A recent report by a Washington-based think-tank, Global Financial Integrity (GFI), on illicit financial flows from developing countries during the last decade (2000-08), has turned the spotlight on Asia. China is found the largest source of illicit capital flows followed by Russia and Mexico. Among other Asian countries, Malaysia (5th), the Philippines (12th), Indonesia (14th) and India (15th) figure among top-20 largest developing countries producing illicit flows.
Illicit is a relatively new entrant in the capital and financial market terminology. Illicit flowsaccording to the reportinclude capital that is accumulated or transferred illegally and contains all unrecorded or unreported transactions that abet accumulation of foreign assets by residents in violation of existing regulatory norms. The conceptual domain of the definition is sweeping and tempts one to conclude that the estimated flows include the wealth stacked in undisclosed accounts in Swiss banks and other tax havens. That though may just be wishful thinking. As the report admits, there are several transactions, particularly hawala, which are impossible to trace through imbalances in different categories of official statistics. The latter also do not capture revenues from black market transactions at prices different from usual market prices and which could eventually find their way into foreign assets in clandestine manners.
Even though the GFIs illicit capital estimates will be less than what they actually are, they provide some valuable insights on countries exporting such capital. Asia is a sizeable exporter of such flows, accounting for almost 45% of total flows during 2000-08. Almost 90% of illicit outflows from Asia are outcomes of what the report calls trade mispricingunder-invoicing of exports and over-invoicing of imports. Exporters understate value of their exports and keep the balance funds in the recipient country. Importers act opposite. Both end up having surpluses enabling acquisition of foreign assets. Almost 75% of illicit capital generated by trade mis-invoicing$445 billion out of $597 billionis seen to flow out of Asia.
The report pays particular attention to five Asian countriesChina, Malaysia, Indonesia, the Philippines and Indiafor their role in contributing to exports of illicit finance. Though China is the largest exporter of illicit finance from trade channels, the rate of growth of the outflows is slowing. This could be due to changes introduced in foreign exchange transactions that have simplified transfer of such exchange abroad and reduced incentives for availing of informal channels.
While China might be looking forward to more success in curbing illicit flows in the medium term, similar prospects appear rather grim for Malaysia, Indonesia and the Philippines. Capital outflows are increasing sharply from these countries. There are several reasons common to the three that augment the flows. Political instability, corruption and income inequality are some of these. All three factors are strong incentives for stashing capital overseas. China and India are not bereft of these virtues. For India, the report notes that greater trade openness has created larger opportunities for trade mis-invoicing since invoicing and documentation procedures have not reformed in line with trade policies.
Notwithstanding the methodological shortcomings, conclusions of the report have important takeaways. First, flight of capital has assumed serious proportions in Asia. Economic growth in Asia appears to be creating new opportunities for greater rent-seeking. Some of these opportunities manifest in accumulation of capital abroad. Capital accumulated abroad represents a loss for source economies. The capital lost, ranging from annual average of $241 billion for China to $11.6 billion for India [Malaysia ($32.6 billion), the Philippines ($12.1 billion) and Indonesia ($11.6 billion) are either well or marginally above India] could have made significant differences to development capacities of the countries, had they been deployed in formal channels at home.
The second issue that can hardly be overlooked is the gap between policies and procedures in developing Asia. This seems to be rampant across the region. Unfortunately, China, India, Indonesia and other large emerging markets do not appear to have modernised or streamlined their rules and procedures as much and as fast as they should have. Their systems fare poorly compared to those in industrialised Asian economies like Japan, Korea, Taiwan, Singapore and Hong Kong. The results of inefficient systems are reputations of being not-too-good places for doing business, perpetuation of corruption and encouraging illegal flight of capital. Costs of opaque and tedious procedures in trade and foreign exchange are much more than what these countries think.
The author is a visiting senior research fellow at the Institute of South Asian Studies in the National University of Singapore. These are his personal views