Black holes in the economy: Informal trade, informal revenue

Muhammad Abdul Mazid | Published: November 22, 2019 20:40:11

The 49-year old Bangladesh economy has got two malignant tumors growing to engulf its successes as an economic hub in south Asia -- one in the area of border trade and the other in revenue realisation as well as public money spending. Numerous studies have confirmed that informal border trade has been a great symptom of systematic glaucoma in Bangladesh economy. At the same time the overall financial mismanagement has been a cutting edge to the eventual economic growth of this energetic economy.

There has been a substantial informal or unrecorded trade across the India-Bangladesh land borders ever since Bangladesh's independence in 1971. Until 1947 there was no border during undivided Bengal. Between 1947 and 1971, border trade was strictly restricted. After 1971, much of  the border trade between Bangladesh and India became quasi legal and best characterised as "informal" rather than illegal, because there has been  wide participation by local people in the border areas, generally bypassing customs posts, and also because -"the field operators generally operate in liaison with the anti-smuggling enforcement agencies". Informal trade of this kind usually involved large numbers of local people transporting small quantities of goods-- often just as head loads or by bicycle rickshaw-- and is sometimes known as  "bootleg" smuggling. At the other extreme, there is trade in larger quantities, mostly by trucks, through the formal legal customs channels, but this also involves explicitly illegal practices such as under-invoicing, misclassification and bribery of Customs and other officials, which is sometimes termed as "technical" smuggling. Trend of India-Bangladesh unrecorded trade confirmed that the trade is essentially one-way, from India to Bangladesh. A 1994 survey estimated that unrecorded trade from Bangladesh to India was only about $10 million, compared with an estimated $371 million from India to Bangladesh. For India, trade with Bangladesh constituted a very small part of its total trade -- just over one per cent in the mid-1990s, and currently about 3 per cent of its total exports and a miniscule share (0.01 per cent) of its total imports. For Bangladesh, India has now become the largest single source of its imports.

Another survey showed that Bangladesh's smuggled imports from India during 2016/17 were approximately of $3236 million, or about 40 per cent of recorded imports from India, and approximately 30 per cent of total imports (recorded plus smuggled) from India. In 2018 India's officially recorded exports to Bangladesh were about $10.2 billion and its imports from Bangladesh $1.2 billion.

Numerous studies of informal and illegal trade between Bangladesh and India pay little or no attention to domestic indirect taxes of the both economies (in India, the central excise tax and the central and state VAT, and the VAT in Bangladesh). Yet these are very important for understanding the nature and modalities of the trade and its economic implications. In both countries agricultural products, livestock and fish are exempted from these taxes, and this is presumably one of the reasons why they dominate the estimates of "bootleg" smuggling. But manufactured products in India, including most processed foods, are subject to indirect taxes which are generally at least 20 per cent (16 per cent central excise tax plus sales tax or state VAT). If these products are purchased in India at retail, wholesale or even from the producing factories, the purchase prices will (or should in principle) include these taxes. Hence, if the goods are then smuggled across the border by the bootleg route, the indirect taxes are a kind of de facto export tax under which the Indian central government and an Indian state government (e.g. Paschimbanga) in effect taxes the eventual buyers in Bangladesh. Alternatively, since the smuggled goods presumably escape paying VAT in Bangladesh, this amounts to a transfer of revenue from the Bangladesh government to the central and state government in India, in so far as the smuggled goods substitute for locally produced or legitimately imported goods that would have been subject to the Bangladesh VAT. It is ironical as well that expensive goods imported by Bangladesh are smuggled to India almost in local currency (through hundi system). In fact, in many ways informal trade distorts the market as well as price mechanism, frustrates fiscal discipline, discourages local industry growth, and adversely affects industrial and economic development policies in Bangladesh.

