shapes and sizes. There’s private debt, corporate debt, and government debt. Among these, public debt is the largest and most important type of debt.
In this article, we’re going to take a close look at public debt and try to answer some common questions about it.
What Is Public Debt?
Public debt is the entire amount, including total debt, of money that a national government has borrowed.
Also, Public debt is different from private debt, which consists of the debts of people, corporate entities, and nonprofit organizations.
Public debt is an important method of bridging the funding gaps of the government.
Careful usage of public debt contributes to stronger economic growth and adds to the ability to service and repay foreign and domestic debt. It also assists the government in attaining its social and community goals.
Types Of Public Debt
Public debt can be classified into several types:
Internal And External Debts
Internal debt occurs when a government raises money by borrowing from within the country. If the government borrows from other countries, this is referred to as external debt.
Redeemable And Non-Redeemable Debts
Redeemable debts are those that the government promises to return at some point in the future (interest plus debt).
Irredeemable debts are ones for which the government never repays the principal but pays interest on a regular basis.
Funded And Unfunded Debts
Funded debt is debt that is owed for a long time or for a specific period of time.
There is a valid agreement, terms, and conditions of repayment, as well as the percentage of interest that must be paid. They are used in the creation of long-term assets.
Compulsory And Voluntary
Voluntary debt is a debt that is not enforced by the law. Compulsory debt, on the other hand, is a legally imposed obligation. People have no choice but to settle their debts in this situation.
Methods Of Debt Repayment
There are four ways to repay debt. Here’s a look at each:
Repudiation refers to the act of refusing to recognize or pay a debt. It’s often used as a political tool to score points with voters.
The United States used this method after the Revolutionary War and the War of 1812. More recently, Ecuador defaulted on its debt in 2008.
This procedure is not recommended as it can lead to a loss of credibility and trust, making it difficult to borrow in the future.
Refunding is the process of replacing assets that are aging with new securities when they come onto the market.
Debts may be returned prior to the date on which they are scheduled to mature.
This method is often used by companies and governments to take advantage of lower interest rates.
It also allows them to extend the maturity date of the debt, giving them more time to repay.
This is not like any other kind of return. Before they reach their maturity date, aged securities are exchanged for brand-new securities.
One common strategy for reducing one’s overall debt burden is to refinance loans with high-interest rates into loans with lower interest rates.
A sinking fund is a special fund set up to pay off government debt. The creation of this fund has a theoretical validity in that it forces the government to pay off previous obligations on a regular basis.
This system requires the government to set aside a particular amount of money from the budget each year for this fund.
While public debt can be useful for governments, it’s important to use this tool carefully.
If not managed correctly, public debt can lead to high levels of inflation and a decrease in the currency’s value.
It can also cause a country to default on its debt, which can have devastating consequences.
Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.