Planning For It! : Economy

Money Laundering and its Economic Effect

Yogi — Thu, 16 May 2013 05:56:00 GMT

Money laundering in one of the most debated topics in our country right now. Cobra post revelations regarding involvement of the whole banking sector in laundering activities has pressurised the regulator to implement stringent rules and regulations to curb these practices. Money Laundering in a global problem and has serious socioeconomic impact. Let’s try to figure out what money laundering is and why it is a global problem. We will also discuss the economic impacts which force the regulators to be on tenterhooks.

What is money laundering?

Have you ever washed clothes (Laundering, I mean)? Laundering of cloths makes dirty cloth appear clean. Money laundering has the same effect – It makes dirty money appear clean. Dirty money (basically cash) here means the money earned from illegitimate sources like embezzlement, bribes, crime, frauds etc. You do not pay taxes on dirty money and there is a fear of seizure once it comes to the knowledge of regulators. So, basically, you cannot use dirty money until it’s cleaned via money laundering process.

How money laundering is carried out?

There are ‘n’ number of discovered and yet to be discovered ways of money laundering. We will discuss the most commonly used method which has three steps.

Bringing the money into financial system – As the dirty money is purely in the form of cash, the very first step is to bring it into the legitimate financial system. Here, banks play a major role either willingly or unwillingly. If they are willing, (as is the case in cobra post revelations) they will guide you how to do that. Otherwise, dirty money is deposited in different anonymous bank accounts in small chunks so as to make it appear a low value transaction. As low value transaction is not reported, dirty money enters the banking system safely. This process is technically termed as placement.
Hiding the source – In this step, money is made to move in such a way that it get’s untraceable. It is hopped through many accounts (local/overseas), changing the currency, buying financial products or costly items like gold, etc. Basic objective is to make the transactions complex so that reverse engineering gets difficult. Technically, this process is called layering.
Receiving the money back in legitimate form – The money hopped and invested in previous step is recovered via sell transaction or overseas transfer into local accounts which is now invested in some local company. This local company is supposed to have full involvement in the whole process and more often than not promoted by the launderers themselves. This step is the final one and is termed as integration. Now, the dirty money is clean enough to be used with confidence and without fear of getting caught.

Economic Impact of Money Laundering

As regulators internationally are so worried about laundering, it must have far reaching effect on the economy. No tax is paid on the laundered money and it’s made to enter the legitimate system but there must be someone who is paying the cost. It’s basically the whole country which bears the cost. Shell companies which are promoted for laundering process go bankrupt when launderers are caught. The invested money in these companies is wasted without any economic profitability in case of bankruptcy. Banks that finance such companies too, are in a financial mess post the revelation. Money laundering also creates false demand and supply scenarios in sectors they operate leading to skewed economic policy announcements at times which are bound to fail once false demand dwindles. Money laundering has some social effects leading to increase in corruption, crimes and frauds. People who are not involved see money launderer racing ahead which motivates them to choose this path.

About the Author:

The author Bimlesh Singh is a financial advisor. He holds a Bachelor’s degree from IIT and is a CFA Level 2 candidate. He can be reached at expert@investmentyogi.com

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Monetary Policy Tools and its Effects

Yogi — Tue, 14 May 2013 06:14:00 GMT

Monetary policy refers to attempts by a central bank like RBI to control inflation and increase growth rate of economy by employing tools which changes the money supply and interest rates. Let’s try to understand how use of monetary policy tools effects inflation and economic growth in the Indian context. We will also try to understand the trader’s mentality regarding the monetary policy announcements.

Objectives of Monetary Policy

There are two primary goals which an effective monetary policy aims to achieve. First, by monetary policy tools, RBI wants to maintain price level stability and, second broader objective is to maintain a strong and growing economy. RBI tries to maintain price level stability by controlling the inflation rate. By maintaining a stable inflation rate, RBI can also maximize potential GDP and the growth rate of GDP. While maintaining price level stability, the central bank achieves its secondary goals of increasing the incomes and the living standard of common people.

Common investors and Monetary Policy

Since taxation is based on nominal returns and not real returns, high inflation decreases real after-tax return. High inflation rate decreases the tendency of saving and investment as greater uncertainty about future returns increases the risk. This risk element pushes current consumption rather than saving and investment. Lack of savings and investment slows the growth rate of country's economy over time.

Monetary policy tools

Most tracked and talked about tools used by RBI for implementation of monetary policy are Repo Rate, Reverse Repo Rate and Cash Reserve Ratio (CRR). Repo is the rate at which banks borrow money from the RBI. Reverse Repo is the rate at which banks lend money to RBI and cash reserve ratio (CRR) is the portion of saving deposits that banks are mandated to park with RBI.

