Theory question 111
Public FinanceSection B (answer four questions only from this section)
How can a huge national debt affect the economy of a country?
Show the model answer
Debt servicing (interest and repayment) takes a large share of revenue, leaving less for development projects.
External debt servicing drains foreign exchange.
Higher taxes may be needed to pay the debt, reducing incentives.
Large domestic borrowing raises interest rates and crowds out private investment.
It can worsen income distribution (bondholders gain from taxpayers).
It may cause inflation if financed by money creation.
External creditors may impose conditions (e.g. IMF conditions), reducing economic independence.
It reduces the country's credit rating and ability to borrow again.
Burden passed on to future generations.
Distinguish internal and external debt effects where you can.