Where the Hot Money Flows

Illegally generated outflows of cash from developing countries into richer ones have become a torrent, according to a new report by the NGO Global Financial Integrity, with an average of more than US$1 trillion flowing across borders illegally in the latest year measured. China continues to lead the world, with Malaysia a surprising fifth despite its relatively small population.

These illicit flows heighten poverty, cancel investments, and thwart economic development, the report notes, In some measure they also reflect the confidence, or lack of it, in the future of the countries involved.

Illicit outflows are also generated through a lack of governance and political instability, the report notes. “Corruption often involves government officials ignoring their responsibilities or acting in violation of them for some personal, material gain. Thus, corruption also involves bribe-taking, specifically whereby government officials and others including those in the private sector are bribed to encourage or facilitate their action to arrive at a speedier or more favorable outcome to the agent or individual offering the bribe. "“These factors, along with ‘grassroots corruption’ in the private sector involving individuals, private households, and enterprises drive the extensive corruption that can permeate in the society.” The 78-page report, titled Illicit Financial Flows from Developing Countries: 2000-2009 With a Focus on Asia, was published this month. The latest complete year recorded, 2008, showed that the illegal outflows or transfers rose US$1.26 trillion as skyrocketing prices for oil, other minerals, and foodstuffs, generated funds which easily escaped abroad.

"We regard our figures as conservative, since they do not include smuggling, some forms of trade mispricing, and asset swaps," Raymond W. Baker, the director of the organization, wrote in a foreword.

The huge outflows of illicit capital from China account for Asia’s dominance in illicit transfers, the report says. According to what it called conservative estimates, outflows from Asia increased from US$200.1 billion in 2000 to US$495.1 billion in 2008, increasing an average of 12.9 percent per year.

It should be recognized that it’s impossible to capture all the channels through which money can leave a country, the report notes. In particular, it can move through so-called "hawala-style" swap arrangements that are impossible to trace using official statistics. In hawala transactions, a resident of developing country X asks a foreign contact to deposit US dollars in a foreign bank against the payment of local currency to the foreign contact’s local contact or deposit an agreed-upon amount of local currency in a bank account in Country X.

The cross-border smuggling of goods is another important channel through which capital from a country can be transferred illegally without such outflows ever being captured in official trade statistics. Smuggled goods, of course, are not recorded by the customs of the "exporting" country from which the goods are being smuggled nor in the importing country where the goods end up.

The report found that the five Asian countries with the largest total illegal capital flight during 2000-2008 are: China (US$2.18 trillion), Malaysia (US$291 billion), Philippines (US$109 billion), Indonesia (US$104 billion), and India (US$104 billion).

"On average these five countries account for 96.5 percent of total illicit flows from Asia and 44.9 percent of flows out of all developing countries," the report found, although these shares have been declining. The top five Asian countries transferred 36.9 percent of illicit flows from all developing countries in 2008, down from 53.3 percent in 2000.

Although China continues to lead the world in illicit leakages of money, its proportion actually has been falling steadily, the report says, from 46 percent in 2000 to 27 percent in 2008. Russia, the United Arab Emirates, Kuwait, and Nigeria, all of which are exporters of oil, are now becoming more important as exporters of illicit capital, the report said. Whereas in earlier years trade mispricing accounted for the bulk of such transfers, in which residents can acquire foreign assets illicitly by over-invoicing imports and under-invoicing exports, in the two latest years money flowed out through balance of payments accounts.

Specifically, from 2006 to 2008, trade mispricing grew by 30 percent, but over the same period disappearances from balance of payments accounts grew by 46 percent, the report continued, suggesting that "a growing proportion of hidden transfers is occurring out of government coffers, perhaps consistent with the huge run-up in revenues generated in oil producing countries. As world trade recovers, it would not be surprising to see these two channels for illicit flows reverse again, returning trade mispricing to the dominant means of moving unrecorded funds.

The report, written by researchers Dev Kar and Karly Curcio for the NGO, anticipates that the rate of growth of illicit financial outflows will slow to 2.9 percent above 2008, yet is still expected to hit a total volume of US$1.3 trillion.

The researchers based their methodology on what is called the World Bank Residual model, using the change in external debt, adjusted for trade mispricing. Unrecorded capital leakages through the balance of payments change in external debt component capture illicit transfers of the proceeds of bribery, theft, kickbacks, and tax evasion. The Gross Excluding Reversals method captures the outflow of unrecorded transfers due to trade mispricing.

"Apart from differences in the extent to which major exporters of illicit capital drive such flows from developing countries, the methods for the transfer of these funds also vary," the researchers found. While trade mispricing is the major channel for the transfer of illicit capital from China, the balance of payments is the major conduit for the unrecorded transfer of capital from major exporters of oil such as Kuwait, Nigeria, Qatar, Russia, Saudi Arabia, the United Arab Emirates, and Venezuela. Mexico is the only oil exporter where trade mispricing is the preferred method of transferring illicit capital abroad.

The current report is an update to the 2008 Illicit Financial Flows from Developing Countries: 2002-2006 which found that developing countries lost US$859 billion to US$1.06 trillion in 2006. Illicit outflows have increased to a range of US$1.26 trillion to US$1.44 trillion in 2008 and on average, developing countries lost between US$725 billion to US$810 billion per year over the nine-year period 2000- 2008.

Global Financial Integrity is supported by grants from the Ford Foundation.