Following the traders

The announcements regarding key policy rates like repo, reverse repo and cash reserve ratio are tracked by the traders in stock and bond market. They utilize these announcements to make some short term but substantial profit. This profit potential lies in understanding some basic after effects of the policy rate changes. By cutting rates, RBI gives room to banks to lower the cost of loans for their customer’s. The whole business model is heavily dependent on interest costs. This list includes companies from sectors like Auto, Housing Finance, Real Estate and Banks themselves. This whole lot is termed as interest rate sensitive as prevailing policy rates have a huge impact on their profit margins. Similarly bond prices are also rate sensitive and are inversely proportional to the prevailing interest rate. If the interest rates are high, bond prices will be low and vice versa.

When there is an announcement regarding policy rate cut, all the interest rate sensitive sectors react positively providing a short term profit opportunity. However, you need to plan your investment prior to these announcements. The price adjustment is relatively fast and there is very limited scope of profits in the short run post announcement. Hence, to benefit the most you will have to act quickly.

Normally, policy rate revision rumours start popping up one month in advance. Carefully track the news and once convinced that the rumours are not baseless, you can take long position in interest rate sensitives.

Word of Caution

This strategy is of short term nature and you should book your profits before actual announcements are made, as rumours might actually be rumours only and if there is no policy rate cut, your profits might get wiped out. I am reiterating, treat this investment as a short term investment and book your profits before the actual announcement. Better be safe than feel sorry.

About the Author:

The author Bimlesh Singh is a financial advisor. He holds a Bachelor’s degree from IIT and is a CFA Level 2 candidate. He can be reached at expert@investmentyogi.com.

Calculators:

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The Upcoming Market Triggers (JAN 2012)

Yogi — Sun, 01 Jan 2012 17:43:10 GMT

Current Scenario

The year’s ended, but I don’t see any respite from troubles in equity market and the world economy. Though inflation has shown some signs of slowing down but simultaneously, the industrial growth is also moving towards negative. In last few days, stock market of world’s major economies were trading with a cautious note. The recent Euro Zone meeting, concluded to rescue it from a drastic economic collapse, had resulted in a Luke warm response from the financial world. The action taken during Euro Zone meeting was not decisive enough to overcome the debt crisis. The Indian market has also taken several blows in its attempts to fight the economic crisis. Recently GDP growth has been revised down from 9% to 7.25-7.75%, the IIP data has drastically come down to -5% in second week of December and the rupee has crashed down against dollar to around Rs 52. The tax collection in India is expected to slow down due to weak industrial activity. Since most of the troubled economies are China’s main business market, China’s growth is also under deep pressure to cope with the low demand. The property market in China has shown some slowing down signal, and it could further escalate the problem.

Expected Scenario and Important Events

Inflation to cool down

The Inflation in India and other emerging economy is expected to cool down consistently. The weak IIP data suggests low industrial demand, and the prices of agri based commodities are also expected to ease in coming days. Already, the food inflation in the 2nd week of December has come down to 4.5%. With the drop in crude price and industrial slowdown, it is expected that inflation will fall further in the coming months.

(IMPACT OF INDIAN STOCK MARKET: POSITIVE)

Crude and Energy Price Expectation

Energy has a major role in influencing the economic conditions. So far the world has seen crude prices jumping towards a new high despite European slow-down along with a great global economic concern; the crude price is not expected to cool down in coming months. The recent escalation in tension between Iran and US is expected to further push prices in upward direction. In a situation of any restriction/ban on Iran's oil export, the price of energy product is expected to show a sharp increase in coming months. This would have an adverse effect on the equity market. The impact of energy price escalation would have a severe effect on the inflation and Indian government’s intention to control current account deficit in short term.

(IMPACT OF INDIAN STOCK MARKET: Negative)

The Value of Indian Rupee

For last two months, the depreciation of Indian rupee against dollar had been the biggest concern for the government and the RBI. Though in credit policy review of December 2011, the RBI has decided to keep the key rates unchanged but still the depreciation of Rupee is expected to continue until Rs 56-57/$. Amid lots of speculations about RBI decreasing the CRR rate, a curb on FOREX trading has been ordered by it to check manipulative speculation. Further, if the world economic condition worsens, then RBI is expected to sell some of the Gold that is holding. The FII inflow/Outflow is also important to watch, as any negative rumor can make them pull out money in coming days causing Rupee to decline against the dollar.

(IMPACT OF INDIAN STOCK MARKET: NEGATIVE)

Elections in Five State

The elections for five states assembly have been announced by the election commission during Feb 2012. Its result would have a great impact on the central government’s stability as well as the stock market. Due to elections, the budget session is also expected to be postponed to second week of March 2012 i.e. after the result of assembly election. The market seems to be very volatile due to increased frequency of rumor based information flow in coming months.

