KEY LDC DEBTORS: GRAPPLING WITH CAPITAL FLIGHT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87T01127R001000820001-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 45
• Document Creation Date: December 22, 2016
• Document Release Date: March 16, 2011
• Sequence Number: 1
• Publication Date: September 1, 1986
• Content Type: REPORT

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f Confidential
Directorate o
Intelligence
Key LDC Debtors:
Grappling With Capital Flight
Confidential
G/ 86-10059
September 1986
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Intelligence I I 25X1
Key LDC Debtors:
Grappling With Capital Flight
and the Office of East Asian Analysis
Office of African and Latin American Analysis
Office of Global Issues. It was coordinated with the
This paper was prepared by
Comments and queries are welcome and may be
directed to the Chief, Economics Division, OGI
Confidential
G/ 86-10059
September 1986
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Key LDC Debtors:
Grappling With Capital Flight
Key Judgments Capital flight, which has bled nearly $180 billion from eight key LDC
/rt/ormation available debtors over the past 10 years, remains a major obstacle to the solution of
as oI15 July 1986 their international financial problems:
was used in this report.
? Capital outflows are keeping foreign borrowing requirements hig at a
time when access to foreign financial resources is severely limited.
? Lenders, frustrated that over 70 percent of net foreign borrowing since
1982 has been used to acquire foreign assets, are seizing on capital flight
and using it to justify further lending cutbacks.
Unless these countries take steps to stem capital outflows, we believe their
international financial crises will linger, multiplying domestic economic
problems and undermining political stability.
Our analysis of past attempts to stanch capital outflows indicates that
tighter capital controls are not the answer. Controls have been effective in
discouraging capital flight, but funds are still being funneled abroad. We
found that many residents can circumvent even the most stringent capital
controls. The elite often operate above the law or take advantage of their
connections in the business community and the bureaucracy to move funds
abroad. The less powerful employ a myriad of tricks to purchase foreign as-
sets without detection. Rather than relying on harsh penalties and moral
suasion to stem capital outflows, we believe a better strategy would be to
attack the root causes of capital flight.
Past experience indicates that structural reform would halt the exodus of
capital from the key LDC debtors by removing the powerful economic
incentives to shift funds abroad. We believe these countries would retain
more of their capital if their governments took steps to establish:
? Realistic exchange rates. A policy of maintaining real exchange rate
parity with trading partners seems to be an important deterrent to capital
flight. Brazil has hewed to such a policy and has been very successful in
limiting capital outflows.
? Attractive returns at home. Capital outflows also seem to slow when
domestic assets become as lucrative as foreign assets. When their interest
rate was established by auction, Mexican treasury bills attracted some
funds that might otherwise have fled abroad.
? Astable environment. A tranquil economic and political environment
also seems to lead to lower levels of capital flight. In Argentina, capital
outflows plunged when the Alfonsin administration adopted sounder
~
economic policies and strengthened democratic institutions
iii Confidential
G/ 86-10059
September 1986
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Confidential
We believe, however, that there are formidable economic and political
obstacles to structural reform in the key LDC debtors. Currency devalua-
tions increase the burden of the foreign debt and boost inflation in the short
run. Devaluations also upset politically powerful elites who have grown
accustomed to buying foreign goods at bargain prices. Financial market
deregulation increases local borrowing costs in the short run, leading to
larger government budget deficits and slower economic growth. In addi-
tion, even if these countries adopt sounder economic policies and strength-
en democratic institutions, it will take time for them to establish a track re-
cord of economic and political stability.
If the key LDC debtors succeed in overcoming these obstacles to structural
reform, the foreign assets accumulated by residents of these countries may
hold a key to the solution of their international financial problems. We
believe residents of these countries own a stock of foreign assets equal to at
least half their foreign debt. If these countries implemented structural
reform, they might entice back some of this capital. Any capital that was
repatriated would help relieve balance-of-payments pressures and cut
foreign borrowing requirements. Even if residents held onto their overseas
assets and repatriated only the earnings, the impact on international
accounts would be significant.
If these obstacles prove insurmountable and the key LDC debtors fail to
adopt structural reform, we believe capital outflows will remain stubbornly
high and international financial problems will continue to dog these
countries. They will have an increasingly difficult time balancing interna-
tional accounts when inflated foreign borrowing requirements run up
against growing resistance to new lending. If lenders are unaccommodat-
ing, these debtors will be forced to trim their international "expenses."
Historically, they have reacted to financial crises by slashing imports, but
this option may now be unacceptable because the ensuing drop in real
incomes could have serious political consequences. It is more likely that
they will target debt service payments. If concessions are not granted by
creditors, more debtors may suspend principal repayments and limit
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Contents
Key Judgments
Foreword
Introduction
Before the Financial Crisis
Outflows Up Sharply
Most Debtors Hit Hard
After the Financial Crisis
Outflows Taper Off
Most Debtors Still Plagued
Mechanics of Capital Flight
Capital Flight Artists
Moving Capital Abroad
Safehavens for Flight Capital
Fallout From Capital Flight
Economic Problems Multiplied
Political Stability Undermined
Looking Ahead
Appendixes
A.
