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Sources of Public Debt: Internal and External Sources

Governments may raise public debt from both the internal and external sources. The effects of public debt are determined also by the sources and its size. The sources of public debt are as follows.

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A. Internal Sources

  1. Individuals and Private Organizations - Individuals and private organizations provide loans to government with the purchase of securities like bonds and treasury bills. They provide loans reducing consumption, diverting savings accounts and corporate securities, and out of the funds that would remain idle. This source of debt normally does not exert inflationary pressure, except that from the idle funds, as there will be just a transfer of purchasing power from public to the government and no more money supply.
  2. Financial Institutions – Financial institutions, other than the commercial banks, like Provident Fund, Insurance Companies, Finance and Investment Companies, Co-operatives, Mutual Funds, etc. are the important source of public debt. These institutions normally provide loans to government to reduce their cash-holdings to earn some interests, for the safety of funds and to maintain liquidity. Normally, these institutions prefer to invest on government securities in a situation when there is no sufficient for loan advancements on other activities. Borrowing from this source is likely to inflationary as the funds would not have been spent if it was not loaned to government.
  3. Commercial Banks – Commercial banks provide loans to government out of the excess cash reserves and by credit creation. Like other financial institutions, the commercial banks also provide loans to government in a situation when there is no sufficient demand for bank credit. Borrowing from commercial banks increases money supply in the economy, and is likely to exert inflationary pressure in the economy. 
  4. Central Bank – The Central bank is the lender of the last resort to the government. The central bank, as being the monetary authority of the government, is responsible to manage the public debt on behalf of the government out of its reserve funds and by credit creation against the government securities. bullions and foreign exchange reserves. Borrowing from the central bank has double-fold possibility of credit creation leading to excess money supply in the economy leading to inflation.

External Sources 

Normally, public debt from external sources is raised to finance the development projects and to manage the problem of deficit in the Balance of Payments. Whatever be the sources, borrowing from external sources is likely to exert more inflationary pressure, at least until the gestation period of the projects financed from these sources. The external sources are: 
  1. Foreign Nationals and Private Organizations – Government may borrow from this source by issuing its securities in the international financial market.
  2. Donor Governments – Normally the developed countries’ governments provide loans to the developing countries for development projects in the form of foreign aids.
  3. International Financial Institutions - The international financial institutions like World Bank, IMF, UNCDF, IFC, and ADB, etc. provide loans to governments to finance development projects and to manage the BOP problems.
  4. Funds of Some Countries and Business/Economic Forums – Governments may borrow from the funds created by some countries and business or economic forums like Saudi, Kuwaiti, and OPEC funds.
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