Challenges of Stopping Capital Flight

Capital flight, though not so visible as other economic anomalies, is a matter of concern for poor countries like Nepal. Such countries have to mobilise internal resources and depend on foreign countries and international agencies to speed up development. When internal capital goes out to foreign countries, it affects a country in one way or the other. In Nepal, individuals or organisations are prohibited from investing in foreign countries. This provision is mentioned in Nepal’s Act on Restricting Investment Abroad, 1964. Nepali individuals or firms are also prohibited from opening accounts in foreign countries. However, affluent Nepalis, especially politicians and top-notch businesspeople, are said to have placed deposits in foreign banks. Switzerland tops the countries where Nepalis have deposits. 

As per the Annual Banking Statistics, 2022 of Switzerland’s Central Bank, deposits of Nepali individuals and firms reached Rs. 70.76 billion (equivalent to 485.59 million Swiss francs at Rs. 145.72 to the Swiss franc).  The deposits were Rs. 43.70 billion (equivalent to 299.89 Swiss francs) in 2021. As per the report, the deposits of Nepalis were the second highest among the South Asian countries, with India leading the deposits. It may be noted that the deposits of India, Pakistan and Bangladesh declined in 2022, whereas those of Nepal surged.

Secrecy in banking

Swiss banks do not disclose details of clients, including depositors. They maintain a high level of secrecy in banking operations. So it is arduous to find out who the Nepali depositors are and how much money they have in the Swiss banks. As such, Swiss banks are often accused of encouraging people or firms around the world to indulge in money laundering by depositing with them money earned through illicit means such as serious crimes, tax evasion, corruption, arms trafficking, drug trafficking and terrorism financing. Besides, some other countries like Singapore and the United Arab Emirates have also emerged as hubs for such deposits. 

In 2019, the Centre for Investigative Journalism (CIJ), Nepal, in its NepaLinks investigation report, disclosed 55 Nepali individuals, including non-resident Nepalis (NRNs), who had transferred money to offshore destinations. After the disclosure of the sensational report, then-Finance Minister Yuba Raj Khatiwada formed an investigation commission to probe the matter but the commission did not fulfil its task. Nepali banks do not usually place funds in Swiss banks. Bankers and government officials are of the opinion that a surge in deposits abroad is due to the trend of depositing commission or kickbacks earned through multi-billion government contracts to foreign banks. 

The other factor is illegal trade practices such as over-invoicing while opening letters of credit (LCs) for the import of goods or services from foreign countries. Over-invoicing is used in trade-based money laundering, in which money is transferred from the importer to the exporter. It is believed that a huge sum of money is transferred to foreign countries through over-invoicing. To halt capital flight to some extent, it is imperative to stop the practice of over-invoicing in LCs. It may be noted that the Nepal Rastra Bank has also warned banks to be alert to over-invoicing in LCs.

Hundi is another factor through which outflows of money from Nepal take place. Some people, especially affluent businesspeople, use this method of money transfer. When there was a liquidity crunch in the banking sector some months ago, it was speculated that one of the causative factors was money transfer from Nepal to India through the Hundi system. The Hundi system is a challenge to the banking channels. Even remittances are sent back to Nepal through this system. But curbing this system is a Herculean task. That is why, it has been continuing despite being an illegal means of money transfer. 

There is still another factor responsible for capital flight: investments in cryptocurrency. Transactions in cryptocurrency are illegal in Nepal. In accordance with the Foreign Exchange (Regulation) Act, 1962, cryptocurrency is not recognised as foreign currency. As such, any transaction in this virtual currency is deemed illegal. Still, transactions in cryptocurrency have been going on in the country. Some people have also been arrested for engaging in such illegal activities. 

Capital flight has a negative pushback on a country’s domestic investments and economic growth. Capital flight strains the internal resources required for development works. The tax base is also eroded as no tax can be imposed on the ill-gotten money transferred to foreign countries, especially those with a tax heaven. When there is huge capital flight, it depletes the internal resources of a country. As a result, a country has to depend on official development assistance. Capital flight retrenches domestic investments, slows economic pace and hampers poverty alleviation efforts. 

Violation of the laws

What is more, capital flight exacerbates inequality and inequity. The tax burden falls heavily on lower- and middle-class people, while the wealthy bear a smaller tax burden as most of their wealth has landed in foreign countries. Further, the scourge of exchange rate depreciation hits those who have not hidden their wealth. Those who have transferred their wealth to foreign countries are least bothered by such a phenomenon. In Nepal, those who have power or who are associated with the powers that be indulged in capital flight in flagrant violation of the laws. 

One of the prominent factors contributing to capital flight is a breakdown in governance. It is due to rampant corruption, a glaring infringement of the laws and weak enforcement of the laws. For a cash-strapped country like Nepal, it is essential to curb capital flight so as to consolidate internal resources for development. If capital flight were to be stopped, the problem of liquidity that more often than not surfaces in the banking sector could be solved to a great extent. So the government should take concrete measures to eliminate, or at least reduce, capital flight from the country to foreign destinations.      

(Maharjan has been regularly writing on contemporary issues for this daily since 2000.)