Determining the Optimal Ratio Between Internal and External Public Debt for the Latvian Economy

Public debt or public borrowing is considered an important source of income to the government. If revenue collected through taxes and other sources is not adequate to cover government expenditure, government may resort to borrowing. Public debt may be raised internally or externally. Internal debt refers to public loans floated within the country, while external debt refers loans floated outside the country. According to economic theory, the state should primarily borrow on the domestic market. Domestic debt limits the state's risks to the domestic market. In a crisis, the domestic debt can be monetized by the central bank through the purchase of government debt obligations. But domestic debt is associated with the redistribution of financial resources in the state's domestic market. If the state's domestic financial market is small and poorly developed, it is difficult for the government to attract the necessary financial resources. If there is a shortage of funds in the domestic financial market, the government can borrow on foreign financial markets. Foreign markets allow the state to attract the necessary capital to finance important projects. However, with external borrowing, the state loses part of its income, which is paid to external creditors in the form of interest. Foreign borrowing is usually accompanied with vulnerability that may result in debt crises since central bank is unable to produce the foreign currency required to repay external debt. The paper examines the relationship between internal debt and external debt in public debt structure. The aim of the paper is to analyse the main models of public debt management and to develop an optimal ratio between internal and external debt for the Latvian economy.