72% of India's lost capital is held overseas
The report says this is a conservative estimate as it doesn’t include smuggling, certain forms of trade mispricing and missing data. Factor those in, and the country has lost at least half a trillion dollars.
The flight of capital from the legal system accelerated once the Indian government eased its tight control with economic reforms that started in 1991, the report says. Part of the problem was that Indian’s economic liberalization wasn’t accompanied by better governance or more accountability in the system. So, while this period started liberalization of trade, lowering of trade barriers, less control and less oversight, it also led to an increase in bribes (to get your goods out of customs more quickly, for instance) and higher tax evasion.
India’s underground economy has been estimated at 50% of the GDP, making it about $650 billion at the end of 2008. Of this, 72% is held abroad, estimates Dev Kar, the author of the report and a former senior economist at the International Monetary Fund. “All countries need investment and get the capital from domestic savings and foreign savings,” says Kar. You can make up some of the gap of this lost capital with domestic savings, but the rest has to be borrowed at a price. “The cost to the country [of this loss of capital] is real,” he says.
Without a doubt economic reform post 1991 has fostered a faster pace of economic growth. However, analysis shows that more rapid economic growth in the post-reform period has actually led to deterioration in income distribution. A more skewed distribution of income implies that there are many more high net-worth individuals in India now than ever before and it’s this group, along with private companies that are the primary drivers of illicit flows from the private sector in India (rather than the common man).
The report also found that from 1995 to 2009 the Indian private sector shifted away from bank deposits to deposits in overseas financial sectors. As the share of OFC deposits increased from 36.4% of total deposits in 1995 to 54.2% in 2009, and deposits in banks fell commensurately to 45.8% in the last year. OFCs are subject to even less oversight than banks and typically hold a larger share of illicit funds. The source of that increase was no doubt India’s burgeoning underground economy, the report states.
Since tax evasion is a major driver of the underground economy, efforts to expand the tax base and improve tax collection can help curtail illicit flows, says Kar. He also recommends redistributive policy measures to ensure that growth remains inclusive or generate many of the rich who drive illicit flows. Here Kar is not suggesting a socialist strategy but rather stepping up to deliver the basics to the masses. “In India vast swathes of the population have no access to clean water, to education, to healthcare, their children are malnourished, and they don’t see any of the benefits of faster rates of growth,” he explains. “India needs to pay more attention to the Millennium Development Goals [and meet some of these needs.] There’s a whole host of things you can do with $460 billion.”
To curtail illicit flows he suggests the government should: (i) ensure that the rule of law is applied fairly and swiftly, (ii) strengthen regulatory and legal institutions (iii) adopt policy measures to improve both public and corporate governance such as improving tax compliance and collection. These domestic measures need to be complemented by tighter regulatory oversight of banks and OFCs by developed countries in order to ensure that financial institutions do not facilitate the absorption of illicit capital, he says.