Originally Published 2013-07-29 11:11:25 Published on Jul 29, 2013
One can see the problem of illicit financial flow in a narrow view in terms of loss of tax revenue, but the more often missed out perspective is that these illicit flows create imbalances in the global economy that upset the efficiency of capital. Illicit financial flows cannot be curtailed without the collaborative effort of both developing as well as developed countries
Inadequate financial governance: Nowhere near perfect solution
" The present, inadequate state of international financial governance has created the space in which fraudulent actors are able to flourish. Despite limitations of existing models to estimate illicit flows, Global Financial Integrity (GFI), a research organisation working to curtail illicit financial flows, estimated that in 2010 that the developing countries lost an estimated $ 859 billion through illicit outflows.

There is an urgent need to cooperate among countries, both developed and developing, to tackle global imbalances in the financial system arising out of illicit flows. Illicit financial flows have become a central and integrated constituent of the global economy. They are no longer peripheral or isolated. As studies and methodologies on this issue have evolved, the impacts of these illicit flows on economies are becoming increasingly discernible.

The economic consequences of illicit flows are highly asymmetric - the impact of such flows is far more severe for developing countries than for rich ones. Loss of corporate tax revenue for developing countries translates into smaller provisions for critical social services for the public. More so, there is a greater loss to the economy as a whole, as the money could otherwise be used to support local investment and growth. For richer nations, despite losses in tax revenue, there is net benefit at the end of the tunnel as laundered money is usually deposited in their own financial centres.

These problems are not just limited to developing countries. The economies of Greece and Cyprus demonstrate how illicit flows can destabilise economies and governments of developed countries. These flows feed into the shadow banking system used by multinationals and individuals to avoid and evade taxes. The same system manages the proceeds of corruption, terrorism and transnational crime. Illicit flows are a symptom of a deeper governance malaise.

International political response

The above-described scenarios illustrate how combating illicit financial flows requires greater coordination and information sharing among nations.The issue of illicit financial flows is now firmly on the agenda of the G-20 and the G-8 and various elements of it are enshrined in UN instruments, such as the United Nations Convention against Corruption (UNCAC).

Five years since the crisis, both the G8 and G20 leaders have shown the resolve to seriously address the issue of financial opacity and illicit outflows. The recommended policy interventions and objectives are encouraging but we are yet to see significant coordination and implementation efforts to harmonise into a common framework.

One of the core objectives of the G20 forum is to limit global imbalances in financial flows, which extends to the need to guard against the possibility of regulatory arbitrage. If comparable regulatory standards are not implemented in all jurisdictions simultaneously, financial activity is likely to migrate to less regulated jurisdictions as well as into shadow banking. The G20 has urged all jurisdictions to stand ready to conclude Tax Information Exchange Agreements at the earliest - they do not mention a time frame.

The Financial Action Task Force (FATF) is mandated to identify and monitor high-risk jurisdictions, but with the lack of a comprehensive model to estimate illicit flows, the task is difficult. Many times the difference between licit and illicit flows is blurred - the recent case of Apple's tax strategy to save billions of dollars of US taxes through Irish subsidiaries.

Possible options

The existing efforts to tackle illicit flows are mostly oriented towards domestic anti-money laundering actions. Though the intent is there, there is enough evidence to suggest that these actions have not done the needful. Each country controls the exit and entry of financial flows depending on the strength of state institutions. However, there is a need for a much broader range of policy options to deal with illicit flows - mutual legal assistance, asset recovery and policies to curb the space provided by in adequate financial governance. These efforts demand much greater engagement by countries in the international community.

Political initiatives like the G20 and G8 should back coordinated efforts for automatic cross-border exchange of tax information, country-by-country reporting for multi-national corporations, disclosure of beneficial ownership information for all companies, and greater enforcement of and penalties for trade mispricing, exploitative transfer pricing and money laundering.

On a domestic level, policies should be strengthened to ensure customer due-diligence, beneficiary owner requirements, regulation of service providers, including lawyers and notaries that perform such functions. Improvements in these areas could potentially have a significant impact, given the role played by institutions and their often privileged contact with their clients.

The attempt should be to promote a new global standard of information exchange and reforming international accounting standards. Instead of only debating on the issues of tax compliance and fairness, developed economies should set an example by agreeing to automatically exchange tax information with each other. Developing and emerging economies should willingly join the efforts to collaborate, as they have much more to lose from the asymmetric relationship.

India's Role

Illicit financial flows out of India grew at a rate of 11.5% per year while in real terms they grew by 6.4% up to 2008. According to a report commissioned by the Finance Ministry, a total of $213.2 billion went out of India through illicit outflows since 2008. Around 40% of foreign direct investment to India comes from the small island country of Mauritius.

But does one truly believe that these funds have originated from there? A recent decision of the Foreign Investment Promotion Board (FIPB) to reject three FDI proposals routed via Mauritius on the grounds that the investors did not reveal the identity of the ultimate beneficial owner, is an encouraging sign.

For the challenges that India is confronted with, it is not comforting to know that illicit financial flows out of India are growing yearly as we become more integrated with the global economy. Increasing public debate on this issue has helped. Late last month the FATF stated that it has decided to remove India from its regular follow-up process for determining its compliance to the global standards.

Internationally, India should build on its position in the G20 to push for greater reform for financial transparency. The solution to the problem lies in both developed and developing countries working together, and this could be a perfect opportunity for India to take up a bigger role on an issue that it itself is plaguing with.


The long-term effects of illicit flows undermine the stability and credibility of institutions, the capacity of the state of perform its functions - making the process socially inefficient. Africa has lost between $597 billion and $1.4 trillion in net resource outflows between 1980 and 2009, far exceeding the money coming in (foreign aid/private-sector flows) and thereby greatly undermining the continent's development.Illicit flows also create distortions in the trade economy by creating barriers to entry and by creating unstable financial markets.

One can see this problem in a narrow view in terms of loss of tax revenue, but the more often missed out perspective is that these illicit flows create imbalances in the global economy that upset the efficiency of capital. Illicit financial flows cannot be curtailed without the collaborative effort of both developing as well as developed countries. Advanced economies must hold their financial institutions to high standards of corporate governance and greater accountability and transparency in their services and must ensure that they do not, in any way, absorb illicit flows from developing countries without regard to the illegal manner in which the capital was generated.

At the same, developing countries need to adopt range of policies based on sound economic policies, strengthening of institutions and implementing the rule of law.

(Rohit Sinha is a Research Scholar at Observer Research Foundation, Delhi)

Courtesy : The Pioneer, July 27, 2013

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