Increasing exports is one of the most important routes for a developing country to better its fortunes. However, there also exists a possibility that a developing country might see its rightful gains from trade being usurped by others. Trade misinvoicing, which involves incorrect reporting of exports or imports from a country, is an important route through which this may occur. According to a December 2015 report by Global Financial Integrity (GFI), fraudulent misinvoicing of trade transactions was revealed to be the largest component of illicit financial flows (IFF) from developing countries, accounting for 83.4% of all illicit flows. To put this in perspective, the $1.1 trillion that flowed illicitly out of developing countries in 2013 was greater than the combined foreign direct investment (FDI) and net official development assistance (ODA), which these economies received that year, according to GFI’s estimates. It is no wonder that curbing IFFs has been incorporated in the United Nation’s Sustainable Development Goals framework.

As is obvious, preventing trade misinvoicing entails first identifying it to the level of countries and exact products. A United Nations Conference on Trade and Development (UNCTAD) study released last week shows that developing countries exporting primary products have alarmingly high levels of trade misinvoicing. The study has looked at five countries: Chile, Côte d’Ivoire, Nigeria, South Africa and Zambia for the period from 2010 to 2014. It covers a representative sample of products in the three main categories of primary commodities: oil and gas; minerals, ores and metals (copper, gold, iron ore, silver and platinum); and agricultural commodities (cocoa). For the countries selected in the study, exports of these commodities constitute a large part of the total exports.

Before discussing the magnitude of trade misinvoicing it is useful to discuss the concept in brief.

What exactly is trade misinvoicing and why is it done?

For foreign trade transactions to be considered sound, the following should hold. Every commodity leaving country X for country Y should leave the same money trail in both places. In other words, if country X’s official records show an export of $100, country Y’s books should have an import of the same amount. To be sure, there would be a certain difference as exports are calculated on a free on board basis (fob) and imports on a cost, insurance and freight (cif) basis. Anything else after accounting for this factor would suggest trade misinvoicing.

If the value of exports for exporting country is less than what the importing country reports as imports after adjusting for cif, it would amount to export under invoicing. The opposite would be the case for over invoicing. Export under invoicing in the exporting country would entail an import over invoicing in the importing country.

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Trade misinvoicing can have three broad motives: maximizing profits by evading taxes in either of the countries; circumventing currency controls and using the extra foreign exchange for other purposes; and bypassing bureaucratic hurdles to speed up execution and settlement of transactions. In practice, such activities often take place along with legitimate trade, which provides a good cover.

Extent of export misinvoicing in developing countries

The UNCTAD study has calculated estimates of export misinvoicing by selected countries and products for the sizeable time periods. The results suggest significant export misinvoicing, although with drastic variations across countries and trading patterns. Gold exports from South Africa are the most extreme case. For 14 selected partners, South Africa’s official trade data shows gold exports worth just $3.17 billion (in 2014 constant dollars), whereas partners’ data shows the value of exports from South Africa to be $ 117.12 billion. India is the biggest trade partner of South Africa in gold exports. China appears on almost every selected country’s export misinvoicing list, suggesting that these countries are losing a lot of money in exports to the Asian giant.

India is not immune to trade misinvoicing

The malaise of IFF outflows via trade misinvoicing is not something which is confined to African countries. A 2014 working paper by Raghabendra Jha and Truong Duc Nguyen at the Australian National University’s Crawford School of Public Policy estimated that a total of $186 billion worth of IFF went out from India through the route of trade misinvoicing. To give an idea, India’s total exports in 2015-16 were worth $262 billion. The paper also shows that there has been a significant spike in trade misinvoicing from 2004 onwards.

These statistics show how despite significant exports, developing countries are failing to realise the gains from trade. Even in India, where the present government is trying to encourage exports via Make in India, there seems to be considerable scope for tapping illegal flow of funds through trade which is already happening.