Understanding National Debt: How Governments Borrow and Spend

National debt is a fundamental component of a nation’s financial framework, influencing economic policies, growth, and stability. This comprehensive guide simplifies the concept, exploring its definition, purpose, and impact on the economy. Whether you’re new to the topic or seeking clarity, this overview will provide a clear understanding of why governments borrow, how debt affects national and global economies, and its relevance to everyday life.

Let’s explore what national debt is, why governments borrow money, how it affects the economy, and why it matters to you.

What Is National Debt?

National debt is the total amount of money a country’s government owes to lenders. These lenders could be individuals, banks, financial institutions, foreign governments, or international organizations. It’s also known as government debt, sovereign debt, or country debt.

When a government spends more than it earns through taxes and other revenue, it needs to borrow money to make up the difference. For example, governments borrow to pay for large projects, fund public programs, or respond to crises like pandemics or natural disasters.

How Does National Debt Work?

Governments borrow money by issuing financial instruments like bonds and treasury bills. These are essentially promises to repay the borrowed money with interest by a specific date.

For example:

• Internal debt is money borrowed within the country from local investors, banks, or citizens.
• External debt is money borrowed from foreign lenders, such as international organizations (e.g., the World Bank) or other governments.

India’s National Debt: A Snapshot for 2024-2025

Let’s look at India’s national debt situation to understand how it’s structured and what it looks like in numbers.

Key Insights:

• Internal debt accounts for the majority of the government’s liabilities.
• External debt is relatively smaller but still significant.
• The total debt is projected to grow from ₹168.73 lakh crore in 2024 to ₹181.68 lakh crore in 2025, showing an upward trend.

Why Do Governments Borrow Money?

Governments borrow money to meet their financial needs when revenues (like taxes) are not enough. Borrowing is often necessary to fund important areas such as:

• Infrastructure Development: Building roads, railways, airports, and power plants.
• Social Welfare Programs: Funding healthcare, education, and poverty-reduction schemes.
• Economic Growth: Borrowing stimulates the economy by creating jobs and increasing consumer spending.
• Crisis Management: Responding to emergencies, such as natural disasters or economic recessions.

Borrowing isn’t inherently bad—it helps the government fund critical areas of the economy. However, excessive borrowing can create problems.

What Are the Types of National Debt?

Governments manage their finances through two main types of debt:

1. Internal Debt

This is money borrowed within the country, typically through:

• Government bonds: Long-term borrowing instruments purchased by citizens, banks, or financial institutions.
• Treasury bills: Short-term borrowing tools to meet immediate financial needs.
• Small savings schemes: Programs like the Public Provident Fund (PPF) and National Savings Certificates (NSC), where citizens invest money, and the government uses these funds as loans.

2. External Debt

This is money borrowed from foreign sources, including:

• International organizations like the World Bank or International Monetary Fund (IMF).
• Other countries’ governments or foreign investors.

External debt is often recorded at the exchange rate that existed when the loan was issued.

What Causes National Debt to Rise?

National debt grows when the government spends more money than it earns through taxes and other revenues. This is known as a budget deficit.

A deficit often happens when the government adopts expansionary fiscal policies—strategies to stimulate the economy by:

• Increasing public spending, such as funding infrastructure projects.
• Cutting taxes, which leaves people with more money to spend but reduces government revenue.

While these policies can boost the economy in the short term, they often lead to higher debt levels over time.

Why Does National Debt Matter?

National debt affects a country’s economy in both positive and negative ways.

Positive Impacts:

• Funds Development Projects: Borrowed money supports infrastructure, education, and healthcare.
• Boosts Economic Growth: Government spending creates jobs and stimulates business activity.
• Attracts Investors: Bonds issued by governments are seen as safe investments, which helps maintain economic stability.

Negative Impacts:

• Higher Interest Rates: If debt grows too large, borrowing becomes expensive for both governments and businesses.
• Economic Slowdown: A high debt-to-GDP ratio can reduce growth and consumer spending.
• Risk of Default: If a country cannot repay its debt, it may damage its reputation and financial credibility.

The U.S. National Debt: A Global Perspective

The United States has the largest national debt in the world. As of January 2023, the U.S. national debt stood at $31.38 trillion, including:

• $24.5 trillion in public debt: Money owed to investors like citizens, foreign governments (e.g., China and Japan), and businesses.
• $6.88 trillion in intragovernmental debt: Money owed to federal programs like Social Security and military pensions.

The U.S. national debt exceeds the country’s total annual economic output (GDP). While this is considered unhealthy, investors continue to buy U.S. Treasury bonds because they trust the government to repay them.

How Does National Debt Affect You?

The size of a country’s national debt can directly or indirectly impact your life. Here’s how:

• Higher Interest Rates: Loans for homes, cars, or businesses might become more expensive.
• Slower Economic Growth: Businesses might hire fewer employees, leading to job cuts or slower wage growth.
• Inflation: If the debt weakens the country’s currency, the prices of goods and services can rise.
• Stock Market Instability: Uncertainty about the economy could lead to dips in the stock market, affecting your investments.

How Can National Debt Be Reduced?

Managing national debt requires a careful balance of strategies:

• Raise Taxes: This increases government revenue but can hurt consumer spending and business growth.
• Cut Government Spending: Reducing expenses can shrink the deficit but may harm essential programs like healthcare and education.

Challenges:

• Raising taxes may slow the economy.
• Cutting spending too aggressively can lead to unemployment and social unrest.

Understanding national debt helps us make sense of how governments manage their finances and how those decisions affect the economy and our daily lives. By keeping an eye on government spending, debt trends, and financial policies, you’ll stay informed about one of the most important aspects of any nation’s economy!