Subtracted By $15.7 Billion?

This is the worst case scenario. The best case scenario, according to the study, isn’t too good either: that implies a flight of $1.4 billion (Rs 5,100 crore). The researchers compared the average prices of products the US trades with other countries in the world  with the prices of the same products when it trades them with India to find enormous deviations (see tables). Over- invoiced imports into India in 1994 and 1995 could, according to the study, have been to the extent of $1.5 billion, and under- invoiced exports, as much as $9.9 billion.

Suppose one accepts the $15.7 billion figure for the flight of capital, then the implications are stark, and horrendous. If this outflow had been plugged, the country’s foreign exchange reserves would have been double what it is today. India’s trade deficit and foreign debt situation, too, would have been radically different. For, flight of capital has a cascading effect— it destabilises domestic financial markets and the efficiency of monetary policy, lowers domestic investment and erodes the country’s tax base which, in turn, increases the public sector deficit.

And consider the fact that the US accounts for only about 20 per cent of India’s international trade. This capital outflow may be just the proverbial tip of the iceberg, says Prof J. D. Agarwal, director, Indian Institute of Finance: "Flight of capital may also be taking place to other OECD (Organisation for Economic Cooperation and Development) countries, which together account for about 55- 60 per cent of India’s international trade." He estimates a maximum annual capital outflow of Rs 40,000 crore from India to the OECD countries, half of it to the US.

Over- invoiced imports and under-invoiced exports ( see visuals for how the chain works ) may be utilised to evade income tax, and to convert money obtained from illegal activities into legitimate investments: money laundering. As government agencies sorely lack the capabilityto analyse import and export transactions, abnormal trade pricing could be the least risky technique of shifting capital across borders.

Says Agarwal: "Political uncertainty may be the most potent reason for flight of capital. Exporters seem to think that it is safer to stash money abroad, given the fluid political situation." The rigid controls on foreign currency transactions may be another contributing factor. Agarwal also feels some part of the money is kept as a hedge or reserve to be used when it is needed most, as the Indian Government has the tendency to tighten release of foreign exchange suddenly on the plea that it is in scarce supply.

However, the most important economic reason for abnormal trade pricing is to save corporate taxes. The tax rates in India are much higher than those in the US, points out Agarwal. The money is kept in banks, by opening subsidiaries operating as corporates in the US or it is simply stashed away in secret accounts. It is often used by top Indian executives when they go abroad for business or pleasure, adds Agarwal.

Some, however, see the study as being too alarmist. While agreeing that under- invoicing of exports and over- invoicing of imports does take place, economist Bibek Debroy feels the capital flight figure of $15.7 billion is unrealistically high. With India’s total trade to the US at $7.6 billion in 1994 and $9 billion in 1995, a capital outflow of $5.8 million in 1994 and $5.5 billion in 1995 "is indeed a very suspect figure," he points out.

Debroy recalls that a study conducted in 1989 revealed capital outflow of $2 billion annually to all OECD countries in the 1980s. With the exchange rate between the US dollar and the Indian rupee now at a more realistic level, there is now not much of an incentive to stash money abroad, he feels. In fact, the flight of capital from India has dropped in the past few years, according to him.

R. K. Dhawan, director general, Federation of Indian Export Organisation, agrees: "While it is right to say that there is both under- invoicing and over- invoicing, the figures quoted in the study are reckless and way off the mark. Also, there is no logic in keeping capital abroad. This capital will lie, sort of idle, as the rate of interest is much lower abroad than in India. Moreover, few exporters will want to face the risk of being caught in FERA violations."

Debroy, in fact, argues that the very methodology used in the study is full of loop-holes, like comparing apples and oranges. But the American researchers beg to differ. They say: "We used the global price matrix to select the average prices of all commodities traded between the US and India and the average prices for all commodities traded between the US and the world. We analysed every import and export transaction between India and the US during 1994 and 1995. First we analysed India’s import prices for products purchased from the US and compared them to the average import prices for products with identical characteristics purchased from the US by the world. For every India import transaction we determined the deviation of price when the observed price was greater than the US/ world average import price by at least 10 per cent. A similar analysis of India/ US export transactions to determine the value of under- invoicing in exports was conducted."

So what’s the solution?  Should the Indian Government clamp down brutally on the offenders? No, says Debroy emphatically.  The right way to stop flight of capital is to rationalise both exchange rate and taxes, he feels, so that the compulsion to keep money abroad is minimised. Dhawan suggests a one- time amnesty for those wanting to bring back capital that may be hoarded overseas, as former finance minister Dr Manmohan Singh did with the India Development Bonds. But the Government should include a rider. For example, by making it compulsory that such money is invested in five- year infrastructure bonds or other such schemes, before it is actually given the seal of legitimacy.

The bottomline: the extent of flight of capital may be disputed, but there’s agreement on the fact that the problem is serious, and that the Government has to do something, quickly. But could so much money have never reached Indian shores, where it was destined for, without political and bureaucratic connivance?