Hidden Capital Movements through Falsified Trade & FDI Data: Empirics and Theory Comprising BRICS & the USA

Usually developing countries are characterised by capital scarcity and hence resort to stringent trade and capital control policies. This might become counterproductive and provide incentives to the international traders and investors for corrupt practices and as a result, scarce capital might move across the borders illegally. Traders might under-report export and over-report import to send the capital abroad. Later by over-reporting the amount of foreign investments (FDI), part of flown away capital might come back home. Even if imports are under-reported due to high tariff and non-tariff barriers, still corrupt exporters might under-invoice to supply the illegal foreign exchange to finance unreported import. Analysing the data from BRICS with the USA as trade partner, this paper establishes a definite relationship between export and import mis-invoicing and most importantly discovers a link between the hidden capital outflow through trade channel and hidden capital inflow through FDI channel empirically by Johansen Cointegration test and Panel VECM. Based on empirical observations, this paper builds up an analytical framework and determines the optimal rate of FDI, export and import mis-reporting as functions of several policy variables like spot and expected exchange rates, domestic and foreign interest rates, FDI return, tax rates etc.