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

Forms of subsidies
A cash payment to producers/ consumers is an easily recognizable form of a
subsidy.
It also has many invisible forms
(It may be hidden in reduced tax-liability, low interest government loans or
government equity participation. If the government procures goods, such as food
grains, at higher than market prices or if it sells as lower than market prices,
subsidies are implied).

Different type of subsidy

Cash Subsidy: Providing food or fertilizer to consumer at lower price.

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, even when this maybe desirable on economic grounds, and
Generally low efficiency levels of governmental activities.
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. Several types of inefficiencies
Several types of inefficiencies may accompany the public provision of services. Apart from
direct costs like overstaffing, poor maintenance of assets, procedural delays, and delays in taking
critical decisions, 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, by eliminating producer
inefficiencies.

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 Governments budget from Rs.5,225
crore in 2002-03 to Rs.6,573 crore in 2003-04. Moreover, there were reports of under recoveries
by public sector oil marketing companies leading to demand for greater subsidies.

Thus, Subsidy reforms need to follow a scheme of priorities by focusing on selected

sectors, which yield maximum results. A scheme focusing on services in which there
is considerable scope for higher recovery in the non-Merit category may constitute
the first step.

SECURITISATION
Securitization is the financial practice of pooling various types of contractual debt such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations and
selling said consolidated debt as bonds, pass-through securities, or collateralized mortgage
obligation to various investors. The principal and interest on the debt, underlying the security, is
paid back to the various investors regularly. Securities backed by mortgage receivables are called
mortgage-backed securities while those backed by other types of receivables are asset-backed
securities.
Critics have suggested that the complexity inherent in securitization can limit investors' ability to
monitor risk, and that competitive securitization markets with multiple securitizers may be
particularly prone to sharp declines in underwriting standards. Private, competitive mortgage
securitization is believed to have played an important role in the U.S. subprime mortgage crisis.
In addition, off-balance sheet treatment for securitizations coupled with guarantees from the
issuer can hide the extent of leverage of the securitizing firm, 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.S. financial institutions before
the financial crisis, and the need for bailouts.
The granularity of pools of securitized assets is a mitigant to the credit risk of individual
borrowers. Unlike general corporate debt, the credit quality of securitised debt is non-stationary
due to changes in volatility that are time- and structure-dependent. If the transaction is properly
structured and the pool performs as expected, the credit risk of all tranches of structured debt
improves; if improperly structured, the affected tranches may experience dramatic credit
deterioration and loss.

Objective:
The objective of many securitisation structures is to isolate the SPV from the risks associated
with an insolvency of the originator. In order to meet this objective:
The SPV and the originator must be treated in an insolvency as separate entities; and
The sale of assets to the SPV must be a true sale that is, 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.
The law has evolved differently on each side of the Atlantic in relation to these issues.

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. This market has been in existence since
the early 1990s, though has matured significantly only post-2000 with an established narrow
band of investor community and regular issuers. According to Industry estimates, the structured
issuance volumes have grown considerably in the last few years; though still small compared to
international volumes. Asset backed securitisation (ABS) is the largest product class driven by
the growing retail loan portfolio of banks and other FIs, investors familiarity with the underlying
assets and the short maturity period of these loans. 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, lack of secondary market liquidity and the risk arising from
prepayment/repricing of the underlying loan.
In the early 1990s, securitisation was essentially a device of bilateral acquisitions of portfolios of
finance companies. There were quasi-securitisations for sometime, 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. These transactions often included provisions, which offered
recourse to the originator as well. In recent years, loan sales have become common through the
direct assignment route, which is structured using the true sale concept. Though securitisation of
auto loans remained the mainstay throughout the 1990s, over time, the market has spread into
several asset classes housing loans, corporate loans, commercial mortgage receivables, future
flow, project receivables, toll revenues, etc that have been securitised.
Within the auto loan segment, the car loan segment has been more successful than the
commercial vehicle loan segment, mainly because of factors such as perceived credit risk, higher
volumes and homogenous nature of receivables. Other types of receivables for which

securitisation has been attempted in the past include property rental receivables, power
receivables, telecom receivables, lease receivables and medical equipment loan receivables.
Revolving assets such as working capital loans, 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.[72] During 2006, 22% of homes purchased were for investment
purposes, with an additional 14% purchased as vacation homes. During 2005, these figures were
28% and 12%, respectively. In other words, a record level of nearly 40% of homes purchased
were not intended as primary residences. David Lereah, National Association of Realtors's chief
economist at the time, stated that the 2006 decline in investment buying was expected:
"Speculators left the market in 2006, which caused investment sales to fall much faster than the
primary market."
Housing prices nearly doubled between 2000 and 2006, a vastly different trend from the
historical appreciation at roughly the rate of inflation. While homes had not traditionally been
treated as investments subject to speculation, this behavior changed during the housing boom.
Media widely reported condominiums being purchased while under construction, then being
"flipped" (sold) for a profit without the seller ever having lived in them. Some mortgage
companies identified risks inherent in this activity as early as 2005, after identifying investors
assuming highly leveraged positions in multiple properties.

Credit default swaps:

Default risk is generally accepted as a borrowers inability to meet interest payment obligations
on time For ABS, default may occur when maintenance obligations on the underlying collateral
are not sufficiently met as detailed in its prospectus. A key indicator of a particular securitys
default risk is its credit rating. Different tranches within the ABS are rated differently, with senior
classes of most issues receiving the highest rating, and subordinated classes receiving
correspondingly lower credit ratings. Almost all mortgages, including reverse mortgages, and
student loans, are now insured by the government, meaning that taxpayers are on the hook for
any of these loans that go bad even if the asset is massively over-inflated. In other words, there
are no limits or curbs on over-spending, or the liabilities to taxpayers.

However, the credit crisis of 20072008 has exposed a potential flaw in the securitization
process loan originators retain no residual risk for the loans they make, but collect substantial
fees on loan issuance and securitization, which doesn't encourage improvement of underwriting
standards