B.
Estimating Capital Flight
Supporting Data
Page
iii
vii
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Key LDC Debtors:
Grappling With Capital Flight
Foreword The international spotlight is increasingly being trained on the continuing
exodus of capital from debt-troubled LDCs. Attention was recently drawn
to this phenomenon by the Baker Initiative on LDC debt, which made the
stanching of capital flight a prerequisite for the additional financing called
for in the plan. Several US banks soon released short studies of the capital
flight problem. The press responded by publishing articles and editorials on
capital flight that drew heavily on the bank studies. Previous research on
this subject has focused largely on the magnitude of capital outflows.
Many important aspects of the capital flight problem have not been
thoroughly examined. This research paper takes a broad look at the flight
of capital from eight key LDC debtors over the past decade. The
magnitude, mechanics, and side effects of capital outflows are discussed in
detail. A subsequent paper will examine capital flight trends over the
longer term, in particular assessing the prospects for repatriation of the
capital shifted abroad before the international financial crisis of 1982.
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Figure 1
Key LDC Debtors, 1986
Boundary representation is
not necessarily authoritative.
706118 (545039) 7-86
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Key LDC Debtors:
Grappling With Capital Flight ~
Every individual endeavors to employ his capital
so that its produce may be of greatest value. He
generally neither intends to promote the public
interest, nor knows how much he is promoting it.
He intends only his own security, only his own
gain.
Adam Smith
The Wealth of Nations (] 776)
During the past 10 years, capital flight has been a
destabilizing force in the key LDC debtors (see figure
1).' Our analysis of balance-of-payments and foreign
debt data indicates that nearly $180 billion of capital
fled these countries during the period from 1976 to
1985-nearly half of net foreign borrowing (see figure
2). Elaborate mechanisms, both legal and illegal, were
devised that enabled nearly all segments of society to
participate in the foreign asset rush. A vast array of
personal property and financial instruments were
acquired in industrial countries, neighboring LDCs,
and offshore banking centers. This unprecedented
buildup of foreign assets aggravated existing econom-
ic and political problems. Capital flight, which helped
trigger the foreign debt crisis, remains a major obsta-
cle to solving the financial problems of the key LDC
debtors.
' Key LDC debtors include Argentina, Brazil, Chile, Mexico,
Nigeria, Peru, the Philippines, and Venezuela. These developing
countries, of strategic interest to the United States, have encoun-
tered serious economic problems as a result of their large foreign
debt. Capital flight, defined as the net accumulation of foreign
assets by private citizens, was estimated using the "implicit capital
outflow" method (see appendix A for details). Our estimates should
be viewed only as benchmarks representing the minimum level of
capital flight. Dollar values are measured in 1985 US dollars and
Figure 2
Key LDC Debtors: Capital Flight
by Country, 1976-85
Billion 1985 US $
Mexico
Venezuela
Argentina
Brazil
Nigeria
Peru
Chile
303892 886
Before the Financial Crisis
Outflows Up Sharply
According to our estimates, the flight of capital from
the key LDC debtors accelerated dramatically before
the international financial crisis of 1982 (see figure 3).
Capital flight reached a peak of $31 billion in 1981-
up from only $9 billion in 1976. Rapidly growing
capital outflows from Mexico and Argentina generat-
ed most of this surge in aggregate capital flight. In the
growth rates were calculated from constant-dollar values.0
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Figure 3
Key LDC Debtors: Capital Flight,
1976-85
three years before the financial crisis, capital flight
hovered around $30 billion per year. Judged by
almost any criterion, the $86 billion that was drained
from the economies of these eight debtors during
1980-82 is significant. It represents 52 percent of
their net foreign borrowing, 12 percent of their gross
fixed investment, and nearly 3 percent of their gross
Although political turmoil historically has been the
key cause of large capital outflows from LDCs, the
unprecedented flight of capital during 1980-82 can be
traced primarily to economic mismanagement. Before
the financial crisis, the governments of the key LDC
debtors pursued misguided economic policies that
made the purchase of foreign assets almost
irresistible:
? We believe overvalued exchange rates were the key
cause of this capital exodus (see inset). As the world
moved toward flexible exchange rates, these debtors
defended fixed rates of exchange. By reducing
import costs, this policy was supposed to spur
development and hold down inflation. When loose
monetary policy sparked inflation, however, their
real exchange rates appreciated substantially-over
30 percent during 1978-81. Overvalued exchange
rates, coupled with free access to foreign exchange,
spurred capital flight by making foreign assets
cheaper and raising the specter of impending
devaluation.
