Public Debt Mgt

Public debt is the result of govt borrowing from private

individuals and financial institutions with the promise of
paying back the money borrowed plus interest
Purposes of Public Debt
- Managing the national economy
- Making expenditures that exceed revenues over a long
period
- Making exp. that exceed revenues over a short term
period
- Financing specific capital expenditures
(Public Capital- large components such as highways, airports,
roads, transit systems, and railways; local, municipal
components such as public education, public hospitals,
police and fire protection, prisons, and courts; and critical
components including water and sewer systems, public
electric and gas utilities, and telecommunications)

Characteristics of Public Debt

1.Form of Debt
Bearer form and registered debt
contracts
2. Obligation Bases
Debt contracts are also called
securities. The term indicates that
repayment is secured by the contract.
The obligation based may be general
obligation, limited liability obligation
and moral obligations

Characteristics Contd
3. Tax Status
Public debt may have special tax
treatment
4. Time Periods
The debt contracts specify time periods
Short,Intermediate, and Long
5. Amounts
Total amount, Face value, and One time
borrowing amount are the three types.

Characteristics Contd
6. Rates
It refers to interest (also effective) rates
7. Ratings
It shows the creditworthiness of the
issuing organization.
8. External guarantees
Govt guarantees may be given for local
govt, if they are allowed to borrow.
Financial institutions or insurance
companies may give guarantee

External guarantee
External guarantee loan is a letter of
guarantee issued to a principal(Bank)
in a foreign country guaranteeing that
international trade commitments will
be fulfilled by the banks customer.
If the contractual obligation is not
fulfilled in due time and as specified,
the bank/Govt pays the principal the
agreed amount of money.

Characteristics Contd
9.Special features
- Call Option
- Put Option : It allows debt holders
to demand the payment (It is
opposite to Call option)
- Rollover option: It allows the
borrower to extend a debt contract in
time beyond the maturity date with a
higher interest rate

Exercise of calls

Exercise of Puts

Characteristics Contd
10. Innovation.
Innovative forms of debt should be
within the legal provisions of public
debt and tax provisions.
E.g: Variable rate instruments
Instruments with foreign
currency denominations
Lease agreements

Public Debt Process

PD process involves all the steps
from borrowing money to payments
of debt.
The process involves the following
steps:
Step 1. The decision to borrow money

-identify the purpose

-consider the cost of borrowing

Public Debt Process Contd

Step 2. Provide legal advice to the
officials responsible for issuing debt
- It minimizes possible errors
Step 3. Decide the amount to borrow
- Borrow the lowest reasonable
amount
- The amount should be the required
amount

Public Debt Process Contd.

Step 4: Design a debt issue
- Design features which are attractive for
both the borrower and the lenders
- Design features for minimizing costs
Step 5 & 6 : Marketing Efforts and the
development of debt contracts
- Ads for issuing bonds
- Debt contracts should be accompanied
by a Prospectus

Public Debt Process Contd

Step 7: Exchange of ownership of debt
contracts for money
- A debt issuer signs a contract with the
underwriter, transferring ownership
Step 8: Administration of debt
- The administration includes handling the
debt proceeds, maintaining records,
fulfilling debt contract requirements,
handling call options

Cost of Capital Public Sector

As there is no specific model available, a
number of possible discount rates are
used.
However, there are two main approaches:
1. Social Opportunity Cost Rate
- Pub. Sector funds comes from private
sector. So, the social opportunity cost
is the pre-tax rate of return in private
sector

Social Opportunity Cost

the opportunity cost to the society of
making a certain good or service, at
the expense of using the factor of
production for a different good or
service

Social Opportunity Cost

Economics
The opportunity cost to the society of
making a certain good or service, at
the expense of using the factor of
production for a different good or
service

Cost of Capital Public Sector

2. Social Time Preference
It is the after tax rate of return required by
society to induce it to sacrifice present
consumption for the promise of future
consumption as generated by the
investment
Factors such as the age structure of the
population, growth prosperity etc should
be considered

Time preference
Inclination of a consumer towards current
consumption (expenditure) over future
consumption, or vice versa. What may induce
a consumer to delay consumption is called
Rate of Time Preference amount of money
(expressed as a proportion of the consumer's
current income) that will compensate him or
her for forgoing current consumption.

Expert Opinions on Cost of Capital

1.Zero cost as the donors do not expect
return
2. Zero cost , but expects return for
replacing
assets
3. The cost is low, which is equivalent to the
return available from short term securities
4. Capital has the same cost as the cost of
capital in the private investments

Types of Debt
Short Term
Bills, Notes, Bank Loans, A/c
Payable,
Unpaid bills and claims, Cash
discounts
- Intermediate Debt
The period is usually 1-5 years

Types of Debt Contd.

Long Term Debt: is appropriate where
(for)
- the project will not require replacement
for many years (E.g.city hall, heath
facility)
- The project can be financed by service
charges to pay off the debt
commitments
- Needs are urgent for public health or
other emergency reasons

Long Term Debt Contd

- Intergovernmental revenues may be
available on a continuous basis to
guarantee the security of the debt
- (For)Financing projects in areas of
rapid expansion where the demand
on resources are comparatively large
and unforeseen

BONDS
It is the most common long term debt
It is a Prom. Note ensuring that the
lender will receive periodic payments
of interest and at maturity repayment
of the original sum invested.
Face value is the amount that the
issuer pays on maturity
Coupon rate is the interest rate

Types of Bonds
General Obligation Bonds: are backed
by full faith, credit and taxing power
of the issuing authority. Govt can levy
taxes to meet debt service
requirements
Special Tax or Spe. Assessment Bonds:
are payable only from the proceeds
from a special tax levied from the
beneficiaries (Highway bonds)

Types of Bonds
Revenue Bonds : are issued to finance
a revenue-producing enterprise such
as the construction of a toll road or
bridge
Stepped Coupon Bonds: use a serial
maturity schedule, with coupon rates
that start at lower levels and
progressively increase to higher
levels

Types of Bonds
Zero-Coupon Bonds: are not eligible
for any interest, but sold at a deep
discount.
Capital Appreciation Bonds: are
compound interest bonds
Tender Option Bonds:allows the
investor to submit for redemption
before maturity.

Types of Bond
Flexible Interest Bonds: The yield changes
over the life based on some interest index
issued by reliable authorities
Detachable Warrant Bonds: the holder can
buy more securities at the same price and
rate of return
Inflation Protection Bonds: The Principal
will be adjusted for inflation without
changing the interest.

EXTERNAL BORROWING
External debt is defined as the
amount of disbursed and outstanding
contractual liabilities of residents of a
country to nonresidents to repay the
principal with or without interest, or
to pay interest with or without
principal.

Factors to be considered in
borrowing

Borrowing Policy
-Develop well thought- about policies
-Assess the requirement for capital
-Look for foreign capital and then
design projects
- Select a reasonable period
- Terms, repayment, interest etc
should be considered in borrowing

Factors Contd..
Central Borrowing Authority
- As a result, the total national
borrowing is recorded at one place
- Second, the borrowings can be
controlled well
- Third, the community knows the
liability
- Finally, it helps better planning of
future borrowings

Factors Contd
Limits and Guarantees
- Can fix the upper limit keeping the
repayment capacity in mind
- Guarantees may be given by the
Govt or financial institutions

Factors Contd
Foreign Exchange Controls
- Free flow of foreign capital affects
many aspects of the economy
including balance of payments.
- So strict control on foreign
exchange is necessary.
- Exchange control regulations
influence the Public Debt
Management

Factors Contd.
Proper deployment of external
resources
- should not be used for luxuries
- should be utilized for proper
purposes
- if the purpose is not specified, use
it in industries to increase production
or infrastructure facilities.

Factors Contd..
Prompt Debt Servicing
- Develop a habit of prompt payment of
interest and the principal on time.

Timely Implementation of Projects

-Some countries are fast in designing
projects and borrowing,but slow in
implementing projects
- If the loan is not used on time, the
lenders may charge a commitment fee

Factors Contd
Transparency
- Ensure transparency to all
transactions and avoid corruption
Expanded World Trade (Export)
- The loan has to be paid back. So
find place in foreign markets to earn
foreign exchange

Factors Contd..
Encouragement to foreign Private
Investments
- Offer incentives such as
repatriation of profits and capital etc
Investment Preferences
- Investment of foreign capital should
be in areas vital to the devt of the
country.

Factors Contd.
Import Substitution
- Reduce the imports to save foreign
exchange
Citizens Remittances
- Encourage the Diaspora to remit
their income to the country.

Factors Contd.
Adoption of a sound negotiation
strategy
- A team of multi-disciplinary
professionals including lawyers,
accountants, economists should
negotiate with the lending institutions.
- They should be aware of the
international laws and practices of
borrowing

Public debt
Analyzing PD
PD Outstanding= total debt level a govt carries at
a specific time.
Debt service = annual payment of principal and
interest.
Debt capacity =the level of debt a govt can afford
Possible measures of debt capacity
1. Debt outstanding a s a percentage of taxable
property values = Debt outstanding / taxable
property values. (Or) Debt outstanding /
personal income

Public debt
2. Debt outstanding per capita = Debt
outstanding / Population
3. Debt service as a percentage of revenue
= Debt service / revenue
(1) and (2) are called debt outstanding
ratios and (3) is called debt service ratio
Additional debt capacity is available if the
current debt level of government does not
exceed its benchmark debt ratio.