Explaining the significance of the hundi market

There are four conclusions of the analysis in my previous article. 

In that article, we estimated the supply of foreign exchange earned by Bangladesh workers abroad sent through the hundi market as $20 billion with a range of $17-23.6 billion. 

The demand, excluding capital flight, of users of the hundi market was estimated at $21 billion with a range of $18-25 billion. 

1. The estimates suggest there is only modest capital flight going through the hundi market. We note that over-invoicing of capital goods imports is an important source of capital flight but that does not involve the hundi market. However, the hundi market is used for capital flight by prosperous Bangladeshis (small and medium business owners, lawyers, doctors, engineers, civil servants) sending money abroad for building up reserves for emergency purposes for retirement, or education of children. This capital flight is likely to fall in the range of $0.6-1 billion per year. [15-20,000 persons sending $50,000/year]
2. When the Covid-19 pandemic struck, we saw that imports fell from 2018-19 to 2019-20 [L/C settlements] by $5.3 billion while remittances through the banking channel rose by $1.8 billion.   This is consistent with a decline in under invoicing reducing the hundi demand and so increasing the banking channel flow. In 2020-21 imports were $2.7 billion less than in 2018-19, whereas remittances increased by $7.6 billion. This surge in remittances cannot be explained by the fall in imports. Also this change suggests a decline in capital flight financed through the hundi system. The entire operation of the hundi may have been more difficult due to the pandemic so that the banking channel grew from an impaired performance of the hundi system. Also remittances may have increased in response to rising economic distress within Bangladesh. The year 2020-21 was a period of great disruption. 
3. Balance of payments and GDP estimates: The informal hundi market has a significant impact on the overall view of the balance of payments.  Inclusion of the informal transactions would raise imports and remittances, which would balance out leaving the current account deficit unchanged. But the amount of imports would increase substantially. Thus there is a significantly greater trade deficit. Remittances are income for households and would be partly consumed, partly saved and partly invested (land and housing). Assuming the BBS estimates for private consumption and investment are correct the increase in imports would directly reduce GDP. This would reduce GDP in 2018-19 by about 3% (but not necessarily change the growth rate as 2017-18 GDP would also be reduced). That is, one now counts as production what was actually imported. 
4. We can predict that the flow of remittances will decline significantly in the 2021-22 financial year and also in 2022-23, as imports grow, under invoicing expands, and the operation of the hundi market returns to normal. In the first seven months of FY22 remittances were $3 billion less than in the same period of FY21. Imports increased, world inflation and depreciation of the Taka will raise import prices, and the amount of under invoicing will grow. 

Is the hundi system a good thing?

We leave the reader to consider the following: The hundi system supports the operation of markets that would be less flexible without this facility. 

India, for example, benefits from the flow of visitors and funds from Bangladesh and the substantial informal trade. So do Bangladeshis. 

Without the hundi system the use of Indian experts in the RMG sector would either be more expensive or less extensive. 

The RMG and textile sectors would argue that these foreign workers are needed as skilled Bangladeshis are not available.  

The Bangladesh tariff rates are extremely high and encourage investment for production for the domestic market and discourage investment in export industries. 

The hundi market undermines official trade policy, as the effective tariff rates are lowered, encouraging investment in the export industries. 

If you believe that export led growth is the correct strategy for Bangladesh to achieve rapid economic expansion and that it is politically impossible to change the anti-export bias of the official trade system then the hundi system is a significant element of export led growth. The hundi system also lowers the prices that consumers pay for imported goods as the taxes collected are lower.  

The hundi system reduces government revenues by a substantial amount (0.75–1% of GDP). 

Compare two outcomes: More government expenditures and higher consumer prices (a curtailed hundi market); or lower current government expenditures and lower prices (an expanded hundi market)?  

Capital flight

We have concluded that capital flight associated with the Hundi market is rather small, $0.6-1 billion per year, as supply and demand in the Hundi market, without capital flight, are almost in balance.

However capital flight takes place through several other means: 

1. Scams where imports are made by fake local companies from fake foreign companies. The bank lends money for the imports which never arrive. The scammer ends up with money abroad from payment to the fake foreign company and leaves the bank with a bad loan. One only knows about such scams when the bank finds out that the scammer has left it with a bad loan; often the local company involved just vanishes. But the amount of capital flight through such scams must be limited.
2. Over invoicing of capital goods imports. Capital goods have low import taxes. The actual cost of a capital goods may be very difficult to determine, so a high price may not raise any alarms at customs. The returns to over invoicing may be very high.   However there is a limit as capital goods imports are of the order of $5 billion/year and over invoicing by 25% on the average seems an upper limit on capital flight. This suggests capital flight through this channel would be not greater than $1.25 billion.
3. Under invoicing of RMG exports: The Bangladesh RMG company sets up a company called XXX in the US or the EU.   The actual buyer contracts with XXX for the required orders. XXX contracts with the Bangladesh manufacturer (which owns XXX) for the order but at a lower price. When everyone is paid XXX ends up with a few percent of the order in dollars. The manufacturer in Bangladesh has successfully shifted some of his earnings to the EU or the United States. This is not a very good channel for capital flight as most RMG factories have low margins. Extensive use of this channel would soon ruin the Bangladesh manufacturers who employed this. 

We have identified four channels for capital flight.

1. Direct use of the Hundi. We estimate a maximum of $0.6-1 billion/year
2. Over invoicing of capital goods imports we estimate a maximum of $1.25 billion/year
3. Scams. This will be very limited
4. Under invoicing of RMG exports. We believe this is also limited.

Altogether the level of capital flight will probably not exceed $2-3 billion per year.

Reducing capital flight requires such as:

1. Pre-shipment Inspection for all capital goods imported to verify the prices.
2. Certification by BGMEA of the reality of the foreign buyer of record on the invoice and checking the prices against a database.  Also a Pre-shipment Inspection Company can check on the company buying the garments. 

Realistically with a $500 billion economy 0.5% or $2.5 billion/annum capital flight is difficult to block.

Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics