The challenge of black economy

Arun Kumar

AT the G20 summit in Turkey, the PM talked about the need to address excessive banking secrecy and sought international cooperation for the return of illicit money to the country of origin. It is a plea for moderation and not ending of banking secrecy. Is this meaningful given that 90 tax havens exist which thrive on various degrees of banking secrecy and/or low tax rates? Further, many of them belong to advanced countries. Would the partial end of banking secrecy result in loopholes that would enable illicit funds to continue to flow? Is there a case for a complete transparency in banking?

Banks, especially those in tax havens, have often denied information about their clients on grounds of banking secrecy. This enables those who use illegal means to earn illicit incomes to escape detection by the authorities. Thus, secrecy in banking has encouraged the proliferation of illegality in the world — drug trafficking, illegal fishing, terrorist financing and so on. The Financial Action Task Force (FATF) has said looking for dirty money is like looking for a needle in a haystack. There are various electronic mechanisms to transfer money across nations like, SWIFT. Software devised from time to time to detect suspicious transactions has failed.

Trillions of dollars are moved daily in financial transactions in derivatives trade or stocks and bonds. Illegal money moving daily is not even 1 per cent of these amounts. Mechanisms are available to hide the trail of the flow of these funds, like ‘placement’ and ‘layering’. President Obama mentioned that from one house in a tax haven, thousands of companies operate. These are shell companies used to transfer money around the globe between various tax havens and finally to the destination where the money is parked. The PM has, therefore, rightly flagged the need to tackle the complex legal and regulatory frameworks in financial markets. 

Various banks have been caught helping individuals hide their dirty money or helping them evade taxes. There is also the case of Rudolf Elmer of Swiss Bank Julius Bar who stole bank data and passed it to Julian Assange. Elmer was arrested by the Swiss authorities and Assange did not make the list public.

Stealing data from banks in secret jurisdictions has been an important source of getting information about entities that hold accounts there. This has been the case with the LGT Bank of Liechtenstein and HSBC in Switzerland. In the former case, Kleibe of LGT sold stolen data to the German government for 4 million euros in 2007. The Germans offered the names free of cost. While other governments took the lists and started prosecution, the Indian Government refused to take it. Later, under court pressure, it accepted the list and started investigation but the inordinate delay didn’t help. 

Hervé Falciani stole data from HSBC and offered it to the French government in 2008. Again, India refused to take this data till the court pressured it to do so. Initially, 627 names came. Double Taxation Avoidance Agreement (DTAA) was invoked to argue that secrecy prevented the lists from being made public. But this was an invalid argument.

In neither the LGT nor HSBC cases the DTAA is relevant since the data did not pertain to incomes in either of the two countries. LGT case was about accounts in Liechtenstein and not in Germany or India. HSBC case was about accounts in Switzerland and not in France or India. Further, it was not income in the countries concerned but assets held in a third country. Finally, it was about stolen data being offered by whistleblowers and not data that was obtained officially by Germany or France. Both the UPA and NDA governments stalled the revelation of names. The SIT was ordered by the Supreme Court in 2011 in the Jethmalani and others case but was not set up till May 2014. More than a year later, it is not clear what impact the SIT has had on the Indian black economy. 

Falciani kept mentioning that only 1 per cent of the names had been released but the government did not get further names. Journalists of the ICIJ revealed another list containing 500-odd names. The 1,150 names that India received from the two lists is just a teaser since lakhs of rich Indians hold funds abroad. As the Bank of Baroda case reveals, even Indian banks have been indulging in such practices. Clearly, the government has not been proactive in seeking names. On the contrary, the government has been seeking to dilute protection to whistleblowers by amending the relevant Bill in Parliament.

This is in contrast to the Birkenfeld UBS case in the US. Birkenfeld used to travel routinely between Switzerand and the US. He was tracked by the IRS of the US and information collected on his activities. He was found to be acting on behalf of UBS, enabling US citizens to defraud the income tax authorities. He was caught and both he and UBS were prosecuted in 2007. The Swiss government argued that action against UBS could lead to the collapse of the financial system of the world. They also characterised the demand of IRS for the revelation of 52,000 names of US citizens holding accounts with UBS as a fishing expedition. The court rejected these arguments and threatened to order the US government to take over the bank. Immediately, UBS settled and agreed to pay $780 million fine and release names of 4,500 accounts. Thus, the US authorities succeeded because they were proactive. 

The Indian Government’s plea that DTAA and TIE will help in revealing names of those with accounts abroad does not hold water. The first DTAA was signed in 1990 but not one name has come under it till the stolen data came. It is also not expected because DTAA is about white incomes and not undeclared black incomes. Similarly, TIE can only be about declared incomes. 

Thus, while the PM’s statements on banking secrecy are welcome, they will carry little weight unless the government shows the will to tackle the problem in India head-on. It has been soft in tackling the black economy because of political considerations and essentially indulges in diverting public attention. No wonder the black economy has grown from 4-5 per cent of the GDP in 1955-56 to the present over 60 per cent. 

The HSBC case is an example of the government’s passivity. Evidence exists that HSBC indulged in havala operations in India but it has not been prosecuted. Instead it is now closing its operations in India. Other MNC and Indian banks also indulge in the same practice in the name of catering to their high net worth individuals. Recently, the strange case of SGFX Financials has surfaced. Its assets jumped in five months from 0.7 million pounds to 70 billion pounds. Pawar’s name has been dragged in but he has challenged it. 

There is need to end banking secrecy but India has not done so. UBS was found to be involved in the Hasan Ali case but it has escaped prosecution. Businesses can have secrecy about their business but not about incomes which is a public issue because of taxation. Similarly, banks should not be allowed secrecy about deposits and depositors. So, action is needed in India while expression of hope in G20 will yield little.

— The writer is a former professor of economics, JNU