Trade Mis-Invoicing Between India & USA: An Empirical Exercise

AuthorAmit K. Biswas,Subhasish Das
Publication Date01 Feb 2021
02_FTR961344_ncx.indd Article
Trade Mis-Invoicing
Foreign Trade Review
56(1) 7–30, 2021
Between India & USA:
© 2020 Indian Institute of
Foreign Trade
An Empirical Exercise
Reprints and permissions:
DOI: 10.1177/0015732520961344
Subhasish Das1 and Amit K. Biswas1,2
India shares its majority of international trade with the United States of America.
But a huge amount of discrepancy is frequently observed in the recorded bilat-
eral trade statistics between these two countries. The main reasons are caused
by several restrictions prevailing on the account of international trade in India.
Export is found to be under-reported consistently whereas import data shows
both over and under mis-invoicing in a periodic swing. This paper focuses on the
determinants of this data fabrication with the help of empirical exercises. Several
macroeconomic policy variables are taken to build up an econometric model and
are tested statistically with the help of time series econometrics. Among all, rela-
tive interest rate plays the most important role to influence export and import
mis-invoicing, followed by spot exchange rate and forward exchange rate. The
exercise also finds a uni-directional causal relationship from import mis-invoicing
of a period to export mis-invoicing of the next period.
JEL Codes: C10, C13, C61, F13, F14, F21, K42
Export, import, mis-invoicing, interest rate, exchange rate, forward premium
1 Visva Bharati University, Bolpur, West Bengal, India.
2 Institut für Internationale Wirtschaftspolitik, Bonn, Germany.
Corresponding author:
Subhasish Das, Visva Bharati University, Bolpur, West Bengal 731235, India.

Foreign Trade Review 56(1)
Less developed countries (LDCs) are often characterised by their low level of
capital formation, which submerges them into a vicious circle of poverty. Capital
plays an important role to come out of such low-level equilibrium trap. Following
the theories economic development, the developing countries including India are
heavily encouraging the foreign capital in the form of Foreign Direct Investment
(FDI) and Foreign Institutional Investment (FII). But any honest effort of inviting
foreign capital is self-defeating if corrupt activities on the part of international
traders move domestic capital out of the country illegally and, perhaps, allow it
to return to the home country later in the guise of foreign capital. Given this back-
ground, we propose an exercise where we precisely try to find out if corrupt
practices like mis-reporting by international traders aggravate the problem by pro-
moting capital flight which would adversely affect a country’s effort for capital
India, who exports almost 18 per cent of GDP in the year 2017, is the seventeenth
largest export economy in the world. One of the most important partners is the
United States of America (USA) with whom India trades almost 16.1 per cent of her
total trade. In this paper, the main focus will be on the extent, nature and determi-
nants of trade data fabrications associated with the bilateral trade between India and
the USA. Though India is globalised in a greater extent now than before, the country
is heavily depended upon protectionist trade and exchange policies along with strict
capital controls, to manage its balance of payment (BoP) and scarce foreign cur-
rency reserves. However, the presence of regulatory controls on trade and payments
induces exporters and importers to engage in illegal transactions. Such actions, in
turn, lead to the emergence of black markets for scarce foreign exchange as well as
illegal capital outflow. Despite the recent global trend of liberalising trade regime,
many countries (particularly, the less developed countries) still continue to have
significant rates of tariff and non-tariff barriers along with managed (usually over-
valued) exchange rates. If tariff rate is high, the importers get incentive to under-
invoice imports. Such under-invoicing activities will lead to a demand for foreign
exchange through illegal channels carrying a Black Market Premium (BMP), which
may be defined as the difference between legal (official) and illegal (black market)
exchange rate. Now if the premium is higher than tariff rate, the importers will over-
invoice. Therefore, the amount of this over-invoicing is outsourced to foreign by the
corrupt importers. Coming to the question of exporters, they will over-invoice if
there is some attractive export subsidy. But if that subsidy is less than BMP, the
exporters induce to under-invoice. Exporters will report lower export values to the
official authority and sell the rest of the unreported foreign exchange to the illegal
market for the premium. Therefore the amount of this under-invoicing is a part of
illegal capital outflow from the country. Moreover, even after under-invoicing
export, if exchange rate is depreciated, it becomes advantageous for corrupt traders
to take back the capital into the domestic markets through FDI channels. In this way,
an illegal market of foreign exchange emerges in the local economy where the bulk
demanders are the under-invoicing importers and the bulk suppliers are the under-
invoicing exporters.

