Tuesday, January 7, 2014

Is the market-registration price wedge a good second-best policy?

It is widely believed that the difference between market value and (government notified) registration rates (basic or guidance value) in India are a major contributor to the creation of black money and its amplification. Across the country, sales transactions are generally recorded at the registration rates, which are much lower than the actual transaction rates. A lower officially recorded transaction price helps buyers and sellers minimize their outflow on stamp duty and capital gains tax.  

But on the positive side, it is also believed that the wedge works to the advantage of mortgage lenders since it leaves them with an asset whose actual valuation is much higher than its declared collateral value. Given the impressive growth of mortgage market in the country, it will be interesting to explore the contribution of the price-wedge to the development of this market. 

In line with "second-best" models approach, it would appear that the price-wedge, despite all its distortions, may have had important unintended consequences. It may have provided property lenders the additional collateral cushion required to expand their lending activity. In other words, the premium may have incentivized financiers to readily lend against properties. It may also have served as a buffer against declines in property prices, thereby acting as a form of default-risk insurance, for the entire financial system.   

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