Explain the four classification of debt?


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Beth Kennedy Profile
Beth Kennedy answered
Public borrowing, where a government borrows in order to fund public services, is the sole cause of public debt. It can be caused internally or externally- meaning it can be caused within the government's country or outside a government's country. The four classifications of debt are as follows:

  • Funded and unfunded debt
  • Short-term, medium-term and long-term debts
  • Voluntary and compulsory debt
  • Productive and unproductive debt
Funded debt is where debt is payable after a certain length of time- usually 30 years or more. A fixed sum must be repaid, along with a fixed rate of interest. Funded debts are used for permanent projects such as developing economic and industrial infrastructure. To repay this debt the government sets up a separate fund and the debt is repaid on maturity. Unfunded debt is used to meet temporary needs of the government. The duration is shorter and the rate of interest is extremely low. The debt should be paid at the due date with interest.

Short-term debt matures within 3 to 9 months of borrowing. The rate of interest is usually low and the short-term debts are usually incurred due to a temporary glitch in funds. Long-term debts are taken on for 10 years or longer. These are generally used for developmental programmes and long-term needs of the public authorities. Medium-term debts are paid back in 5 years or more and are used for both  developmental and non-developmental programmes.

Voluntary debt is where loans are given by members of the public on a voluntary basis. This may include market loans and market bonds. To get voluntary loans the government will make a plea in the media and will offer a high interest rate for those who do decide to provide a voluntary loan. Compulsory debt usually arises when there is war or crime. The loan is similar to taxation, except it is put into action more rapidly.

Productive debt involves raising money for productive purposes in the economy. The loan is used to add to the productive capacity of the country's economy. It can be used for railway construction, irrigation, power generations, etc. The interest is paid out of government-earned income. Productive loans are usually paid within the lifetime of a property or project, meaning they are self-liquidating. Unproductive debts do not add to the productive capacity of the country's economy. They are usually loans used for war and famine relief.

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