Capital Flight: Getting Rubles Back to Russia

Once back in London or New York, company economists returning from a fact-finding week in Moscow tend to tailor their "capital flight" message to the audience. When reporting to an eager marketing department, they talk about large-scale inward investment. But in front of the skeptical company chairman, they moan capital flight is still high.


All manner of capital flight estimates are currently being bandied around the conference circuit. "Illegal capital flight" is generally calculated using three technical items from Russia's trade data: "non-transferred export revenue," "barter trade" and "errors and omissions." Capital flight thus detected through the balance of payments is deemed "illegal" as it represents the tendency of money managers to get money out of the country using falsified import contracts and "payment without deliver." Economists reckon illegal capital flight in 1995 was around $8 billion, a sharp increase since 1994 when the figure was $3.5 billion.


To "illegal" capital should be added its "legal" counterpart. The first component of this total is derived from holdings of hard currency by Russian individuals and companies. Individuals and firms generally hold hard currency to hedge against inflation. Such holdings are rather arcanely defined as capital flight as they represent claims on a U.S. bank by Russian residents. Goskomstat, the government's statistical agency, reckons that given Russia's much-improved inflation performance during 1995, hard currency holdings rose only $600 million in 1995, compared with $7.8 billion in 1994.


The second component of legal capital flight comprises the declared increases in assets held abroad by commercial banks. After increasing by only $300 million in 1994, in 1995 this component actually fell by $2.8 billion -- that is, the banking sector experienced a net inflow of recorded funds. The combination of tiny increases in hard-currency holdings, and the banking sector performance, meant 1995 saw a $2.2 billion inflow of funds under the legal capital flight heading.


The sum total for 1995 was net capital flight of $7.7 billion. An identical methodology gives a 1994 figure of $10.8 billion. While this is an improvement, there are two major reservations.


The first is the large increase in illegal flight capital. New import controls were introduced at the beginning of 1996, allowing officials to more accurately compare cash flow from the importers' bank accounts with customs information from the delivery of goods. This system is more likely to provide businesses with headaches and customs officials with chances to take bribes than it is to detect illegal capital flight.


The second reservation concerns the net inflow of funds into the banking sector during 1995. One reason has been the ruble currency band and the real appreciation of the ruble. This has allowed Russian banks to get better returns on ruble assets in Moscow rather than hard currency counterparts in London or New York.


Nobody knows the real level of capital flight. The trade data that form the basis of the estimates are notoriously ropey. And commercial banks know well how to keep the government's eyes off their accounts. But if the margins of error are constant, the numbers deserve to be taken seriously. They provide, at least, a barometer of Russia's financial reality, if not an indicator.


But to think capital flight can be controlled is wishful thinking. The only genuine way to stop it is to provide incentives for capital to remain. And the best incentive is low inflation. The economy last year achieved lower inflation; capital flight also fell.