Government Subsidies
Government Subsidies
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).
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.
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.
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.
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