Tainted money

Published : May 22, 2009 00:00 IST

A branch of Switzerlands largest bank, in Zurich. Pressure on the Swiss banking industry to reveal more is bound to increase.-FABRICE COFFRINI/AFP

A branch of Switzerlands largest bank, in Zurich. Pressure on the Swiss banking industry to reveal more is bound to increase.-FABRICE COFFRINI/AFP

THE money is tainted; it is a drain of wealth from the country, being located in secretive Swiss banks; and the sums involved are large. Not surprisingly, the issue of monies stashed away by Indias rich and powerful in numbered accounts in Swiss and similar banks is periodically raised, provokes controversy and then enters a period of hibernation. It is revived periodically for a number of reasons.

Most often, the transfer of money to Swiss bank accounts involves a violation of tax, foreign exchange and/or other laws of the country, and therefore is illegal and morally repugnant. To boot, the sums involved are not small. Finally, these reflect surpluses that can be used to finance much needed development initiatives in the country, but are now being kept idle abroad to facilitate illegal accumulation. Their existence is symbolic of an elite that places self before the nation. This is even truer of alleged payoffs for award of defence contracts.

The moral and nationalistic indignation this generates leads to the correct demand that violations of law that permit accumulation of such wealth abroad need to be investigated, the offenders must be prosecuted and the money brought back and directed towards pushing growth and improving welfare. Morality aside, equity demands that the rule of law should apply for all.

Currently, three factors have combined to revive the controversy in India. First, early this year, in a major breakthrough, prosecutors from the United States Internal Revenue Service (IRS) investigating violations of tax laws by American citizens managed to force UBS, Switzerlands largest bank, to reveal the names of 250 nationals who were suspected of having evaded payment of about $300 million in taxes by using offshore accounts. The bank also agreed to pay the U.S. government $780 million to settle the issue.

These sums are indeed small. But this decision of a banking system that thrives because of the countrys secrecy laws was a huge concession with major ramifications. Even in the case of the U.S., the 250 names involved were a small proportion of the 19,000 accounts that are allegedly held by Americans in Swiss banks. The sums held by these 250 would only be a small fraction of the $20 billion that the IRS suspects was illegally ferreted away between 2002 and 2007.

Pressure on the Swiss banking industry to reveal more was bound to increase. And, the U.S. was just one country. If secrecy laws were being relaxed to accommodate the U.S. because it is an important economic player, it would become difficult for the system to resist pressures to reveal the names and details of account holders from other countries, including developing countries such as India, which need the money to raise per capita incomes and reduce poverty. On the other side, the pressure on governments to demand, obtain and act on similar information increases. Thus, the possibility that the sums involved could be tracked and investigated was bound to revive the issue in India.

The second factor leading to a revival of the debate was the release of estimates of how much money could be illicitly flowing to accounts abroad from developing countries, India in particular. Provided by Global Financial Integrity, a programme of the Centre for International Policy, these estimates based on accepted methodologies suggest between $858.6 billion and $1.06 trillion flowed illicitly from developing countries in 2006.

India ranked fifth among developing countries with illicit outflows of around $22 billion to $27 billion a year during 2002-06, following Russia ($32-$38 billion), Mexico ($41-$46 billion), Saudi Arabia ($54-$55 billion) and China ($233-$289 billion). At current exchange rates, the figure at the lower end of the range amounts to more than Rs.110,000 crore a year. If a quarter of that could be recovered as tax it could go a long way in financing the National Rural Employment Guarantee Scheme each year. And if the whole amount is spent within the country, it would amount to a demand stimulus of close to three and a half per cent of gross domestic product , which could help reverse the current slowdown in growth. If there is so much money that could be kept back at home the issue is bound to be controversial, even if the figure is just an estimate.

Finally, all this has occurred when India is in election mode. With an issue at hand which can provoke moral indignation and fuel nationalistic sentiment, it would be too much to expect the opposition to let it be never mind the fact that flows of this kind were occurring even when the principal opposition party, the Bharatiya Janata Party, was in power at the Centre.

Whatever the combination of circumstances that have brought the issue to the fore once again, the case for exploiting the opportunity is strong. Domestically, tax and foreign exchange laws must be implemented more stringently. And internationally, the government must exert itself to obtain the information that could reduce, even if not put an end to, this menace.

