Public Debt and Borrowings: Bridging the Revenue-Expenditure Gap

When a government’s ambitions outpace its income, it turns to borrowing. From building highways and metro lines to funding welfare schemes and meeting unexpected crises, governments rarely have enough tax revenue to cover every commitment. This is where public debt steps in, functioning as a financial bridge between what the state earns and what it must spend. Understanding how this borrowing works, why it matters, and how it shapes the economy is essential for anyone studying public finance.

What is public debt? 🔗

Public debt, also called sovereign debt or government debt, refers to the total outstanding liabilities that a government owes to lenders within the country and abroad. It represents all past borrowings that still need to be repaid, typically with interest. Governments usually borrow when tax collections, duties, and other revenues fall short of the expenditure required to run the country.

In simple terms, if the Union Budget projects spending of ₹53.47 lakh crore but receipts (excluding borrowings) of about ₹36.51 lakh crore, the gap of roughly ₹16.96 lakh crore must be bridged through borrowings. These borrowings accumulate over the years to form the national debt. Internal debt currently accounts for about 96.59% of India’s total public debt, while external debt makes up the remaining 3.41%, showing how heavily the country relies on domestic sources.

Why do governments borrow? 🔗

Borrowing is not a sign of weakness; it is often a strategic tool for growth. Governments around the world use debt to manage both routine shortfalls and extraordinary demands. The reasons for public borrowing generally fall into four broad categories.

Low current revenue 🔗

Tax revenue is often insufficient to cover the range of services a modern state provides. Pensions, subsidies, healthcare, defence, and administrative costs have grown faster than collections in many years. For FY 2024-25, total expenditure stood at ₹46.56 lakh crore, with revenue expenditure alone at ₹36.04 lakh crore, much of which went to salaries, pensions, and subsidies on food, fertiliser, and fuel. When regular income falls short, borrowing fills the gap.

Unplanned expenditures 🔗

Wars, pandemics, floods, earthquakes, and other emergencies demand sudden and heavy spending. No budget can fully anticipate such shocks. Extraordinary events like wars or natural disasters necessitate higher spending on relief and reconstruction, often leading to increased fiscal deficits. Borrowing allows the government to respond quickly without raising taxes overnight.

Economic development 🔗

Large infrastructure projects, such as highways, railways, power plants, irrigation canals, and urban transport, involve enormous upfront costs. These investments pay off over decades but cannot be financed solely through annual tax receipts. A well-known rule of public finance, sometimes described as the golden rule, states that when borrowed money is used for investment or developmental purposes, it leads to growth in GDP or national income. This growth, in turn, expands the tax base and helps repay the debt.

Economic stabilization 🔗

Borrowing is a key tool for managing business cycles. During recessions, governments spend more to revive demand, create jobs, and restore confidence. When the economy goes into recession, deficit spending through tax cuts or government purchases can stop the devaluation and help turn the economy back into a stable position. Conversely, during inflationary booms, debt repayment can reduce money in circulation and cool the economy.

Classification of public debt 🔗

Public debt is not a single uniform category. Economists classify it in several ways depending on the source, purpose, terms of repayment, and degree of coercion involved. Understanding these classifications helps in assessing the quality and sustainability of a country’s borrowings.

Internal and external debt 🔗

Internal debt is borrowed from lenders within the country, such as citizens, commercial banks, insurance companies, provident funds, and the Reserve Bank of India. It is usually denominated in domestic currency, which shields the government from exchange rate risks. Internal debt in India is divided into marketable and non-marketable categories, with dated government securities and treasury bills being the most significant instruments.

External debt is raised from foreign sources, including multilateral institutions like the World Bank and the Asian Development Bank, bilateral partners, and international capital markets. India’s external debt is held in multiple currencies, with the U.S. dollar making up the largest share. While external borrowing can bring in real foreign resources, it carries currency risk and must eventually be repaid in foreign exchange.

Productive and unproductive debt 🔗

Productive debt, also called reproductive debt, is used to finance income-generating projects such as railways, power plants, irrigation works, or factories. A productive public debt is self-liquidating in nature, as the assets it creates generate enough revenue to pay interest and eventually repay the principal.

Unproductive debt, in contrast, is spent on activities that do not directly generate income, such as wartime expenditure, famine relief, or administrative buildings. Because unproductive loans do not add to the productive capacity of the economy, they are called dead-weight debts. Repaying them requires additional taxation, which can burden future generations.

