Government subsidies

A subsidy, often viewed as the converse of a tax, is a potent welfare-augmenting instrument of fiscal
policy. Derived from the Latin Word ‘subsidium’ a subsidy literally implies coming to assistance
from behind. However, their beneficial potential is at its best when they are transparent, well
targeted, and suitably designed for practical implementation.
Definition
The Oxford English Dictionary defines subsidy as “money granted by State, public body etc to
keep down the prices of commodities etc” Subsidies bring out desired changes by effecting
optimal allocation of resources, stabilizing the price of essential good & services, redistributing
income in favor of poor people thus achieving the twin objective of growth & equity of nation.
Subsidies will be targeted sharply at the poor and the truly needy like small and marginal farmers,
farm labour and urban poor.
Subsidies in areas such as education, health and environment merit justification on grounds that their
benefits are spread well beyond the immediate recipients, and are shared by the population at large, present
and future. For many other subsidies, however the case is not so clear-cut. Arising due to extensive
governmental participation in a variety of economic activities,
Subsidies, as converse of an indirect tax, constitute an important fiscal instrument for modifying marketdetermined outcomes. While taxes reduce disposable income, subsidies inject money into circulation
. Subsidies affect the economy through the commodity market by lowering the relative price of the
subsidised commodity, thereby generating an increase in its demand. With an indirect tax, the price of the taxed
commodity increases, and the quantity at which the market for that commodity is cleared, falls, other things
remaining the same. Taxes appear on the revenue side of government budgets, and subsidies, on the
expenditure side.

Objectives
Subsidies, by means of creating a wedge between consumer prices and producer costs, lead to changes
in demand/ supply decisions. Subsidies are often aimed at :
1. Inducing higher consumption/ production
2. Offsetting market imperfections including internalization of externalities
;3. Achievement of social policy objectives including redistribution of income

even when this maybe desirable on economic grounds. procedural delays. Increase in explicit budgetary subsidies on food and fertilizer There is a wedge between subsidies that are actually received by the users of the service and subsidies that are borne by the Government. such as food grains. Apart from direct costs like overstaffing. subsidies are implied). at higher than market prices or if it sells as lower than market prices. Several types of inefficiencies Several types of inefficiencies may accompany the public provision of services. If the government procures goods. poor maintenance of assets.Forms of subsidies  A cash payment to producers/ consumers is an easily recognizable form of a subsidy. and delays in taking critical decisions. Different type of subsidy        Cash Subsidy: Providing food or fertilizer to consumer at lower price.  It also has many invisible forms (It may be hidden in reduced tax-liability. there are systemic inefficiencies High costs of service provision and low or negligible recoveries through user charges are the two critical factors leading to high subsidies. Costs need to be reduced. . and Generally low efficiency levels of governmental activities. Interest or credit subsidies Tax subsidies In kind subsidies Procurement subsidies Regulatory subsidy Equity subsidies CAUSE OF SUBSIDIES ‘SPROLIFERATING IN INDIA     The expansion of governmental activities Relatively weak determination of governments to recover costs from the respective users of the subsidies. low interest government loans or government equity participation. by eliminating producer inefficiencies.

Subsidy reforms need to follow a scheme of priorities by focusing on selected sectors. Moreover. the affected tranches may experience dramatic credit deterioration and loss. Private. there were reports of under recoveries by public sector oil marketing companies leading to demand for greater subsidies. subprime mortgage crisis.S. Thus. SECURITISATION Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages.5. or collateralized mortgage obligation to various investors. commercial mortgages. The principal and interest on the debt. In addition. the credit risk of all tranches of structured debt improves.and structure-dependent. and that competitive securitization markets with multiple securitizers may be particularly prone to sharp declines in underwriting standards. Securities backed by mortgage receivables are called mortgage-backed securities while those backed by other types of receivables are asset-backed securities. competitive mortgage securitization is believed to have played an important role in the U. A scheme focusing on services in which there is considerable scope for higher recovery in the non-Merit category may constitute the first step. thereby facilitating risky capital structures and leading to an under-pricing of credit risk. Off-balance sheet securitizations are believed to have played a large role in the high leverage level of U.573 crore in 2003-04. financial institutions before the financial crisis. Critics have suggested that the complexity inherent in securitization can limit investors' ability to monitor risk.The unprecedented and steep rise in the international prices of crude and petroleum products has led to an increase in the explicit subsidy bill in the Central Government’s budget from Rs. and the need for bailouts.225 crore in 2002-03 to Rs. underlying the security. The granularity of pools of securitized assets is a mitigant to the credit risk of individual borrowers. if improperly structured. off-balance sheet treatment for securitizations coupled with guarantees from the issuer can hide the extent of leverage of the securitizing firm. which yield maximum results. the credit quality of securitised debt is non-stationary due to changes in volatility that are time. auto loans or credit card debt obligations and selling said consolidated debt as bonds.6. is paid back to the various investors regularly. . pass-through securities.S. Unlike general corporate debt. If the transaction is properly structured and the pool performs as expected.