Over the decades, trading (both formal and informal) between Bangladesh and India has been characterised by certain conspicuous features. Firstly, there are longstanding concerns in Bangladesh arising from the perennial trade deficit with India, and large volumes of informal imports from India across the land border which avoid Bangladesh import duties. Secondly, even though (because of the disparity in the size of the two economies) India's trading relationship with Bangladesh is less significant for it than it is for Bangladesh, closer economic integration with Bangladesh is nevertheless seen as a very important way of reducing the economic and political isolation of the seven Indian eastern and north eastern states from the rest of the country. Thirdly, the appreciation of the real Taka/Rupee exchange by about 50 per cent since mid-1980s has contributed to the expansion of informal Indian exports to Bangladesh, and retarded the growth of Bangladesh exports to India. Fourthly, the hawala or popularly known hundi networks are seen to perform better than the formal banking system in terms of simplicity, speed, transaction costs, and reliability, and for these reasons they are not only financing much of the informal bootleg smuggling trade from India to Bangladesh, but also substantial parts of the exports to Bangladesh that should go through the legal routes. Informal exports from India to Bangladesh are also paid for by gold and Taka smuggled into India. The smuggled Taka are used to buy Rupees from informal foreign exchange traders who offer considerably more favourable Taka/Rupee rates than can be obtained from banks, which are obliged to first convert the taka into US dollars and then to Rupees, as there is no official direct Taka/Rupee foreign exchange market.

In the area of financial as well as macroeconomic management Bangladesh has experienced a sever set back and backlash over the past decades. The development process of Bangladesh has been, unfortunately, significantly linked with corruption, irregularities and misappropriation, thus creating a strong ground of elements and events to originate a series of economic scandals in the country. For the last few years, the country has been experiencing such scandals, one after another, on a large scale. Most of the elements to originate such scandals are actually rooted in the past. With the change of musical chairs of policymaking some new elements have been added time to time. Over the period the size of the economy along with some new and 'innovative' tricks has inflated the volume of scandals.

World Economic Forum in a recent survey disclosed the ineffectiveness  of the country's efforts to combat corruption. The report further said that, "Difficulty in obtaining credit, poor monitoring and supervision both in banking and capital markets, weak regulation, poor financial auditing and reporting, and rise in money laundering are the major concerns." The Report prescribed, "Strong political stand is required against corruption, wasteful or delayed public spending and local government system requires strengthening."

There are some complexities in defining informal economy or informal economic activities. Certain types of income and the means of their generation are unregulated by regulatory institutions in some countries but regulated in other countries. The informal economy, generally untaxed in nature, commonly includes goods and services of any kind and category. They include private unincorporated enterprises, individuals or households that are not constituted as separate legal entities. Hence, for such entities, no complete accounts are available that would permit a financial separation of the production activities of the enterprise from the other activities of its owners. Informal revenues are earned by revenue collectors and enforcing agencies, they are not only depriving the exchequer, are also cheating the national economy, bringing others in the lap of informal activities.

Underground activities like crime, corruption, bribe, money laundering, smuggling etc are not part of informal economy but activities of criminal nature. Almost every country has an informal economy with differing dimensions, the highest being developing countries where up to 60 per cent of the labour force is in the informal sector. A recent study of donors says that 35 per cent of GDP of Bangladesh is in informal sector. Undeclared income could account for up to 80 per cent of GDP -- some US$110 billion. Tax evasion is pervasive in Bangladesh as such Tax GDP Ratio remains at the lowest level. Reliable statistics of informal economy is hardly reliable.

Well-thought-out decision making procedure, transparent process and unambiguous laws and regulations reduce mistakes at the policy planning level and minimise corruption. With the perpetual prevalence of the informal economy, informal sectors and criminal activities have remained almost synonymous in Bangladesh. It remains a cardinal fact that legal instability and high volatility of fiscal and business regulations increase informal economic activities. The taxation regulation, foreign exchange arrangements, trade and tariff rules and procedures, environmental laws and regulations, competition regulation, consumer protection and regulations concerning financial inclusion should be easier, simpler, clearly defined and properly enforced.

Dr Muhammad  Abdul Mazid is a  former Secretary to the Government  and  former Chairman, NBR.


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