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Illicit Financial Flows
20 June 2011
The urgency for least developed countries is to ratify United Nations Convention against Corruption and customize its provisions by enacting essential legal frameworks, which are more directly relevant to the prevention and sanctioning of illegal financial flows through its strong anti-money laundering measures.
Over 7,000 participants, including heads of state and government, representatives of international organizations and non-governmental organizations, gathered in Istanbul, Turkey, to attend UN the LDC IV Conference from May 9-13. The conference assessed the results of the 10-year Brussels Action Plan, adopted in 2001, and agreed for new strategies, though not up to the mark, for sustainable development of LDCs (Least Developed Countries) for the next decade.
There are 48 LDCs, 33 of which are in Africa, 14 in the Asia-Pacific region, and one in Latin America and the Caribbean. However, the UN conference has set an ambitious goal of halving their number by 2020, although only three countries have "graduated" from LDC status since they were categorized in 1971. With a population of 880 million, the LDCs represent the poorest and weakest lot on earth. Besides bearing the burnt of crises from financial to food security to climate change, a UN report made public during the conference also reveals that illicit financial flows (IFF) are diverting colossal scarce resources away from LDCs. This may be a Herculean challenge for them to tackle.
IFF involves cross-border transfer of the proceeds of corruption, trade in contraband goods, criminal activities and tax evasion. In recent years, considerable interest has arisen over the extent to which such flows may have a detrimental impact on development and governance in the developed, developing and least developed countries alike. The US-based non-profit research body, Global Financial Integrity (GFI), estimates that even developing countries are collectively losing as much as US$1 trillion annually as IFF through corruption, trade in smuggled goods and criminal activities such as drug trafficking and counterfeiting. This is 10 times the amount they receive in foreign aid. Developing countries also annually lose US$20-40 billion through corrupt acts such as bribery of public officials, which is the equivalent of 20-40 percent of official development assistance (ODA).
The report, commissioned by GFI on behalf of UN for its LDC IV Conference, finds that approximately US$197 billion flowed out of the 48 poorest developing countries over the period 1990-2008. The volume has increased from US$9.7 billion in 1990 to US$26.3 billion in 2008 implying an inflation-adjusted rate of increase of 6.2 percent annually. The top 10 exporters of illicit capital account for 63 percent of total outflows from the LDCs while the top 20 account for nearly 83 percent. Trade mispricing accounts for the bulk (65-70 percent) of illicit outflows from the LDCs, and the propensity for mispricing has grown with increasing external trade. The report says African LDCs accounted for 69 percent of total illicit flows, followed by Asia with 29 percent and Latin America with 2 percent.
The urgency for least developed countries is to ratify United Nations Convention against Corruption and customize its provisions by enacting essential legal frameworks, which are more directly relevant to the prevention and sanctioning of illegal financial flows through its strong anti-money laundering measures.
Ratio of illicit outflows to GDP averages about 4.8 percent but there is wide variation among LDCs. Of the top 10 countries with the highest illicit flows to GDP ratio, four are small island countries, two are landlocked, and four are neither. In some LDCs, losses through illicit capital flows outpace monies received as the ODA. Thus, illicit capital flight has been identified as a major hindrance to development and a burning issue for the least developed countries.
Nepal in Top Ten
It is interesting to observe that Nepal is the sixth top exporter of IFFs losing US$9.1 billion from 1990-2008. This is nearly eight times more than the ODA Nepal received during this period. LDCs like Nepal are losing much more than what they receive through development aid. Other top 10 exporters are Bangladesh with US$34.8 billion, Angola with US$34 billion, Lesotho with US$16.8 billion, Chad with US$15.4 billion, Yemen with US$12 billion, Uganda at US$8.8 billion, Myanmar with US$8.5 billion, Ethiopia with US$8.4 billion and Zambia with US$6.8 billion.
