Public debt is the amount of money that is obtained by a Government through internal and external sources for the purpose of developing a country. There are two main kinds of public debts.

1. Productive and Unproductive Debts:
   Productive debts are those which are used in turn to create assets which will yield a substantial amount of income in order to pay for the interest and loans productive debts are, for example, used on irrigation projects, roads, and railways etc. Productive debts are also known as (i) Active debt which is spent on projects which will yield money income and increase the purchasing power of the community, and is also known as (ii) Reproductive debt which is also used to create assets which yield income to pay the loans and interest.

Unproductive debts are those debts which are used on projects which will not really benefit the Government financially but are rather merely for public interest e.g. public parks, museums, libraries etc. Unproductive debts also apply to periods of war. Unproductive debt is also known as (i) Passive debt or (ii) Deadweight debt.

1. Short Term and Long Term Debts:
   This kind of debt is in line with internal debt. Short term loans are obtained by the sale of treasury bills and also by ways and means of advances from the Central Bank., Their main function is to bridge the gap temporarily between the current revenue and current expenditure, i.e. if Government expenditure exceeds Government revenue, short term loans are obtained. However, this is generally practiced in developed countries only because LDCs usually maintain a higher level of expenditure than their revenue. Short term are also obtained when interest rates are high and Government needs money to finance projects and thus raises tax until the interest rates fall. Short term loans are also known as floating debt. Long term loans are obtained for major projects i.e. productive projects e.g. railways, roads etc. Such loans are also needed for defense purposes and during the war period itself. Rates of interest on long term loans are higher than short term loans and therefore commercial banks and industries are induced to invest their surplus funds to gain greater profits.

Public debts are taken to fulfil the following requirements.

1. Inflationary Situation: As a result of inflation prices of goods and services go up. In order to bring them down again, Government issues public loans to the people to reduce their purchasing power. Consequently the money will come back to Government and with a reduction in money supply prices of goods and services will go down once again.




2. Financing Public Works: Particularly during the phase of depression the Government would have to increase its expenditure on investment and thus create employment for the people, loans will be needed to start the ball rolling.




3. Economic Development: This is mainly the case with third countries. Their Government is trying in vain to achieve a desirable level of everything in the country and thus huge expenditure have to be incurred for this purpose. Loans are greatly needed.




4. Defence Purposes: Whether a country is at war or not, the Government still has to maintain a fairly high level of expenditure on their defence. Although these are unproductive measures but they still have got to be considered to a great extent.

These debts once matured are paid by these methods some of which are desirable than the others.

1. Utilization of Surplus Revenue: Generally speaking this method is not really in use now for the following reasons. (i) Government tries to avoid surplus budget as it reflects a bad image on the government of a country. (ii) A surplus budget is rarely substantial to pay off debts.




2. Purchasing Government Bonds: The Government itself may resort to purchasing its own stock in the market which is done through a surplus budget or obtaining loans at the low rates.




3. Terminable Annuities: This is mainly for repayment of permanent debt. It is done by agreeing to pay the creditors a certain fixed amount annually. These installments/payments are called annuities.




4. Conversion: This method is rather more to be the side of reducing the burden debt by converting a high interest rate loan to a low interest loan. It actually is not a method of repayment. Assuming that a Government obtains a high interest rate loan and with the passage of time finds that the money market is easy to obtain credit, the Government will then convert the high interest rate debt into a low interest rate debt by collaborating with the creditor to accept the reduction in rate of interest. Supposing that the creditors do not agree, the Government then provides a new loan at the low interest rate and pays the debt of high interest rate.




5. Sinking Fund: Generally this is the main and latest method of repayment of debt secured by Governments throughout the world. A fund will be set aside for which a certain amount of money out of the government is issued each year. After a certain period the sum total is calculated and is used to pay the interest and loan.