the market has spread into several asset classes – housing loans. toll revenues. though has matured significantly only post-2000 with an established narrow band of investor community and regular issuers. investors’ familiarity with the underlying assets and the short maturity period of these loans. it should not be capable of being set aside by an insolvency officer of the originator or recharacterised as a secured loan of the purchase price. and • The sale of assets to the SPV must be a ‘true sale’ – that is. the structured issuance volumes have grown considerably in the last few years. In order to meet this objective: • The SPV and the originator must be treated in an insolvency as separate entities. etc that have been securitised. The law has evolved differently on each side of the Atlantic in relation to these issues. where creation of any form of security was rare and the portfolios simply got transferred from the balance sheet of the originator to that of another entity. lack of secondary market liquidity and the risk arising from prepayment/repricing of the underlying loan. securitisation was essentially a device of bilateral acquisitions of portfolios of finance companies. project receivables. which is structured using the true sale concept. future flow. There were quasi-securitisations for sometime. Though securitisation of auto loans remained the mainstay throughout the 1990s. though still small compared to international volumes. The mortgage backed securities (MBS) market has been rather slow in taking off despite a growing housing finance market due to the long maturity periods. loan sales have become common through the direct assignment route. SPV in the Indian context: The growth in the Indian securitisation market has been largely fuelled by the repackaging of retail assets and residential mortgages of banks and FIs. corporate loans. higher volumes and homogenous nature of receivables. In recent years. commercial mortgage receivables. the car loan segment has been more successful than the commercial vehicle loan segment. Asset backed securitisation (ABS) is the largest product class driven by the growing retail loan portfolio of banks and other FIs. According to Industry estimates. Within the auto loan segment. In the early 1990s.Objective: The objective of many securitisation structures is to isolate the SPV from the risks associated with an insolvency of the originator. mainly because of factors such as perceived credit risk. over time. This market has been in existence since the early 1990s. which offered recourse to the originator as well. Other types of receivables for which . These transactions often included provisions.

Media widely reported condominiums being purchased while under construction. or the liabilities to taxpayers." Housing prices nearly doubled between 2000 and 2006. and subordinated classes receiving correspondingly lower credit ratings.[72] During 2006. default may occur when maintenance obligations on the underlying collateral are not sufficiently met as detailed in its prospectus. these figures were 28% and 12%. Revolving assets such as working capital loans. During 2005. Some mortgage companies identified risks inherent in this activity as early as 2005. stated that the 2006 decline in investment buying was expected: "Speculators left the market in 2006. including reverse mortgages. a record level of nearly 40% of homes purchased were not intended as primary residences. Almost all mortgages. this behavior changed during the housing boom. While homes had not traditionally been treated as investments subject to speculation. a vastly different trend from the historical appreciation at roughly the rate of inflation. National Association of Realtors's chief economist at the time. then being "flipped" (sold) for a profit without the seller ever having lived in them. and student loans. respectively. meaning that taxpayers are on the hook for any of these loans that go bad even if the asset is massively over-inflated.securitisation has been attempted in the past include property rental receivables. lease receivables and medical equipment loan receivables. A key indicator of a particular security’s default risk is its credit rating. are now insured by the government. . with an additional 14% purchased as vacation homes. David Lereah. after identifying investors assuming highly leveraged positions in multiple properties. telecom receivables. 22% of homes purchased were for investment purposes. with senior classes of most issues receiving the highest rating. credit card receivables are not permitted to be securitized Homeowners default: Speculative borrowing in residential real estate has been cited as a contributing factor to the subprime mortgage crisis. which caused investment sales to fall much faster than the primary market. In other words. In other words. power receivables. Different tranches within the ABS are rated differently. Credit default swaps: Default risk is generally accepted as a borrower’s inability to meet interest payment obligations on time For ABS. there are no limits or curbs on over-spending.

which doesn't encourage improvement of underwriting standards . the credit crisis of 2007–2008 has exposed a potential flaw in the securitization process – loan originators retain no residual risk for the loans they make.However. but collect substantial fees on loan issuance and securitization.