by Tricia Yeoh. First published in The Sun 19 December 2013
Greater scrutiny needs to be placed on public officials, especially in their relationship with the private sector, in light of reports and indicators.
In the Global Financial Integrity (GFI) report released last week, Malaysia was ranked as the fourth highest in the world in terms of illicit capital outflow, just after China, Russia and Mexico. Malaysia had a cumulative outflow of US$370 billion from 2002 to 2011 – or a whopping RM1.2 trillion in total. This is a significant increase of almost 30% from its last report, where over the previous 10 years up to 2010, Malaysia exported US$285 billion, or RM921 billion of illegal funds.
Illicit outflows in this context are defined as illegally earned, transferred or utilised cross-border transfer of funds, which can generally be categorised as either money disappearing from the national balance of payments, or as trade misinvoicing.
There are several sources of such illegal outflows. One possibility is that our macroeconomic conditions have been considered so unstable as to have triggered loss of investor confidence in the economy, and subsequently capital flight out of the country. Recall that earlier this year, Fitch Ratings downgraded Malaysia from “stable” to “negative” outlook, noting the country’s poor public finances and uncertain budgetary reform prospects. (The government has since announced that the goods and services tax will be introduced from mid-2015, which is expected to help in fiscal consolidation).
Second, public officials have also been identified as one of the leaky valves, who are able to “siphon money away from public coffers and into secret offshore bank accounts”. This is both caused by and creates an underground economy, in which external contractors foster relationships with friendly officers to win government tenders. Indeed, model simulations of Mexico’s illicit outflows confirmed a dynamic interaction between illicit flows and the underground economy that each drove the other.
In a separate study in 2009, academics from Germany and Austria estimated that the shadow economy in Malaysia constitutes 30% of its GDP, even higher than Mexico. And this was taking the conservative definition of market-based legal production of goods and services that are deliberately concealed from public authorities.
It is interesting to use Mexico as a case study, given that it ranks only one place above Malaysia in the current GFI report. Several findings from a detailed analysis of Mexico’s conditions are relevant and ought to be taken as lessons for us, and these are examined below.
For instance, a stable relationship was found between the volume of illicit outflows and the onset and aftermath of its macroeconomic crises, during its 41-year period of study.
Two such crises included a 1976 balance of payment crisis, and the 2007 global economic crisis, after which illicit flows increased as a percentage of GDP.
The finding that a macroeconomic crisis caused illicit financial outflows to increase one year past the crisis is something to be cognisant of, especially since Malaysia has faced running budget deficits since 1998, and a diminishing size of our balance of payments surplus. We are also dangerously nearing the federal debt limit of a debt to GDP ratio of 55%.
In Malaysia’s case, our illicit outflows as a percentage of GDP seemed to spike in the years 2005 and 2010 consisting of about 25% of GDP as opposed to 17-18% of GDP in all other years dating from 2002. One could conduct further studies to examine why the outflows were particularly rampant in these years.
A second observation is that illicit flows (as a percentage of GDP) increased after the North American Free Trade Agreement (NAFTA) was implemented, possibly because trade openness provided traders more opportunities to misprice trade. This was also exacerbated by high rates of inflation.
Policymakers should also take note of this, given negotiations of the Trans-Pacific Partnership Agreement and renewed talks of the EU-Malaysia Free Trade Agreement. There are certain benefits that would accrue from free trade, including potentially increasing economic growth through access to bigger markets, but weak institutions and legal frameworks may then facilitate mispricing, and in turn, illegal capital outflow.
The government’s response to these reports is somewhat mixed. On one hand, it is taking measures to address concerns, for instance amending the Anti-Money Laundering and Anti-Terrorism Financing Act to better control for cross-border transfers. Second and more recently, directly negotiated contracts are being published online, and such contracts lie at the heart of kickbacks and bribery.
But these are nowhere near addressing structural and governance-related issues. In the case of Mexico, some specific recommendations included to shrink the underground economy through transparency and accountability involving the award of government contracts, and collecting information on beneficial ownership of companies and financial accounts. Prudent macroeconomic measures would be required to reign in excessive spending, leakages and wastage. Customs administration should also be reformed by ensuring customs invoices are accompanied by a legal undertaking of pricing accuracy by exporters and importers.
The same can surely be argued for Malaysia. Labuan is placed 12th in the Financial Secrecy Index 2013, which ranks jurisdictions according to their secrecy and possible tax havens to attract illicit financial flows.
This year, Malaysia climbed one rank in Transparency International’s Corruption Perceptions Index 2013. Although this is to be applauded, it should be noted that Malaysia performed worse in one of the contributing indices, within which country experts are asked whether public officials who abuse their positions have been prosecuted, and whether government has successfully contained corruption.
Much work is still needed in weeding out corruption at its very core. The GFI report has demonstrated the disingenuous relationship between public officials and the private or underground sector, which without the rule of law, leads to massive capital outflow. Policymakers would do well to sit up, take notice and be very, very worried.