Sinking Fund:

Sinking fund is a fund which aims at sinking the debt obligation. It facilitates for regular retirement of public debt. It operates in  such a way that the government deposits a fixed amount of revenues into this fund every year aiming at the  regular retirement of public debt. Many economists believed that this is best method of debt redemption. Under this method, the Fund accumulates over a period of time by setting aside a small amount every year from the revenue budget which increase at compound interest rate. So that it will be useful by the time the debts mature.  Sinking fund is accumulated from the beginning until the debt is matured. But now it is not a  very effective instrument as the stock of debt has exceeded number of times than the real size of the sinking fund.

According to Hugh Dalton sinking fund should be financial and accumulated out of current revenues of the government and should not be financed from borrowing sources. If the sinking fund is financed with borrowing resources, it does loose its purpose and cannot be called as sinking fund. In many countries sinking fund is not accumulated from year to year over a period of time. Generally some amount of resources from the revenue account is allocated from the current year budget allocations which are used for repayment of debt in the same year. But the existence of such fund with small annual accrual has become irrelevant in view of the mountainous and fast growing debt obligation in India as well as in several other countries in the world.

Theoretically, sinking fund is a good means for orderly retirement of public debt. But this is a slow process of repayment of debt and there is every chance of diverting the resources from the fund for other uses at the time of resource crunch.