? Negative returns on domestic assets were also an
important cause of capital flight. Governments fixed
nominal interest rates at low levels, in some cases
for ideological reasons, but generally to encourage
domestic investment and facilitate consumption.
When inflation accelerated and governments failed
to adjust interest rate ceilings, real interest rates
grew increasingly negative. By 1982 the real return
on bank deposits in the eight debtors was - 25
percent per year while the real return in the United
States was at an alltime high of 7 percent. In
addition to yielding an attractive return, foreign
assets offered as a bonus protection from domestic
currency devaluations.
? Heightened uncertainty also spurred capital flight.
By 1980 residents were realizing that the harsh
economic adjustment postponed by massive foreign
borrowing was imminent. The serious economic
imbalances caused by misguided economic policies
were obvious-growing trade deficits, spiraling in-
flation, and widening government budget deficits.
Estimating the returns and risks of domestic assets
was impossible when the timing, pace, and extent of
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the coming adjustment was unknown. In addition,
there was increased political uncertainty in these
countries as a result of planned transitions to
civilian rule, martial law, military coups, and rising
political opposition. Savvy residents opted to move
their assets overseas.
Most Debtors Hit Hard
Of the key LDC debtors, our estimates indicate that
Mexico was the hardest hit by capital flight. During
1980-82 an annual average of $11 billion was shifted
abroad-up from an average of $4 billion during
1976-79 (see table 1). These funds could have fi-
nanced an 18-percent boost in plant and equipment
investment if they had remained at home. The deadly
combination of a highly overvalued exchange rate and
easy access to foreign assets sparked this capital
hemorrhage. The peso appreciated by 51 percent in
real terms during 1978-81, and weak capital controls
and proximity to the United States allowed ready
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Table 1
Key LDC Debtors:
Capital Flight Trends, 1976-85
Average Annual Capital Flight
(Billion 1985 US $J
1976-79
1980-82
1983-85
Total
13.8
28.7
12.2
Argentina
3.1
8.7
0.1
Brazil
2.3
0.1
1.1
Chile
-0.3
0.2
-0.1
Mexico
3.6
10.6
5,7
Nigeria
0 0
2 2
2 0
Peru
0.3
-0.4
0.4
Philippines
1.0
1.5
-0.7
Venezuela
3 9
5 8
3 7
access to foreign exchange. In addition, the savings
pool was expanding rapidly. Rapid GDP growth,
powered by oil exports, spurred domestic savings.
Foreign borrowing-$29 billion in 1981 alone-led to
a dramatic jump in savings from foreign sources.
Argentina and Venezuela also suffered severe capital
flight. They lost an average of $9 billion and $6 billion
per year, respectively, during 1980-82-significantly
more than during 1976-79. In these two countries,
capital flight as a share of GDP, at 5 to 8 percent, was
the highest of any of these debtors. As in Mexico, an
overvalued currency and free and legal access to
foreign exchange proved disastrous. During 1978-81,
the real value of the peso Argentino shot up by 80
percent and the Venezuelan bolivar appreciated 30
percent in real terms. In Argentina, instability was
high. Erratic policies and triple-digit inflation weak-
ened the economy, while Peronism, the Falklands war,
and the planned democratic transition heightened
political uncertainty. In Venezuela, rising inflation
pushed real interest rates into the -10 to - 15
percent range during 1979-80.
Capital Flight As a Share of:
(Percent)
1976-85
Net Borrowing
Gross Fixed
Investment
GDP
17.8
3.8
1.3
47.6
69.0
12.5
8.4
10.8
1.9
1.8
2.1
0.4
-O.1
NA
NA
NA
6.3
63.9
13.5
2.7
1.3
57.4
5.0
1.3
0.]
12.8
3.6
0.5
0.6
24.2
6.4
1.4
4.4
11 ].8
21.9
5.8
Capital flight from Nigeria and the Philippines drift-
ed upward to an average of about $2 billion a year
during 1980-82. While dwarfed by the outflows from
the larger debtors, funds salted abroad amounted to
about a tenth of fixed investment. Widespread corrup-
tion boosted capital flight as politicians, bureaucrats,
and cronies secured ill-gotten gains abroad. Accord-
ing to a recent Nigerian Government investigation,
members of the Shagari government garnered billions
of dollars in bribes and kickbacks during the country's
oil boom. Press reports indicate that like amounts
were skimmed from foreign loans, diverted from state
enterprises, or siphoned off development projects in
the Philippines. Political uncertainty was also a fac-
tor. President Shagari's tenuous grip on power led to
frequent coup plotting, and opposition to President
Marcos's autocratic rule was intensifying. Economic
policies, while erratic and often flawed, played a
Chile, Brazil, and Peru kept capital flight in check
during 1980-82. Brazil's success at controlling capital
outflows is surprising. Of the $35 billion that was
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borrowed abroad and the nearly $1 trillion of GDP
that was produced, only $400 million left the country.
