Natural Resources and Illicit Financial Flows from BRICS Countries

Abstract

Natural resources wealth constitutes a fundamental pillar of economic development in BRICS countries which seek to swiftly catch-up the advanced economies. However, this catching-up process is coupled with an increase in capital flight. This paper aims at investigating the determinants of capital flight in BRICS countries over the period 2001–2017, while putting a greater emphasis on the role of natural resources. The econometric analysis reveals that natural resources exert a positive effect on capital flight, suggesting that natural resource rents fuel capital flight in BRICS countries. Empirical results show also that capital flight is determined by macroeconomic and institutional factors as well. However, the disaggregated analysis by natural resource components show some disparities that cannot be overlooked. Despite the large benefits of natural resources wealth, curbing the capital flight waves remains a key challenge that faces the BRICS grouping in order to ensure that profits are maximized for the good of countries.

Appendix: Algorithm for Capital Flight Measurement

Following Boyce and Ndikumana (2001) and Ndikumana et al. (2015), this appendix provides the detailed algorithm for computing capital flight series based on the residual method of the World Bank. Accordingly, capital flight is defined as the difference between total capital inflows and recorded foreign exchange outflows. In a given year t the capital flight for a country is given by:

$${Flight}_{t}={(\Delta DEBT}_{t}+{FDI}_{t})-\left({CA}_{t}+{\Delta RES}_{t}\right),$$

(4)

where CF is the computed capital flight; ∆$DEBT$ is the change in total external debt outstanding; FDI is the net foreign direct investment, CA is the current account deficit, and $\Delta RES$ is net additions to the stock of foreign reserves.

However, to correct for potential discrepancies due to exchange rate fluctuations, Boyce and Ndikumana (2001) suggested adjusting the change in the long-term debt stock for fluctuations in the exchange rate of the dollar against other currencies. For a country i, the U.S. dollar value of the beginning-of-year stock of debt at the new exchange rates is obtained as follows:

$${NEWDEBT}_{i, t-1}=\sum_{j=1}^{7}({\alpha }_{ij, t-1}*{LTDEBT}_{i, t-1})/({EX}_{jt}/{EX}_{j, t-1})+{IMFCR}_{i, t-1}/({EX}_{SDR,t}/{EX}_{SDR,t-1})+{LTOTHER}_{i, t-1}+{LTMULT}_{i, t-1}+{LTUSD}_{i, t-1}+{STDEBT}_{i, t-1},$$

(5)

where LTDEBT is the total long-term debt; ${\alpha }_{ij}$ is the proportion of long-term debt held in currency j, for each of the seven non-US currencies (i.e., the euro (from 2000); French franc and the Deutsche mark (up to 2000); Swiss franc, Yen, SDR, and British pound); EX is the end-of-year exchange rate of the currency of denomination against the dollar (expressed as units of currency per U.S. dollar); IMFCR is the use of IMF credit; LTOTHER is long-term debt denominated in other unspecified currencies; LTMULT is long-term debt denominated in multiple currencies; LTUSD is long-term debt denominated in U.S. dollars; and STDEBT is short-term debt.

The exchange rate adjustment is therefore calculated as:

$${EXRADJ}_{t}={NEWDEBT}_{t-1}-{DEBT}_{t-1},$$

(6)

Which gives the adjusted change in debt as follows:

$${\Delta DEBTADJ}_{t}={\Delta DEBT}_{t}-{EXRADJ}_{t}={DEBT}_{t}-{DEBT}_{t-1}-{EXRADJ}_{t}={DEBT}_{t}-{DEBT}_{t-1}-{NEWDEBT}_{t-1}+{DEBT}_{t-1}={DEBT}_{t}-{NEWDEBT}_{t-1},$$

(7)

Consequently, we get the residual measure of capital flight adjusted for exchange rate fluctuations from modifying equation (4) as follows:

$${Flight}_{t}={(\Delta DEBTADJ}_{t}+{FDI}_{t})-\left({CA}_{t}+{\Delta RES}_{t}\right),$$

(8)

Ndikumana and Boyce (2003,2011), Ndikumana and Sarr (2019) indicate that trade misinvoicing constitutes a significant share of capital flight. Therefore, we used Global Financial Integrity (GFI) data on trade misinvoincing (MISINV) to calculate the adjusted capital flight as follows:

$${Flight}_{t}={(\Delta DEBTADJ}_{t}+{FDI}_{t})-\left({CA}_{t}+{\Delta RES}_{t}\right)+{MISINV}_{t},$$

(9)