Factbox: Tracking illicit financial flows

JOHANNESBURG Wed Apr 6, 2011 10:13am EDT

JOHANNESBURG (Reuters) - Calculating the amount of money that disappears from poor countries as a result of corruption is complicated. Advocacy group Global Financial Integrity (GFI) estimates that Africa lost $854 billion in illicit financial flows from 1970 to 2008, much of it from resource-rich states.

Its most recent country estimate, provided exclusively to Reuters, is that almost $6 billion vanished from the petrol-rich but poor African state of Angola in 2009. LDE733035

There are two main methods that economists use to measure illicit financial flows out of countries: the World Bank residual method and trade mispricing. The following are some details about the methodologies used by GFI.

* THE WORLD BANK RESIDUAL METHOD relies on balance of payments data that are reported by all member countries of the International Monetary Fund under the Special Data Dissemination System. These figures must be reported in a timely manner and so they are available on a regular and annual basis.

The method basically takes the two broad sources of funding that a country has -- external borrowing (including official aid) and net foreign direct investment (FDI). It matches them up with the use side of the equation, which is the deficit on the current account and the change in official reserves. The latter, among other things, tracks any external debt repayments that have been made on behalf of the country.

Broadly speaking, it is the gap between a country's source of funds over a given time and its use of funds over the same period which highlights illicit or unexplained capital flows.

For example, let's say Country X brought in $10 billion in net FDI and external borrowing but its use of these funds, as shown by the current account deficit (the difference between exports and imports which needs to be funded) and the change in reserves, came to $5 billion. That leaves $5 billion unaccounted for, which must have leaked out of the balance of payments in unrecorded flows. The two figures should balance out, as in an accounting balance sheet.

* TRADE MISPRICING, which tracks commercial corruption, involves the under-invoicing of exports and the over-invoicing of imports (or vice versa).

In the case of Angola in 2009, about $4.6 billion of the $5.8 billion that streamed illicitly out of the country was funneled through trade mispricing, according to GFI's estimate.

On a global scale, this practice is believed to account for about 60 percent of illicit financial flows.

How does it work? Let's take a hypothetical example of export under-invoicing. Say that I'm an Indian tea exporter. I tell the Indian government that I am exporting $3 million worth of tea to a buyer in the United States. But on the U.S. side, the import is reported to be worth $5 million. Where did the other $2 million go that the American buyer shelled out? Probably into my off-shore bank account.

One way to measure trade mispricing is to look at official bi-lateral trade data, though there may be technical problems in the accurate recording of trade statistics.

For example, exports from a hypothetical country to the United States may officially be $30 billion for a set year. But U.S. authorities may have recorded $50 billion in imports from the country. The $20 billion gap here would be unaccounted for illicit flows that went somewhere else.

(Sources: Global Financial Integrity (GFI); Interview with GFI lead economist Dev Kar; World Bank, International Monetary Fund)

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