Illicit financial flows (IFFs) have become a major concern globally, especially in recent years. Ethiopia is not an exception in this regard. The country loses between USD1.3 billion and USD3.2 billion annually in the form of IFFs. This figure accounts for up to 29Pct of the country’s total international trade or 97Pct of the total aid inflows. There are a variety of reasons for capital flight from Ethiopia, including political reasons, decline in economic stability or stricter capital regulation. However, the most prominent causes in Ethiopia are related to the informal sector, crime, trade mis-invoicing and tax evasion, as EBR’s Ashenafi Endale reports.
Nowadays, it is common to hear news stories about the arrest of people trying to leave the country with money, especially hard currency, via borders and airports. A couple of months ago, law enforcement even forced a plane to return to Addis Ababa’s Bole International Airport hours after it took off, in order to arrest a woman who had boarded the flight with close to half a million dollars in illegally smuggled money.
In line with the increasing illegal cross-border movement of capital, the number of cases filed in courts has also been mounting. Since 2014/15, close to 300 cases related to the illegal cross-border movement of capital were filed at the Lideta Federal High Court. 110 of those defendants have already been sentenced, and 99 of the cases are currently being heard. Each case involves sums of ETB50 to ETB300 million.
However, government officials stress that these cases are a very tiny portion of the illegal activity going on in the country. “It is like grabbing the tail of the devil,” says Temesgen Lapiso, director of the Trans-Boundary Crimes Directorate at Lideta Federal High Court.
Indeed, in Ethiopia, illicit financial flow (IFF) is one of the most serious issues being faced by the government and law enforcement. According to the study released by Transparency International in September 2018, called ‘Illicit Financial Flows in Ethiopia’ which covers the years 2005 to 2014, an estimated average of USD1.3 billion to USD3.2 billion has left Ethiopia in the form of IFFs every year. The annual capital flow from Ethiopia is equivalent to about 11Pct to 29Pct of the country’s total trade, 40Pct to 97Pct of aid, or 10Pct to 30Pct of the government’s annual revenue.
Roots of IFFs
Although there is no single agreed on definition of IFF among scholars, the concept is related to the laundering of illegal capital from a country’s proceeds of crime, corruption and tax evasion. There could be different causes of capital flight, ranging from political reasons like regime changes, to a decline in economic stability and strict capital regulations. Sakshi Rai, Programme Consultant at the Centre for Budget and Governance Accountability, a think-tank focusing on public policies and government finance in India, in a 2017 study titled ‘The Specter of Illicit Financial Flows’, classified these factors in to four groups: informal sector, crime, trade, and tax related.
One of the informal sector related factors that pushes capital out from most developing, low income countries like Ethiopia, is the absence of proper banking systems and institutions as well as the dominance of cash based transactions, which creates informal or underground banking channels. “Ethiopia is highly exposed to illicit capital flow mainly due to its dominant cash based economy,” argues Paschal Anosike (PhD), director of the Centre for African Entrepreneurship and Leadership at the University of Wolverhampton. “Cash is in the hands of people beyond the banking system. Therefore it is difficult to trace money, abnormal transactions and currencies.”
Rai points out when the official banking system is weak, people tend to rely on personal relationships, bonds and networks to transfer funds. These funds, in turn, can be used by criminals and the general public to move large sums of money across borders. As the experience of many countries all over the world shows, informal money laundering channels include a traditional system of transferring money commonly known as hawala, which is used mostly by African and Arab countries, as well as the hundi network that is the dominant method of fund transfer in South Asia.
Tesfaye Gebreegziabher (Commander), acting director of the Financial Transactions Examinations and Analysis Directorate at the Finance Intelligence Center (FIC), agrees with the notion that the informal remittance systems in Ethiopia are the main sources of IFFs. “The money obtained from informal operators in the black market from the Diaspora community who want to send money to their families in Ethiopia is used to pay off corrupt officials or to reduce the risk of being charged,” he argues. “The money is also used to acquire properties in other countries by a growing number of business and political elites.”
Stakeholders stress that a shortage of hard currency is the primary reason for the thriving informal fund channels, which in turn, facilitates illicit capital flows. As a result, Ethiopians who run businesses, usually restaurants and shops, as well as unauthorized agents, collect the hard currency from the Diaspora. The official revenue from remittances is currently USD3.5 billion. “The loss due to illegal remittances is at least twice the official figure,” says Temesgen. “Informal remittance channels are damaging the economy by facilitating the transfer of capital out of the country.”
However, a bank manager, who asked to remain anonymous, argues that it is wrong to conclude that the fundamental reason for the existence of informal fund transfer channels is the hard currency shortage. “I believe illicit trades continue even if there is surplus hard currency because the informal economy always rewards with more profit,” he said.
In addition to remittances, the other source of hard currency is Ethiopian exporters. “They report lower exports than the actual volume and earn less foreign currency through official channels while keeping the difference in offshore accounts, where it is availed for anybody who wants to use it,” adds Gashaw Tamiru, director of Corporate Law and Human Right Directorate at Lideta Federal High Court.
Addisu Habba, president of Debub Global Bank, however, argues it is all about the mismatch between demand and supply. “Since the Dergue regime, Ethiopia has never had enough foreign exchange to cover its import bills. The main task should be increasing the supply of foreign currency.”
Yet, because owners of illicitly obtained finance are more interested in hiding their money than maximizing its return, Rai argues that macroeconomic factors have little impact when it comes to capital flight. Rather, it is crime related activities including corruption that influence illicit financial flow in a significant manner.
Gashaw says Ethiopia loses a significant portion of revenue due to crime related activities along border areas. “In addition, the overall foreign trade is sabotaged by corrupt officials and illicit traders. Many commodities, including money, are traded illegally. The illicit finance flow,” Gashaw argues, “is higher than we know, if all of the commodities are included in the calculation.’
