Op-eds

India: Fighting Imported Corruption

by Devesh Kapur, University of Pennsylvania
and Arvind Subramanian, Peterson Institute for International Economics

Op-ed in the Business Standard, New Delhi
March 31, 2011

© Business Standard

 


The anger that we feel against today's "elite" bribe-takers in India comes with a major question: Where does that money go? How are such massive amounts of ill-gotten wealth laundered without being easily traced? When Sukh Ram took his cut, he could still put it in suitcases, but when Madhu Koda raked it in, the sheer volume meant he had to be much more creative. Benami land transactions and real estate purchases are possible, but large and frequent purchases are not easy to hide. Discreet foreign jurisdictions have, therefore, become the preferred destination for bad money. And here India's global integration—and the ease of moving money into and out of India, both through current and capital accounts—has facilitated, albeit not caused, skyrocketing corruption in India.

Consider the three dimensions of what might be called globalization-enabled corruption: the analytics, the mechanisms and possible policy solutions.

Macroeconomic Analytics

Two distinct outcomes are associated with globalization-enabled corruption. First, it could simply lead to a flight of capital overseas, as happened in Latin America during its period of instability and continues to happen in corrupt autocracies around the world. But this cannot be the complete story of globalization-enabled corruption in India today. India today, unlike these places, is a booming economy, offering high rates of return for clean and illicit investments alike. Corrupt Indians must be looking to earn high rupee returns on corrupt income, and not just looking for safe havens abroad offering anemic dollar returns. In other words, at least some of what goes out must be intended to come in.

In macroeconomic terms, the old story was that of capital flight reducing domestic savings and investment. The newer version, ironically, might entail fewer macroeconomic costs because savings are not totally lost to the Indian economy. The greater cost is distributional: Not just does public wealth become concentrated in a few private hands, illicit wealth is provided with implicit subsidies in the form of taxes avoided, secrecy conferred, and preferences accorded. This is because this money comes back as the much sought-after "foreign" investment. This is not unique to India. Estimates are that between a quarter and one-third of foreign direct investment (FDI) into China is "roundtripping".

Transfer Mechanisms

Money goes out and comes in many ways. In the case of the current account, money can be easily moved out through services trade. It is much easier to over- or under-invoice services trade just as it is much harder to capture services in the tax net.

Remittances also offer an easy route. The money can be paid overseas to a relative and then sent back to the corrupt official or another relative as remittances. With public sector companies like Oil and Natural Gas Corporation spending billions of dollars on overseas purchases in countries with weak governance, the ambiguities of the purchase price relative to the asset leave room for considerable creativity. Just last week the Comptroller and Auditor General of India pointed out that losses of Rs 1,182 crore were incurred in operations in Russia and about Rs 800 crore in Sudan and Qatar. Losses might simply reflect poor business judgment and practice, but if malfeasance is intended, the scope for doing so is plentiful.

Then there is the banking channel. Madhu Koda, the former chief minister of Jharkhand, who reportedly amassed a fortune of Rs 4,000 crore, may have had more than 1,800 bank accounts all over the world. And in recent weeks, the agencies investigating the 2G spectrum allocation scandal believe that at least five beneficiary companies routed money to entities related to them in the United Arab Emirates, the United Kingdom, Norway, Libya, Singapore, Isle of Man, Jersey, Russia, Cyprus, and, of course, Mauritius.

There is something odd when FDI that comes from Cyprus is as much as that from both France and Germany, or when Mauritius accounts for more FDI into India than all the G-7 countries (more than $53 billion since 2000, close to its cumulative GDP over this period). This is partly the result of Mauritius' low tax regime (three percent effective rate of corporate tax on foreign companies incorporated there) and the tax treaty with India, which is such that an investor routing investments through that country does not pay capital gains tax either in India or Mauritius. It is not just that India loses tax revenues, but the lower transparency there makes it easier to hide the true source of the money. The seeming ease with which rupees made illicitly domestically come back as "foreign" investments through Mauritius to earn rupee returns is perhaps one reason why politicians have not been eager to remedy this situation.

Policy Options

The roots of India's corruption epidemic lie primarily within the country and so do its solutions. But solutions can be both national and international.

Broadly, India should take the lead in pressing for an international regime that makes it easier to share and access information on overseas assets of its citizens. After all, if these assets are legal, no one has anything to worry about. To be sure, the establishment would hardly be enthused about an outcome that works against its interests. But India did take an important step in this direction by joining the Financial Action Task Force (FATF), whose scope can be broadened from terrorism-related financing to cover all illicit wealth. If India's prime minister and the Congress party, the Bharatiya Janata Party, and the Left are as sincere as they claim to be about corruption, this is something to hold their feet to the fire.

Three other steps are also worth considering. First, in the G-20 meetings, India should propose that the International Monetary Fund, the World Bank, and the World Trade Organization work on data systems to reconcile global services trade flows and remittance flows between country pairs. Second, there should be greater scrutiny of the foreign operations and capital flows of state-owned enterprises. And above all, India should abolish any double taxation agreements with countries that are not members of the FATF, membership of which at least offers a modicum of transparency. There are many ways India can, and should, build its strategic partnership with Mauritius—but the treaty must be discontinued as soon as possible. Curbing globalization-enabled corruption will be a long and difficult haul, but discontinuing the tax treaty with Mauritius is a good place to start.



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