(IMPACT OF INDIAN STOCK MARKET: NEGATIVE)

What should an investor do?

When the market is standing on the edges, it's better to take advantage of every opportunity because in such a situation the stock's moment decouples itself from the valuation and fundamentals; the only thing that drives the market in such a situation is “Rumors ". Any negative news in this situation would push the market downwards more then expectation. The investor should just focus on shares with good fundamentals and invest while the prices are at a rock bottom level compared to the actual valuation. For example, the capital good sector seems unattractive at present due to fall of Rupee value against dollar, but I would suggest taking a contrary view. The inflation is slowing down, and Rupee too is expected to stop depreciating after some time. As soon as the RBI decides on rate cut, the investment in the infrastructure sector would take a pace, and capital good's sector would be on the front to take the advantage. Similarly, there are other selective sectors from which investors can reap precious advantage for investment in coming days.

(Investment suggestion: Diversified value picking on sharp corrections with a long-term view. Daily Traders please keep away)

About the author:

Amit Sethi is an MBA (Fin) graduate. He has spent 8 years in Equity research and Stock broking sector. He can be reached at amvilube@gmail.com

World Economy Deformed!

Yogi — Wed, 14 Dec 2011 06:48:55 GMT

How All Started

Let’s start the story from the starting of year 1900. It was a period when colonial age of European countries was getting over. The world wanted to grow as fast as it can, the economic race was running in the vein of whole Earth. Soon, the spaces in the economic path became narrower and fight for dominance brought the World War I. At the end of First World War, the winning countries found that they have not earned anything from the whole chaos. The World economy was still shaky and finding way for better future. The dominant countries thought there’s no meaning of war until anything worth being achieved to rule the world. The thought of dominance took the world towards the World War II. At the end of the Second World War, the US and USSR emerged as bosses of the world. The US took strategic control over the world by utilizing dollar as the World’s currency and hence controlling the majority energy produced by other countries. Time passed, and USSR broke into Russia and other small countries. Finally, US became the single superpower of the world. The United States continued to over utilize dollar for controlling the World. Slowly, the other countries realized the importance of economic growth. The growing countries formed groups to fight the dominance of developed countries. Groups like BRICS, SAFTA and EURO zone snatched the dominance of the longest ruled super power, i.e. United States. Countries also realized that they are buying US treasury bonds (US Debt) for the luxury of American comfort as the US started sweating to repay the debt. The control of US over the world energy market started crumbling due to tension in South-East Asia. The world economy by now had seen The World War I and II, The Great Depression, The Gulf War, The WTC Collapse and now experiencing The Great Debt Crisis.

Current scenario

The story began with dominance, growth and power. The story is still the same. One who holds the ENERGY rules the world. The United States and its alliance have started to use its muscle for Energy dominance by showing its intention to put fresh UN sanctions on Iran. The Russia and China have already declared its intention to block any type of resolution against Iran to impose sanctions in the UN. The debt crisis is deepening in the Euro Zone as there’s no relief enough to sort out this problem. Many large debt instruments are maturing in the year 2012. The inflation is not cooling down significantly anywhere in the world. All measures taken by the central banks of major economies have boomeranged. The fastest-growing economies like China, India and Brazil have shown signs of slowing down.

What Next?

The World is heading towards a deep confrontation for Energy, Food and Security. For secured growth, the crude oil’s faster accessibility has pushed its rate higher and availability is scarce. The higher-energy price has resulted in higher food price. Now, to balance its domestic condition, all the economies are making efforts to gain the energy supply. Since crude oil is a scarce commodity, it would not be possible to ensure proper supply at low price to all the countries. This energy confrontation would decide the economic shape of a new world, new era with the emergence of powers that will dominate the world economy. The action of US on Iran and China on South China Sea has already surfaced as the fight for energy dominance. The developed nations are looking at new ways to dictate the world and selling cleaner technology for low carbon emission to the developing nations, seems part of its strategy. The developed nation tactics to capture the world agriculture market has already been blown after several WTO Doha rounds. The push and pull for agriculture, energy and security has just started creating unrest in the world.

For Investor

The risk averting investors should wait for situations to improve and income pace becomes normal to enter in the market. Investor who dares to take a risk can start targeting fundamentally sound companies to buy cheap during deep corrections in coming days. It is always advisable to buy when things are available at throw away price and sell at a stubborn high. Despite suggestion given above, I am inclined to caution a contrary statement for uninformed investors: “In a situation where money is hard to come, uncertainty is looming everywhere and words have lost the value; it is better to stay in cash then to invest and lose all."

About the author

Amit Sethi is an MBA (Fin) graduate. He has spent 8 years in Equity research and Stock broking sector. He can be reached at amvilube@gmail.com