Das and Biswas 9
The paper is organised in the following manner: The section ‘Literature
Review’ covers a brief review of the existing literature on this topic. The section
‘Empirical Exercises’ is divided into four parts: the first part provides the method-
ology used in the paper, the second part shows the extent of export and import
mis-invoicing over the period, the third part focuses on the empirical exercises to
determine the impacts of policy variables on export and import mis-invoicing and
the last part examines whether there is any causality between export and import
mis-invoicing. The section ‘Conclusion’ makes a brief conclusion of the paper.
Literature Review
The technique of detecting mis-invoicing in international trade through compar-
ing domestic trade data with the one obtained from the partner country statistics
was initiated through a pioneering work by Morgenstern (1963). He calculated the
ratio by the formula: (Country B’s import from country A according to B’s statis-
tics)/(Country A’s export to Country B according to A’s statistics). The technique
was extended to Asian countries by Naya and Morgan (1969). They tested the
statistical significance to find an interesting result: inter-regional trade mis-
invoicing among Asian countries is higher than that of developed countries (DCs).
Bhagawati (1964) made a comparison of the fob export values recorded by
Turkey’s principal trading partners with the cif import values recorded by Turkey.
He found under-invoicing of imports which is a result of high tariff rate. Dornbusch
et al. (1983) tried to examine the black market for foreign exchange in Brazil and
analysed the exchange rate movements based upon the existing stocks of dollars
and expectations about future currency devaluations. This exercise was extended
to other LDCs in Kamin (1993).
Biswas and Marjit (2005) were the first to consider the Indian case of misre-
porting. They compare India’s ‘official’ data with the ‘actual’ data of her major
trading partners to get the discrepancy rate = (Actual export – Official export)/
Actual export. The study rationalised the misreporting phenomena in a theoretical
framework and attributed this misreporting to stringent trade and exchange rate
policies. Biswas and Marjit (2007) build a three-country model to show that given
an unchanged amount of BMP, a preferential trade channel with a low tariff may
generate illegal capital outflows; while a non-preferential channel characterised
by high tariff protection may create illegal capital inflows from abroad. Biswas
(2012) shows that even in the absence of BMP in foreign exchange market, the
exporter may rationally under-invoice to satisfy the illegal foreign exchange need
of the under-invoiced importers facing high tariff protection.
The relationship between macroeconomic determinants and capital flow was
analysed in Cuddington (1986). In his Balance of Payment approach, capital flight
was measured as the sum of private short-term capital outflows and errors and
omissions. He theoretically explained that domestic and foreign interest rate,
inflation rate and expected rate of depreciation are the principal determinants of
capital flight of a country. Pastor (1990) used residual approach where capital
flight is measured as the difference between sources of foreign exchange (Change

Foreign Trade Review 56(1)
in debt + FDI) and uses of foreign exchange (Current Account Deficit + Change
in reserves). He found that inflation rate is the most significant determinant to
influence capital flight. Patnaik et al. (2011) measured capital flight through
export mis-invoicing and import mis-invoicing as a percentage of exports and
imports respectively. This paper established the strong influence of capital account
liberalisation and current account deficit on capital flight. Ferrantino et al. (2012)
the gap between U.S. reported direct imports from China and China reported
direct exports to the U.S. over different products and years. They proved that both
the Chinese VAT and U.S. tariff rate are responsible for widening the gap. Cheung

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