Voluntary and compulsory debt 🔗

Most public borrowing is voluntary. The government issues bonds or securities, and citizens, banks, and institutions purchase them based on interest rates and risk appetite. Voluntary debts are taken from the public when they are willing to lend to the government, while loans taken against the will of the public are known as forced debts.

India briefly experimented with compulsory borrowing under the Compulsory Deposit Scheme of 1964, when certain taxpayers were required to deposit a prescribed amount with the government. Such measures are rare and typically reserved for emergencies.

Redeemable and irredeemable debt 🔗

Redeemable debt carries a fixed maturity date on which the government promises to repay the principal along with interest. These are also called terminable loans. In contrast, irredeemable debts do not have fixed repayment dates, and governments are not always required to pay regular interest on them. Irredeemable or perpetual debt can burden society with indefinite obligations, which is why sound financial practice generally favours redeemable borrowings.

Funded and unfunded debt 🔗

Funded debt is long-term debt, typically exceeding a year, with a clearly defined repayment schedule and often a dedicated sinking fund for its eventual redemption. Funded debts are generally used for productive purposes and are long-term in nature, while unfunded debts are taken to cope with short-term financial needs without a dedicated repayment fund. Treasury bills, which mature within months, are the classic example of unfunded or floating debt.

Marketable and non-marketable debt 🔗

Marketable debt consists of instruments that can be bought and sold in the open market, such as dated government securities (G-Secs) and treasury bills issued through auctions. These instruments are liquid and help develop a deep domestic bond market.

Non-marketable debt includes instruments that cannot be traded, such as securities issued against small savings collections like the Public Provident Fund, National Savings Certificates, and special securities issued to the Reserve Bank. These are typically long-term and captive in nature, providing a stable funding source for the government.

Instruments of public borrowing in India 🔗

The government raises funds through a range of instruments, each serving a different purpose. The main sources of public debt include dated government securities, treasury bills, external assistance, and short-term borrowings. Dated G-Secs are long-term instruments with maturities ranging from 5 to 40 years, while treasury bills mature in 91, 182, or 364 days. Small savings schemes, provident funds, and special securities issued to the RBI also contribute significantly to the overall stock.

The Reserve Bank of India plays a central role in managing this borrowing programme. Under the Reserve Bank of India Act, 1934, the RBI serves as both the government’s banker and its public debt manager, issuing government securities and handling monetary policy that influences debt servicing costs.

Impact of public debt on the economy 🔗

When managed prudently, public debt can be a powerful engine of growth and welfare. When mismanaged, it can become a trap that strangles future budgets.

Positive impacts 🔗

Economic growth: Borrowing for infrastructure, education, and healthcare builds long-term productive capacity. In developing economies with under-utilised resources, budget deficits financed through reasonable debt can be a useful instrument for stimulating growth and raising income.

Production and employment: Investment in roads, ports, power, and digital infrastructure boosts output across sectors. Contractors hire workers, suppliers expand capacity, and downstream industries benefit from better logistics and connectivity.

Consumption and demand: Stimulus measures funded through borrowing put more money in people’s hands, driving up demand for goods and services. This can crowd in private investment rather than crowd it out, especially when the economy is operating below capacity.

Counter-cyclical stabilization: Borrowing allows governments to spend more when private demand is weak and repay when the economy recovers, smoothing out the business cycle.

Negative impacts 🔗

Excessive borrowing has its own dangers. An excessive level of public debt can result in higher interest rates, crowding out private investment and slowing the rate of economic expansion. Other risks include limited fiscal space, inflationary pressures, and intergenerational equity concerns, where today’s borrowing becomes tomorrow’s tax burden.

A high debt-to-GDP ratio also raises red flags for investors and credit rating agencies, potentially increasing borrowing costs and weakening the currency.

Managing public debt responsibly 🔗

Sound debt management is built on transparency, prudence, and long-term thinking. The Fiscal Responsibility and Budget Management (FRBM) Act, enacted in 2003, set targets for debt reduction and aimed to limit general government debt to sustainable levels. The government now aims to bring the central government debt-to-GDP ratio down to around 55.6% this year, moving towards a long-term goal of 50% by 2031.

Effective management involves diversifying funding sources, extending debt maturities to reduce rollover risk, prioritising productive over unproductive borrowing, and ensuring that interest payments do not crowd out essential spending on health, education, and capital formation.

What do you think? Should governments prioritise debt reduction even if it means cutting welfare spending, or is borrowing for social investment a legitimate path to long-term growth? And as a citizen, how much does the debt-to-GDP ratio influence the way you evaluate a government’s economic performance?

References

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