We believe realistic exchange rates and stringent
capital controls account for this success. Safe and
lucrative investments like dollar-indexed bonds also
attracted funds that might have otherwise fled
abroad. In addition, Brazilians strongly prefer to
invest in ventures at home rather than overseas. In
Chile, capital returned as Pinochet maintained eco-
nomic and political order, but the flow was reversed
when unrest resurfaced in the early 1980s. The reflow
of funds to Peru during 1980-82 followed the transi-
tion to civilian rule that was capped by the election of
President Belaunde Terry.
After the Financial Crisis
Outflows Taper Off
Although our estimates indicate that outflows tapered
off after the international financial crisis began in
1982, capital flight continued to torment the key LDC
debtors. When massive capital outflows from Mexico
and Argentina were partially stanched, capital flight
from the eight debtors dropped from $31 billion in
1981 to less than $10 billion a year in 1984 and 1985.
We believe, however, that this loss of capital inflicted
more damage than past episodes of higher capital
flight because of the severe shortage of foreign ex-
change during the period. The $37 billion that fled
during 1983-85 amounted to over 70 percent of net
foreign borrowing-up from about 50 percent during
1980-82. In addition, we believe actual capital flight
may have been considerably higher than our esti-
mates. When foreign exchange controls were tight-
ened after 1982, capital outflows that once were easily
measured were pushed underground and became
nearly impossible to detect.
We believe a combination of new foreign exchange
policies and economic austerity reduced capital out-
flows from the key LDC debtors during the past three
years:
? The most important step taken to limit capital flight
was the move to more realistic exchange rates.
Faced with financial crisis, most of the debtor
Figure 4
Key LDC Debtors: Capital Flight
and Currency Strength, 1976-85
Capital Might
Billion 1985 US $
Real exchange rate index
US $/home currency
countries took steps to correct the gross overvaluation
of their currencies. As a group, they devalued their
currencies by 35 percent in real terms during 1982-
84. These devaluations, with a lag of about one year,
reduced capital flight by over 70 percent during 1983-
85, when foreign assets became more expensive (see
figure 4). Maxidevaluations induced some capital
outflows, however, when they undermined confidence
in domestic currencies and sparked inflation.
? A drop in savings-the funds available to finance
foreign asset purchases-also stifled capital flight.
Forced economic austerity in the key LDC debtors
led to a 13-percent contraction in the pool of savings
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during 1983-85. Sluggish GDP growth limited resi-
dent saving. When real wages fell, residents tried to
maintain their standard of living by cutting back on,
or dipping into, savings. More important, savings
from foreign sources plummeted when foreign bor-
rowing was curtailed. Net foreign borrowing-the
chief source of foreigners' savings-fell from $55
billion in 1982 to $4 billion in 1985.
? Most debtors also implemented stringent capital
controls-a potent short-term deterrent to capital
flight. Despite exchange rate reform, they were
forced to adopt controls because there were still
powerful economic incentives to shift funds abroad.
Controls were supposed to buy time so the lingering
problems of negative real interest rates and height-
ened uncertainty could be addressed. Residents
became adept at circumventing foreign exchange
regulations, however, and capital controls became
more of an irritant than a barrier to capital flight.
Most Debtors Still Plagued
The exodus of capital from Mexico and Venezuela
slowed during the past three years, but capital out-
flows remained alarmingly high (see cartoon). During
1983-85 an annual average of $6 billion and $4 billion
fled Mexico and Venezuela, respectively-roughly 40
percent less than during 1980-82. Maxidevaluations
and stringent capital controls led to this decline. The
real value of the Mexican peso fell by over 40 percent
during 1982-83, and the Venezuelan bolivar was
devalued by one-third in real terms in 1984 alone. In
addition, a savings slump, the result of sluggish GDP
growth and adrop-off in foreign borrowing, reduced
the pool of potential flight capital. Capital flight
remained stubbornly high, however, as the problems
of inflation and negative real interest rates lingered.
In Mexico, rising opposition to the ruling party before
key elections heightened political uncertainty.
One and two billion dollars a year, on average, fled
Brazil and Nigeria, respectively, during the past three
years. In Nigeria, capital flight was about 10 percent
lower than during 1980-82. When foreign borrowing
and petroleum revenues dropped off, so too did oppor-
tunities for graft-a key source of flight capital.
However, outflows continued as Lagos clung to eco-
Most residents q/'key LDC debtors find capital
.flight a more spectacular phenomenon than
nomic policies fostering an overvalued exchange rate,
negative real interest rates, inflation, and stagnant
savings. A successful military coup and continuing
rumors of coup plotting boosted uncertainty. In Bra-
zil, average outflows were about $1 billion a year
higher than during 1980-82. Uncertainty surrounding
transition to civilian rule, the death of President-elect
Neves, and rising inflation probably sparked this
outflow. A realistic exchange rate and effective capi-
tal controls, however, kept a lid on capital flight.
