Document Type: 
Document Number (FOIA) /ESDN (CREST): 
Release Decision: 
Original Classification: 
Document Page Count: 
Document Creation Date: 
December 22, 2016
Document Release Date: 
March 16, 2011
Sequence Number: 
Case Number: 
Publication Date: 
September 1, 1986
Content Type: 
PDF icon CIA-RDP87T01127R001000820001-6.pdf2.73 MB
Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 f Confidential Directorate o Intelligence Key LDC Debtors: Grappling With Capital Flight Confidential G/ 86-10059 September 1986 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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. vii Confidential Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Confidential 25X1 Figure 1 Key LDC Debtors, 1986 Boundary representation is not necessarily authoritative. 706118 (545039) 7-86 25X1 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Confidential 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Q ~~ ~~ ~~ ~ ~ ~~ a r ~'i y~ F ,~ 4 a ~r ~~^ ~~,'~~" ~F~ ~~ ,. ~~ ~ er'~ t , .t ~ t y ~a ~~ ~t*w ^ ' ~ r E ` y ~~ ,~. ~~ ~. ;,Fri. dr,;w ~ ~_ ~.~~ ..,~.~..~YI..~..~'"a.~.,i~ite~a st,e}~i'>rf.i~~~2~ .`'~ ~ ~ ~.~ , . ~~~~ ... , ..~ z, ,'_.. ,, ~ ~ ~ ~ v ~} , ~ i ?~ A l i. P + Y 1 R Q t d t a~\ ~ . a ~ ' ~ a ~ r ~ w~ ~w, ` ~, y ~': ~ ~ h~ ~h ~ ~. ~r,?F ~~ ~i, i~ of t~~r n~w"~w ~ , S ~~ ~ . 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Confidential 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 25X1 25x1 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Confidential 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. Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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. Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 ? 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. Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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. Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 Sanitized Copy Approved for Release 2011/03/16 :CIA-RDP87T01127R001000820001-6 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 Secure your Overseas Deposits with the world's lead ing ba nk. It's as easyasABC. W ddue~ Nd buvneem.~GversJ YrneV we..mmvak wr~w~w.r si~.~ . rva ~u~no :nd u NYC W M i~~xwM o_...... __..... ------~ cmmati~~ rya r-- ----- ~...~... n.~e xeoo n~.~.:n.s ! rv.m. ~u,?gin A~ /sew BWd~g C~eMVr. Yuu un nelw uce of yi~~ 1Lewa~latvle~dingbeak M Wlsa~ ~j' Asian 9.nkinBCenler'. ~~, a viAN nbank lumen rdl moGSSy o