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How much rupee is really stashed overseas?

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In Brief

The decision of the Modi government in India to constitute a special investigative team to probe the illicit accounts of Indians outside India — the first action of the new government — reflects both the sincerity of the government and the political sensitivity of this issue. A recent report has found that India’s losses due to these activities are substantial, with wide-ranging effects on the Indian economy.


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Central to this issue is the need to have accurate estimates of the amount of capital flight actually taking place from India. Given varying estimates of Indians’ illicit wealth abroad, this is easier said than done.

A key component of capital flight is ‘trade misinvoicing’. For any given country, capital flight through trade misinvoicing occurs in two ways. Firstly, there is under-invoicing of exports. This is when the stated value of a domestic country’s exports to a foreign country is lower than the freight and insurance adjusted value of the foreign country’s imports from the domestic one.

Secondly, when the stated value of the foreign country’s exports to the domestic country is lower than the freight and insurance adjusted value of the domestic country’s imports from the foreign country, we have the phenomenon of over-invoicing of imports.

The values of export under-invoicing and import over-invoicing are added to obtain the total value of capital flight through misinvoicing. This exercise is then repeated for all trading partners of the domestic country. The sum thus obtained is stashed in tax havens overseas and is a loss to the domestic country.

A recent paper, by Duc Nguyen Truong and the author, provides significant estimates of capital flows from India through trade misinvoicing. The data analysed is from UN COMTRADE, MIT’s Observatory of Economic Complexity and the IMF E-library. For the period 1988–2012, data was only available for 17 of India’s trading partners: the United Arab Emirates, Brazil, Switzerland, China, Germany, France, the UK, Hong Kong China, Indonesia, Italy, Japan, South Korea, Kuwait, the Netherlands, Singapore, United States and South Africa.

So, what happened between 1988 and 2012? Until 1996, flows fluctuated between both net inflows and outflows. Yet, from 1997 outflows began on a clear upward trend. In particular, since a huge structural break in 2004, the volumes of capital flight have been very high, rising from US$7.65 billion in 2005 to a staggering peak of almost US$40 billion in 2008. Outflows then dipped to just over US$17 billion in 2012.

Over the period 1988–2012 the cumulative outflow from India due to misinvoicing was in excess of US$186 billion. This is an astonishing figure. To put this in perspective, at the end of December 2013, India’s short-term external debt was US$92.7 billion: less than half of total capital flight through misinvoicing in the period 1988–2012.

Figure 1 below provides a summary illustration of the capital flight from India

Source: UN Comtrade Standard International Trade Classification (SITC) Rev. 3.

If left unaddressed, capital flight via trade misinvoicing will continue at high levels. This will play a significant macroeconomic role, affecting GDP growth, interest rate differentials between India and the US, and inflation and exchange rate risk. Capital flight can have substantial effects on India’s macroeconomic performance, particularly with respect to exchange rate risk and inflation risk.

Capital flight has to be checked urgently, not only because it is a drain on India’s resources but also because it continues to have a significant and, by its very nature, uncontrollable effect on the economy. At least some of the failures of current macroeconomic policy in India, in particular the ineffectiveness of monetary policy in controlling inflation and stabilising the exchange rate, could be attributed to capital flight. This kind of capital flight through trade misinvoicing is probably happening from a number of countries. Once the SITC’s work is completed India, along with other countries, should take the initiative to share information on trade flows so that misinvoicing could be halted.

These losses should be recouped. But repatriating vast sums to India in one go would stoke inflationary pressures. It would be more advisable to set up a sovereign wealth fund, the returns from which could be used to buttress India’s current account balance and insulate the economy against any future rise in commodity prices.

Raghbendra Jha is head of the Arndt-Corden Department of Economics and Rajiv Gandhi Professor of Economics at the Crawford School of Public Policy at the Australian National University. A version of this article first appeared here on the Economic Times website.

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