Since 1983, capital flight from Peru and Argentina
has averaged less than $500 million per year. Out-
flows from Argentina plummeted from an annual
average of $9 billion during 1980-82 to $100 million
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per year during 1983-85. Sharp currency devalua-
tion-about 55 percent in real terms during 1982-
85-and stringent foreign exchange controls choked
off capital flight. Euphoria over the transition to
civilian rule and the election of the center-left presi-
dential candidate, Raul Alfonsin, actually sparked
capital reflows. Capital returned despite real interest
rates of - 30 percent and spiraling inflation. In Peru,
modest reflows were reversed during 1983-85. Eco-
nomic mismanagement during the latter stages of the
Belaunde administration, which contributed to rising
inflation and negative real interest rates, spurred
capital flight despite sharp currency devaluations,
tight capital controls, and a shrinking pool of savings.
In addition, it was becoming clear in 1985 that the
continuing political transition would end with the
election of the left-leaning Alan Garcia to the presi-
dency.
Our estimates indicate that, on balance, residents of
Chile and the Philippines have been repatriating
capital during the past few years. While capital
reflows to Chile were small, an annual average of
$700 million appears to have returned to the Philip-
pines during 1983-85. Given the unsettled climate in
the Philippines during this period, capital reflows are
puzzling. Even though the Philippine peso was deval-
ued, capital controls were tightened, and savings
shrank, it is surprising that rising inflation and vola-
tile real interest rates did not induce capital flight.
Moreover, Benigno Aquino's assassination, Marcos's
ill health, growing insurgency, and rising opposition
threatened political stability. Various experts have
speculated that wealthy Filipinos repatriated funds to
keep businesses afloat, to maintain living standards, to
fund longer term speculative investments, or to
finance elections. Our methodology may have cap-
tured these inflows and missed large, well-hidden
capital outflows.
The mechanics of capital flight illustrate why the key
LDC debtors have been frustrated in their attempts to
stop capital outflows. While most segments of society
in these countries acquired foreign assets, residents
with economic and political power were the true
capital flight artists. As capital controls were tight-
ened, these residents devised increasingly elaborate
schemes for moving funds abroad without detection.
Sifting through open-source information and diplo-
matic reporting, we have uncovered about 20 different
ways to execute capital flight transactions without
drawing the attention of the authorities. Having
successfully transferred funds out of the country,
residents purchased an array of financial assets and
personal property in many locations around the world.
Capital Flight Artists
Government officials were implicated in the most
flagrant cases of capital flight from the key LDC
debtors. Per capita, they probably acquired more
foreign assets than any other group. Corrupt officials
at all levels of government salted away funds overseas:
? Corrupt chief executives were the premier capital
flight artists. To ensure financial security after their
power fades, they exploited vast opportunities for
graft and amassed fortunes that had to be secured
abroad. According to press reports, Marcos used ill-
gotten gains to purchase over $3 billion in foreign
assets. The bulk of these purchases were financed by
kickbacks that Marcos's cronies paid to the Presi-
dent and his wife, Imelda-"Miss 10 Percent."
Former Mexican President Lopez Portillo has been
accused by the press of absconding with over $1
billion. Miguel de la Madrid, his successor and the
standard bearer of the "moral renovation" cam-
paign, deposited over $160 million in Swiss banks in
1983 alone, according to a US press report.
? Corrupt cabinet ministers and bureaucrats also
funneled illegal payments overseas (see inset). Before
signing off on major contracts, import permits, or
construction approvals, they often demanded bribes
ranging from 10 to 25 percent, generally with the
proviso that the funds be deposited abroad. The
Nigerian Government estimates that, at the height of
the 1978 oil boom, corrupt politicians were shifting
$25 million a day abroad. Transport Minister Dikko
was accused in the press of stashing over $10 million
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The Binondo Central Bank: Pipeline for Flight Capital
According to press and diplomatic reporting, the
currency black market in Manila's Binondo district is
a major pipeline for capital fleeing the Philippines.
Before the assassination of Benigno Aquino, Chinese
currency traders operated freely, buying and selling
US dollars and transferring them overseas illegally.
Because the black-market exchange rate was close to
the official rate, the government chose to ignore the
operation. However, following the Aquino shooting,
the deferential between the two rates grew ever
larger, putting pressure on the government to devalue
the peso officially. President Marcos, disturbed by
the peso's weakness and jealous of the large profits of
the Chinese traders, took a dramatic step. In Novem-
ber 1983 he ordered Minister of Trade and Industry
Roberto Ongpin to take over the black market.
Minister Ongpin gained control of the black market
and established what came to be known as the
Binondo Central Bank. Given broad powers of arrest,
Ongpin initially tried to coerce the Chinese traders
into o./fering an exchange rate nearer the o.~cial rate.
