If bad money turns into smart money

Written by YRK Reddy | Updated: Mar 3 2007, 05:30am hrs
The investment behaviour of corrupt people till about the early 1990s was probably simple and predictable. Bad money went in search of properties that could be bought with large sums of unofficial money. Police and income tax stories abound with people stacking away hard cash in gunny bags. It is common knowledge that many also used hawala channels, but mostly to finance their consumptive tendencies. The second economy, black money and hawala have been a matter of public policy concern, and initiatives such as Indias amnesty schemes, voluntary disclosures, tax rate reductions and tax base expansion have yielded results.

However, things have changed again in recent years, bringing along worries of systemic risks as well as national security. The changes occurred in tandem with the growth of capital markets and new age industries. Smart operators within the country have found new ways of investing their cash. Benami shareholdings was one known method, especially before the know your customer (KYC) guidelines. It is rumoured that many politicians and civil servants had indirectly acquired equity in start-ups or high-profile corporations. It is also rumoured that much black money has slipped out of the country through the hawala system to offshore tax havens. All this is obviously illegal, but still not a security concern.

However, there is a large amount of money amongst many groups, which may not be friendly to either India or the goals of peace, prosperity and harmony in the world. What do these groups, involved perhaps in drug trafficking, black marketing, illegal intermediation, extortion, terrorist activities and so on, do when they have dormant money They invest it. Bad money turns into smart money, as these shady investors seek to make their surpluses active, accessible and flexible. What better way than setting up a company with well-stated objectives in a distant tax haven That money can get very active indeed through investments in stock markets worldwide. If the investments are large, they may even influence prices to their advantage. Such unstated surplus money is not merely with corrupt politicians, bureaucrats and terrorist groups, but also with secret agencies, secret funds, religious groups with dubious credentials, and so on. As capital markets have grown in range, sophistication and volumes, the returns on bad money may have grown hugely, even disproportionately.

Thus, it is no wonder that Mauritiusnot the UK or the USis the single largest source of FDI for India accounting for over 50% as per recent estimates. The real owners of firms in such tax havens are devilishly difficult to identify, given the complex pyramids or layering of ownership structures. And not all transactions in tax havens are illegal, as many honourable businesses indeed use them for tax advantages.

Acting with courage, conviction and boldness in raising such sensitive issues could eventually bring greater good than harm, as several instances show
Such tax havens are a perfect place for bad money to join good money from banks, legitimate firms, entrepreneurs, private equity funds, venture capitalists and so on. Thus does bad money enter the investment mainstream.

Indias national security advisor, M K Narayanan, had boldly made a point in Munich in the presence of world leaders such as Vladimir Putin, that there have been reports of isolated instances of terrorist outfits manipulating stock markets. The statement, which may have been misconstrued from many angles, has also been denounced quickly mostly arising from fears of a stock market crash than anything else. However, the matter should be analysed in an objective and rational manner. The discovery of international methods and the implementation of anti-laundering measures should be on the agenda. This is imperative now that globalisation has made money electronic, fungible and flexible, and with low respect for barriers.

Acting with courage, conviction and boldness in raising such sensitive issues could eventually bring greater good than harm. Remember how some countries have been tackling corruption and HIV/AIDS successfully merely by being bold and open about the problems