Although drug and human trafficking, terrorism and illegal weapons trades all contribute to capital flight, corruption is one of the major catalysts for illicit finance in Ethiopia. In fact, a significant amount of money is lost to corruption, rent-seeking practices, kickbacks, and bribery. According to Transparency International, Ethiopia ranked 107 out of 176 countries in the Corruption Perception Index last year.
According to the United Nations Development Programme, weak governance generates public corruption and promotes corporate malfeasance. These, in turn, make sending capital out of the country easy. The role of a fragile government in exacerbating illicit capital outflows is also supported by studies that prove the existence of strong correlation between debt accumulation by developing countries and illicit financial flows.
However, the major cause of illicit capital flight in Ethiopia, accounting for 55Pct to 80Pct of the total value, is trade related, and in particular, capital flight through trade mis-invoicing. Abdulmenan Mohammed Hamza, a financial expert with over 20 years of experience, says a large portion of illicit capital flow in Ethiopia is related to foreign trade. “Illegal profit transfer is a common feature of illicit financial flow in Ethiopia,” he told EBR.
Trade mis-invoicing is defined as misstating the value, quantity, or composition of goods on customs declaration forms and invoices, mainly for the purposes of money laundering and tax evading. Studies conducted on the subject reveal that trade mis-invoicing can occur in to three ways: import over-invoicing, export under-invoicing and export over-invoicing.
Import over-invoicing disguises the movement of capital out of a country by using false agreements that indicate a price higher than the original in order to get hard currency from local commercial banks. “Commercial banks ask importers to present agreements between them and foreign suppliers in order to start the process of granting foreign currency,” explains Abdulmenan. “But the banks’ efforts to validate the creditability of the price are inadequate.”
Of course, insiders stress that the lack of a national price index or a directive that allows banks to crosscheck the validity of the prices in the agreement worsens the problem. “Banks often don’t record hard currency requests on official bank sheets. Instead, they have separate records,” argues Temesgen. “We have encountered various cases of this. All banks have such systems, down to their branches.”
On the other hand, under-invoicing is a common practice by exporters in Ethiopia. Exporters negotiate with their business partners abroad and under-invoice their trade agreements. When payment is settled, exporters receive the under-invoiced price through local banks, while the rest is deposited in their foreign account.
However, the main motivation behind trade mis-invoicing is mainly tax evasion. For instance, importers can over invoice their prices in order to inflate their overall costs, which would lower the amount of taxes they owe the government. Exporters also under invoice contracts by lowering the volume of their shipment in order to evade or avoid taxes on corporate profits.
While tax evasion is clearly illegal, tax avoidance takes place through gaps in the laws, lapses in regulations and through unclear structures and arrangements, according to Rai. For instance, Ethiopia losses up to ETB60 billion tax revenue annually due to abuse of tax incentives, according to Adanach Abebe, minister of Revenues.
Although it is hidden by nature and estimates are uncertain, the consequences of IFF are immense. Rai stresses that a dollar lost due to illicit financial flow has more than one dollar’s damage for a given country. For instance, if an exporter mis-invoices a trade agreement for the purpose of evading taxes, the loss to the public purse is not only the tax evaded, but possibly stolen treasury funds that are transferred through the same channels. In addition, the illicit capital that exits the country can be used to finance corruption and regenerate crime.
On the other hand, the study by Transparency International reveals that capital departed from Ethiopia has led to an economic loss of 2.2 percentage points on average, annually. It also estimated that had it not been for IFFs, poverty would have been reduced by about 2.5 percentage points in the last ten years.
Taming the Problem
Many of the actions taken by the government, such as taking suspected offenders to court, have not been successful. “We have run many operations and forwarded hundreds of cases to the police. But almost all of them were dropped through the court processes. Therefore, we stopped taking cases to court last year. But we started again last month,” explains Tesfaye. “Even if black market operators are caught and sentenced, their hard currency and other assets are never confiscated by the government. Even if it is, it never goes to the government’s coffers.”
The FIC conducted a study to identify the sources of illicit capital flight five years ago. But Tesfaye says the problem could not be solved because of an inefficient court system and high corruption. “Law enforcement agencies are weak in collecting evidence. The Federal Police Commission has limited capacity and expertise to investigate.”
On top of theses, the establishment proclamation of the FIC does not give it the power to investigate and prosecute these crimes. “Plus, The FIC usually lacks budget. The Financial Transactions Examinations and Analysis Directorate at FIC only have nine employees, despite it needing at least 50. The same directorate in South Africa has 300 employees,” adds Tesfaye.
Mignot Denekew, attorney of organized and border crossing crimes at Lideta Federal High Court, agrees that very limited efforts have been made to bring economic crimes to court. “Even if cases come to court, it is difficult to convince the court that illicit finance is hurting the country. This is because most of the illicit finance activities and underground economy transaction systems seem technically legal.”
Indeed, there is an ongoing debate about the definition of IFFs and the need for widening it beyond ‘dirty money’ to include financial flows associated with tax avoidance, which, in many cases can be legal. In fact, Rai indicates that there are circumstances in which trade mis-invoicing has been confused with price transfer or profit repatriation, which are legal practices, especially among multinational companies.
Although the country introduced the Prevention and Suppression of Money Laundering and Financing Terrorism Proclamation in 2013, according to a study conducted by Transparency International, its focus is restricted to controlling financing terrorism and money laundering while giving little emphasis to illicit capital outflows from Ethiopia. This is why stakeholders stress that Ethiopia needs to adopt and enforce policies that promote good governance, tackle corruption, go after dirty money and implement transparent tax systems to reverse the situation.
8th Year • Jan.16 – Feb.15 2019 • No. 70