The Binondo Central Bank collapsed
when key traders followed Marcos out of the country.
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overseas. In 1974, Argentina's Minister of Econom-
ics was paid $4 million in a Swiss account after a
nuclear reactor construction contract was signed,
according to a US press report.
Although the press focused on the misdeeds of govern-
ment officials, the business community probably
moved more capital abroad in total. Decisions to
convert domestic profits to foreign assets were based
almost exclusively on economic fundamentals. Promi-
nent businessmen led the way. Flush with local cur-
rency, these sophisticated investors searched both
domestic and international markets for attractive
investments. Businessmen with political connections
often received warning of government actions in time
to reap a windfall. Their connections in banks and the
bureaucracy allowed them to elude capital controls.
For example, Marcos issued hundreds of decrees that
exempted his cronies from a variety of economic
regulations. Small businessmen, especially those deal-
ing with exports, imports, or foreign securities, also
shifted capital abroad. Their small capital movements
were easily disguised as commercial transactions.
Finally, multinational corporations contributed to
capital flight when they remitted funds above legal
limits.
The general public in the key LDC debtors also
participated in a small way in the foreign asset rush.
Even the unsophisticated quickly learned the benefits
of holding foreign assets. Many residents held them
within the country-mostly US dollars "in the mat-
tress.'
The general populaces in these countries also
acquired assets overseas. With weak capital controls,
anyone could shift funds abroad through international
financial channels. Mexicans could move pesos over-
seas for conversion to US dollars by mailing a peso
draft or by electronic transfer. With rigid capital
controls, the man in the street often physically trans-
ferred his capital. Because of the small amounts
involved, local currency, black-market US dollars, or
other valuables could be mailed or carried abroad.
Moving Capital Abroad
Capital flight artists used a variety of methods to
move their capital abroad. Most of the capital that
fled the key LDC debtors before the financial crisis in
1982 moved overtly through legitimate channels. Un-
less the funds were tainted, there was little need to
develop complicated schemes for moving money
abroad when capital controls were so porous. In most
cases, funds were transferred electronically. Residents
made deposits in local banks and the funds were
transferred by wire to accounts overseas. Small trans-
fers were often exempt from transaction reporting.
Argentine banks could transfer $20,000 per day
abroad without declaration. Capital was also physical-
ly carried out of the country. Residents mailed bank
drafts overseas for deposit in foreign accounts or took
large amounts of cash with them on foreign trips. The
latter resulted in large inflows of US currency into the
Federal Reserve districts that include Miami, El Paso,
San Antonio, and San Francisco.
As capital controls tightened after the financial crisis,
residents developed increasingly elaborate schemes to
move funds abroad without detection (see inset). The
least elaborate ploys involved smuggling. According to
press and diplomatic reporting, everything from Kru-
gerrands to cattle was smuggled, but financial as-
sets-cash, bank drafts, bonds, and traveler's
checks-were the preferred cargo. Residents also
transported jewelry, gems, precious metals, gold coins,
stamps, antiques, drugs, and other assets readily
converted to cash. They even smuggled low-unit-value
agricultural and mineral commodities. Most contra-
band was smuggled on common carriers. For example,
despite checkpoints at departure gates, Filipinos fre-
quently arrived in Hong Kong laden with cash and
securities, according to a Hong Kong newspaper.
Customs agents were either deceived or were paid to
look the other way. Large-scale smuggling operations
used private aircraft or boats. Once overseas, contra-
band was converted to hard currency and the proceeds
were invested.
More elaborate schemes to move funds abroad surrep-
titiously usually involved misreporting. Exporters un-
derinvoiced shipments and remitted to the central
bank only a portion of the foreign exchange earned.
Importers overinvoiced purchases and drew more
foreign exchange from the central bank than was
owed. Excess foreign exchange was invested abroad
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Confidential
Surreptitious Capital Flight:
Some Tricks of the Trade
In the absence of restrictions on international capital
movements, capital.flight is accomplished by
straightforward transfers of J'unds by bank draft or by
wire. If capital controls are in place, however, elabo-
rate methods of moving funds abroad without detec-
tion are devised. The creativity of such schemes is
limited only by the imagination of the capital flight
artist. Historically, when authorities closed off one
capital.flight route, resourceful residents discovered
two more. Some tricks include:
? Airline ticket ploys. Before embarking on a foreign
trip, a traveler buys several expensive airline tickets
using local currency. Upon arrival abroad, the
traveler cashes in the unused airline tickets for
hard currency.
? Back-to-back operations. Residents deposit soft cur-
rency in the local branch of a foreign bank. Using
this deposit as collateral, residents borrow hard
currency from a branch of that foreign bank
overseas.
border transactions that are exempt from reporting
regulations. Once the funds are in the United
States, the local bank orders the funds shifted to
the Mexican's account in another US bank.