The report shows that slightly more than 79 percent of cumulative illicit flows from landlocked as well as small-island LDCs over the period 1990-2008 have occurred through trade mispricing. While one can see that the high figure for trade mispricing in small-island LDCs is probably related to trade openness, the corresponding high estimate for landlocked countries seems to be counterintuitive. This is not necessarily so. While it is true that landlocked countries have no direct access to ports for international shipment of goods, they nevertheless trade a lot with neighboring countries such as Lesotho-South Africa, Nepal-India, Bhutan-Nepal, Bhutan-India.
Opportunities for mispricing trade abound where weak customs administration operate in remote and porous borders. LDCs that are neither small islands nor landlocked account for the bulk (slightly more than 84 percent) of illicit flows through the balance of payments for the group of LDCs as a whole. However, within the group that are neither small islands nor landlocked, the conduit for the transfer of illicit capital is more evenly distributed between the balance of payments leakages and trade mispricing.
Over this reporting period, trade mispricing in LDCs has increased at a real rate of 5.8 percent annually compared to the real rate of growth in LDC trade of 9.5 percent indicating that, in the absence of significant improvements in governance, the propensity to misprice trade has grown along with increasing external trade. Trade mispricing occurs when imports are overpriced and exports underpriced on customs documents. The tendency to misprice trade is likely to grow in an environment where anti-corruption capacities, as well as transparency and accountability mechanisms to curtail IFFs and stop leakages of resources are very weak.
The LDCs are major recipients of official external aid, receiving approximately 24.1 percent of total ODA flows in 2009. Yet, over the period 1990-2008, the ratio for the group averaged about 0.6—that is for every dollar received in ODA, 60 cents exit the country in illicit outflows. Of course, there are sharp variations among LDCs with loss of illicit capital outpacing ODA in the most egregious cases as follows—Equatorial Guinea (16.7 to 1), Angola (5.6 to 1), Myanmar (4.7 to 1), Chad (2.9 to 1), Yemen (2.7 to 1), Vanuatu (2 to 1), Samoa (1.7 to 1), the Gambia (1.5 to 1), Bangladesh (1.4 to 1), and the Lao People’s Democratic Republic and Nepal (both at 1.1 to 1). While other LDCs with illicit financial flows to ODA ratios at or below 1 may give the impression that the overall utilization of aid is effective or that governance is not an issue, in reality these countries are large recipients of external aid while illicit outflows are probably understated due to lack of data.
THE DRIVING FORCES
The report states that IFFs from LDCs mainly result from the macroeconomic, structural and governance-related lacunae. Firstly, fiscal deficits, high and variable inflation, overvalued real effective exchange rates, external debt and negative real states of return are some of micro-economic reasons behind financial outflows. Secondly, structural factors such as rising income inequality, faster rates of non-inclusive economic growth and increasing trade openness without adequate regulatory oversight are also fueling outflow of illicit funds. Thirdly, rampant corruption, worsening business climate, underground economy and political instability that result from poor governance are the culprits behind this increasing phenomenon.
To help curb the flight of these funds, LDCs should concentrate their focus on customs and tax reforms accompanied by robust legal institutions and regulatory systems to fight corruption. Watchdogs should also be empowered to provide adequate oversight over operations of the financial system including customs authorities, multinational and domestic companies and collection of taxes. However, these measures can only succeed if there is a strong political will both in the LDCs and developed countries where the lost revenues eventually end up. Given that taxes are the most sustainable source of finance for development, LDCs will have to emphasize for equitable and fair domestic tax systems that do not unduly burden the poor and could boost economic growth that benefits more than a privileged lot.
Besides these reforms, the United Nations Convention against Corruption (UNCAC) can also provide a basis for combating illicit flows through its extensive preventative measures that are designed to prevent corruption from occurring in the first place and illicit flows from being generated. Therefore, the urgency for LDCs is to ratify UNCAC and customize its provisions by enacting essential legal frameworks, which are more directly relevant to the prevention and sanctioning of IFFs through its strong anti-money laundering measures. Given the current pace, skyrocketing illicit financial flows will be the toughest among other challenges for LDCs to confront over the next decade.
Source: Republica
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