Finance

Methods of Redemption of Public Debt

Public debt is (otherwise known as Government loan), is a loan and therefore to be redeemed by the Government on maturity or according to the terms of issue of loan. The government adopts various methods for Redemption of Public Debt based on overall economic situation. The debt may be redeemed in either of the following methods-

 (1) Utilization of Budgetary Surplus: It is suggested that the Government should redeem the public debt by creating budgetary surplus. Surplus occurs when public revenue exceeds the public expenditure. It may result either by increasing tax burden or by decreasing public expenditure which is generally not always practicable. If it is not possible at all the Government purchases its own bonds from the market which may result in automatic redemption of Public Debt. This method is used rarely because of two reasons-

  • now a days, it is not possible to earn surplus due to increase in public expenditure of the Government and
  • if there is a budgetary surplus, it may be used for some other important works which may give more public satisfaction.

(2) Creation of Sinking Fund: Under the system the Government creates a fund known as “Sinking Fund”. For providing amount of loan to be repaid along with interest. The Government, every year transfers a fixed amount to this fund regularly in such a way as the accumulated amount at the end of the term would be sufficient for Redemption of Public Debt and interest due thereon. The sum to be credited to this fund is determined in either of the two ways: –

  • a fixed percentage of the annual income of the Government, or
  • the proceeds of a fresh loan raised for the purpose.

Dalton has suggested that the Government should credit the amount to this fund out of its current income and not out of the proceeds of a fresh loan.

The Sinking fund method of debt repayment is considered to a system method and is widely used because the burden of debt is spread evenly over a period of loan. The method is also increases the credit worthiness of the Government. But the method is considered a slow process of debt repayment.

(3) Conversion of Public Debt: Under this system an existing debt is converted into a new debt. The method is generally adopted when the rate of interest in the market goes down. In such circumstances, the Government gives notice to the lenders to take their money back either in cash or in new bonds. The new bonds bearing low rate of interest are issued either in cash or replaced by the existing debt. Those who do not accept conversion lets their money including interest due in cash. Thus the existing debt is replaced by a new debt. Actually, the debt is not redeemed but only the burden is reduced. The main advantage of this system is that it reduces tile interest burden of the Government. It also helps the tax-payers as they have to bear low rate of interest.

 (4) Capital Levy: It has been the most controversial method of debt repayment or redemption of Public Debt. Many economists favor the levy of tax on wealth and capital to repay the war-time loans The levy should be imposed by the Government on the assets of the richer section of the society to pay off the war-time debt. The people having property above specified limit should be levied on increasing progressive rates.

The method is supported by a number of economists on the following grounds-

 (i) Capital levy affects only the richer Section of the society, poor are left unaffected. It follows the principle of “ability to pay” and help reduction in inequality of wealth and income,

(ii) Quick payment of loan is possible

(iii) It does not create inflation as the taxes do

(iv) It reduces the burden of taxes and this increases production and employment.

But the method is subject to the following criticisms-

 (i) It has adverse effect on capital creation and credit because nobody will like to accumulate wealth. The production and employment will also be affected and adversely.

 (ii) Evaluation of property of everyone to bring. them into the net of levy is really very difficult. The cost of completion of records. will be very high and as such it is against the principle of economy.

 (iii) It is unjust as it spares those who do not save, the method is still Controversial and therefore not followed by most of the Governments

 (5) Terminal Annuities: Sometimes the Government decides to terminate the debt through terminal annuity method. Under this, the Government decide to pay off its debt in equal annual installments which include the interest and the principal. The amount is decided on the basis of annuity table. The main advantage of this system is that the burden of public debt is reduced every year. Government is not to redeem the whole debt but in lump sum.

 6) Refusal of Loan: In some extreme cases, the Government refuses to pay off its debt and the debt is deemed to be redeemed. It generally happens when the Government is taken over through a bloody revolution and the new Government refuses to pay the debt taken off by the old Government.

This method is not considered good because by doing so, the new Government loses the faith of its people in herself and future debt raising becomes difficult. The refusal of foreign loans may lead to tense political relations between the two Governments and sometimes it may lead to war. The Government therefore, must repay the debt taken by itself or by its predecessor Government.

(7) Surplus Balance of payments: External foreign debt may be redeemed through a surplus in the balance of payments of the country. For this purpose, generating surplus in balance of payments is must and, therefore the debtor country should have to increase its exports and curb imports. The accumulated foreign exchange reserves may be used for Redemption of Public Debt.

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