? Check purchasing. Many expatriate workers send
their hard currency paychecks back home to rela-
tives who sell them to brokers in the black market
for local currency. Brokers may resell the checks
for local currency to residents wishing to move
funds abroad. Brokers themselves may deposit the
checks in accounts overseas and use the proceeds to
complete future capital }light transactions.
? Currency smuggling. Physically carrying currency
out of the country is the oldest method of executing
capital.fiight. Smugglers, trying to conceal cash on
their persons or in their luggage, often pay a
premium for high-denomination US currency. (f
deception fails, payments to customs officials speed
the smuggler through checkpoints. Small private
aircraft are also used to ferry cash abroad.
? Black markets. Shadowing the central bank, black
markets act as clearinghouses for foreign exchange,
bank drafts, and other readily convertible.f~nancial
instruments. Besides providing convertible assets
for shipment overseas, black-marketeers can carry
out the actual capital transfer or provide technical
assistance. The black market operating in Manila's
Binondo district is among the most e.>~cient.
? Border bank transfers. Illegal capital movements
can be hidden in interbank transfers involving bor-
der banks. For example, a Mexican could deposit
pesos in a local bank having an account with a US
border bank. ,after a bank official is bribed, the
funds are transferred to the local bank's account in
the US bank bundled with hundreds of
? Export underinvoicing. An exporter presents a
fraudulent invoice, which understates the foreign
exchange earned from an export sale, to the central
bank. Foreign exchange equal to the invoice
amount is turned in to the central bank and the
unreported foreign exchange is invested abroad.
? Fictitious transactions. Residents bribe an official
at the central bank to release foreign exchange for
the declared purpose of meeting import or debt
service payments. The declared transaction never
takes place, but the foreign exchange is remitted to
a foreign bank account.
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? Front companies. Front companies obscure the ulti-
mate destination and owner ojjunds moved abroad.
A tangled web of shell companies with third party
directors and shareholders can be set up easily in
Hong Kong, Panama, the Channel Islands, Liech-
tenstein, or numerous small Caribbean countries.
Law firms in Panama reportedly have such compa-
nies already formed and "on the shell. "
? Import overinvoicing. An importer presents fraudu-
lent documents, which overstate the foreign ex-
change needed for imports, to the central bank. The
central bank remits foreign exchange equal to the
stated amount to the importer, who in turn pur-
chases the imports and invests the surplus foreign
exchange abroad.
? Kickbacks and skimming. Government otjicials and
businessmen demand kickbacks on foreign pur-
chases. On occasion, they also skim off some of the
proceeds from foreign borrowing. To hide their ill-
gotten gains, they almost always require that pay-
ments to them be deposited in overseas bank
accounts.
? Self loans. Residents use hard currency deposits
overseas as collateral for hard currency loans, the
proceeds of which are invested abroad. To meet
debt service payments, they obtain hard currency
from the central bank, generally at highly favorable
rates of exchange.
? Shipment of other assets. Residents buy with local
currency assets that are easily converted to cash
abroad and carry, ship, or smuggle them out of the
country. Preferred assets include precious metals,
uncut gems, jewelry, stamps, gold coins, antiques,
illegal drugs, and negotiable instruments-US
Treasury bills, bearer bonds, and unencoded bank
drgf'ts.
? Swap arrangements. Generally, currency is
swapped. For example, a US firm in need of pesos
deposits dollars in the US bank account of a
Mexican. The Mexican then deposits an equivalent
amount ojpesos in the corporation's bank account
in Mexico. Mexican "maquilladoras"along the US
border often participate in these deals. On occasion,
real estate and other assets are swapped.
? The name game. Residents often execute a myriad
of currency tran.?fers, each under $10,000, in the
names of their chauffeurs, maids, and children to
avoid filing transaction reports in the United States.
They also disperse funds at many banks under
d(/ferent names, often those of third parties who
reside legally in the United States.
? Trade deals. Using local currency, a businessman
buys a commodity exempt from export controls.
The commodity is then discreetly sold or bartered
abroad for hard currency.
? Traveler's check scams. ~gf'ter obtaining permission
to travel, the prospective traveler is authorized to
buy traveler's checks. The traveler then cancels the
trip and mails the checks overseas where they are
deposited in a bank account.
? Triangle letters of credit. To conceal export under-
invoicing, for example, the real exporter in the
Philippines might request that a US importer open
a letter of credit (LOCJ for the actual sale price for
a dummy exporter located in Hong Kong. The
dummy exporter, an agent of the Philippine export-
er, then opens an LOCfor a lower amount for the
Philippine exporter. When the goods are shipped,
two invoices are issued: one by the Philippine
exporter for the dummy exporter and the other by
the dummy exporter for the US importer. The
di/ference remains abroad.