One route to take would be to use the opportunity afforded by the hole in the Swiss banking wall created by the recent limited success of U.S. lawmakers to suck out information on Indian offenders as well. The other is to work towards a better global environment for obtaining information that can help reduce this form of accumulation of black money.

As Raymond Baker, the Director of Global Financial Integrity and author of Capitalisms Achilles Heel: Dirty Money and How to Renew the Free-Market System, puts it in Financial Times (April 24): Most effective in curtailing the massive illicit outflows from developing countries would be a requirement for automatic cross-border exchange of tax information on personal and business accounts and country-by-country reporting of sales, profits and taxes paid by multinationals. With increasing GLOBAL concern over the role of tax havens in promoting tax evasion and money laundering, there is an opportunity now. All this having been said, however, a few words of caution are in order. First, the concern with illicit outflows should not divert attention from the larger issue of tax evasion and avoidance which plague developing countries such as India. Illicit outflows to Swiss and other foreign banks are only one part of the black money generated in the system. Much of it remains in the country. Such domestically retained illicit wealth can be more easily identified and taxed and the generation of new illicit wealth (that may or may not go abroad) more easily plugged.

And estimates on the size of the black economy, the volume of tax evasion, and the amount of disputed and unresolved claims on Indians by the tax department are all as mind-boggling as the figures on illicit outflows of wealth. Moreover, the issue is not just of tax evasion but of tax avoidance facilitated by the loopholes present in and concessions afforded by the tax laws. Examining the revenues foregone because of tax concessions is a first simple lesson on what can be done to find the money to do a lot that remains undone for want of resources.

Second, concern with illicit outflows should not divert attention from the licit flows that are on the rise because of financial liberalisation. Until the early 1990s, Swiss accounts allegedly held by Indians were seen not just as the result of ill-gotten wealth. They, it was argued, were the result of the limits placed on accessing foreign exchange. It was not just that the rupee was not convertible on the capital account, preventing Indians from converting rupees into dollars (say) to acquire assets abroad.

Even foreign exchange for current account purposes such as imports of commodities, travel, health and education was scarce and rationed. This, it was argued, encouraged those who could afford it and find ways to ensure it to transfer and hold money abroad. Economic policy was forcing many to exploit Swiss banking secrecy and violate the law. What the more recent estimates show is that this argument was not all true. Even after the substantial liberalisation of rules relating to accessing and using foreign exchange, monies are being transferred and held abroad.

The real change now is that such transfer occurs in both illicit and licit forms. For example, trade and exchange rate liberalisation notwithstanding the practice of over-invoicing imports and under-invoicing exports to evade taxes and transfer funds abroad continues. Simultaneously, funds are being transferred abroad to acquire assets and hold balances. The outflow of capital in the form of foreign direct investment (FDI) from India during the first nine months (April-December) of financial 2008-09 was close to $12 billion or more than two-fifths of FDI that flowed into the country, that is $27 billion. Not all such outflows are necessary. There has also been an increase in the outflow of foreign exchange from the country in the form of outward remittances under the liberalised remittance scheme for resident individuals. These remittances totalled $9.6 million, $25 million and $72.8 million in the three years ending 2006-07. But they shot up to $440.5 million in 2007-08.

The point to note is that this transfer of foreign exchange abroad is not linked to the earning of such foreign exchange. Nor is it accompanied by an increase in the ability of India to earn a positive surplus of foreign exchange through trade in goods and services and incomes generated from investment abroad.

India records a deficit in its current account so that any excess foreign exchange it possesses has not been earned but has been borrowed. It is a part of that borrowed foreign exchange that is being transferred abroad with no likelihood of return. It could happen that there could be occasions where demands to fulfil commitments on past debt substantially exceed current earnings and inflows, leading to instability and crises of a kind that are now common in the developing world. At that point of time, the burden of adjustment falls on all, not just on those who have ferreted away foreign currency in the past. This too is unacceptable.

Preventing such an outcome requires restricting unnecessary and restrictive inflows and unwarranted outflows in countries where a historically determined subordinate position in global trade and investment flows makes foreign exchange a valuable resource. This should not be forgotten either by the ruling party or its leading opponents when they vent their moral outrage at illicit outflows. Unfortunately, that is what they seem to do.

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