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Confidential
by the traders or by others who acquired it in the
black market. Capital flight artists also misstated
other foreign payments such as loan proceeds and
debt service payments. They even bribed officials to
approve phony transactions. According to the press,
the Mexican Government may have lost access to over
$2 billion in foreign exchange last year because of
misreporting. Fraud was so extensive in Nigeria that
the government hired a Swiss firm to review foreign
exchange transactions.
Clever residents also concocted a host of more exotic
ploys to acquire foreign assets without drawing the
attention of the authorities. These ploys fall into three
general categories:
? Convertible asset ploys. Those intent on moving
their capital out of the country by physically trans-
porting assets abroad had to first obtain assets that
could be easily converted to hard currency. In most
countries, readily convertible assets were scarce or
their possession was prohibited. Citizens without
access to black markets were forced to devise
schemes to acquire bearer bonds, bank drafts, trave-
ler's checks, airline tickets, expatriate workers' pay-
checks, and uncontrolled tradable commodities-all
without detection, for shipment abroad.
? Hidden transfer ploys. Residents also went to great
lengths to ensure that their capital flight transac-
tions through legitimate channels escaped detection.
To avoid reporting requirements, large transactions
were split into numerous small transfers in the
names of relatives and associates. As an added
precaution, residents covered their tracks so that
even if their transactions were detected, they would
not be identified. The most complicated schemes
involved front companies, border banks, and trian-
gle letters of credit.
? Pseudotransfer ploys. Capital flight transactions
that involved pseudotransfers were among the most
exotic ploys. A series of parallel transactions often
enabled residents to acquire assets abroad without
actually transferring funds across the border. Bro-
kers often arranged currency or real estate swaps
between individuals in different countries (see inset).
Residents also used bank deposits in one country as
collateral for hard currency loans in another. It was
nearly impossible for the authorities to detect this
variety of capital flight scheme.
Safehavens for Flight Capital
On the basis of our analysis of press and diplomatic
reporting, we estimate that about three-quarters of
the capital that fled the key LDC debtors found
sanctuary in developed countries (see figure 5). The
United States was the largest recipient of flight
capital, with Switzerland a distant second
Assets in these countries were
preferred because they offered high return and low
risk. Funds were also moved to offshore money cen-
ters in Panama, Hong Kong, and smaller havens like
the Cayman Islands, the Channel Islands, and The
Bahamas. These offshore havens attracted flight capi-
tal because of their strict bank secrecy laws and
laissez faire regulatory policies that encouraged shady
financial dealing. Flight capital was often laundered
in these offshore havens en route to a final destination
elsewhere. Finally, a small amount of flight capital
flowed to nearby LDCs. According to the press, some
Filipinos salted away funds in Singapore and some
wealthy Argentines moved capital across the Rio de la
Plata to Uruguay.
Residents of the key LDC debtors invested their flight
capital in an array of assets overseas. Press and
diplomatic reporting suggests that about two-thirds of
this flight capital was used to purchase financial
assets. Bank deposits and US Treasury bills were
preferred because they were liquid, safe, tax free, and
simple. Stocks, bonds, and commercial paper were
also popular. Ironically, press reports indicate that
some residents avoided banks with high exposure in
debt-troubled LDCs. Flight capital was also invested
in tangible assets, mostly real estate. Residents ac-
quired personal property ranging from houses and
condominiums to antiques, jewelry, artwork, and pre-
cious metals. They also used flight capital to buy
business property-office buildings, factories, banks,
supermarkets, shopping centers, automobile dealer-
ships, restaurants, and boutiques. In short, many
residents of the key LDC debtors have made ready for
themselves new lives overseas.
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Capital jlight facilitators have played an important
role in the exodus of capital from the key LDC
debtors. Those aiding and abetting capital jlight
include:
? In the key LDC debtors, black-market traders are
probably the most important facilitators of capital
.flight. They provide the foreign exchange, bank
dresfts, bearer bonds, traveler's checks, and other
negotiable instruments to residents who then carry
or ship these readily convertible assets overseas.
Black marketeers also provide other capital.flight
support services. For a fee, they may execute the
actual capital transfer or just provide technical
assistance to clients wishing to shift funds overseas
themselves.
? Ironically, many commercial banks with high expo-
sure in the key LDC debtors are wooing Right
capital through "international private banking"
(IPBJ departments. One US bank, with over $26
billion in IPB assets, has over 1,500 employees
dedicated to this activity worldwide, according to
the press. Many commercial banks are involved in
transferring clients'funds abroad. Some even help
clients set up ojfshore trusts and shell companies to
conceal capital transfers. Bankers publicly deny
involvement with capital.flight
? Stringent capital controls have spawned a unique
class of capital.flight facilitators known as blocked-
funds specialists. They look for escape hatches for
funds trapped by foreign exchange controls. Ac-
cording to the press, two US.firms are leaders in
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