Trade fraud risk index

University of Copenhagen

Detecting trade fraud risk and assessing revenue loss – The case of Kenya

2023-(ongoing)

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Summary

Trade fraud in the form of import undervaluation is one of the largest contributors to illicit financial flows from developing countries, with around 87% of such flows attributed to trade mis-invoicing in the period 2005-2014. The study proposes a new Trade Fraud Risk Index (TFRI) that measures the prevalence of CIF-FOB differences at HS 4-digit industry level, ranks countries by their relative risk of import undervaluation, and tracks the evolution of this risk over time.

To construct the TFRI, QBIS analysed the distributions of CIF/FOB unit value ratios across around 230 importing countries, around 230 exporting countries, around 1,230 industries and the period 2000-2019, totalling around 24 million observations. Three distinct distributional patterns were identified — exponential, Laplace and log-normal — corresponding to low-income/high-corruption countries, high-income/low-corruption countries, and transitional economies respectively. By combining the index with trade volumes from CEPII's BACI database and WTO tariff rates, the methodology further quantifies the value of CIF-FOB trade gaps and the associated potential customs revenue loss at HS 4-digit industry level.

The methodology is applied to Kenya as a case country, drawing on around 220,000-250,000 customs declarations per year from the Kenya Revenue Authority over 2015-2023. Kenya's TFRI fell from 1.2 in 2005 to 0.4 in 2019, and its trade gap declined from 31% to 7% of FOB value. Nevertheless, the assessed potential additional tariff revenue of around USD 307 million corresponds to around 19% of Kenya's actual tariff revenue in 2019, with the largest revenue gaps in textiles, mineral oil, plastics and ceramics.

Publication

The results of the study are presented in the draft article Detecting trade fraud risk and assessing revenue loss – The case of Kenya, co-authored with the Development Economics Research Group (DERG) at the University of Copenhagen. The article has not yet been submitted for peer review or to an academic journal. The study results are intended to be shared with anybody having interests in using its content to support customs administrations, ministries of finance and international organisations in monitoring trade fraud risk, and to anybody contributing to the design of risk-based inspection programmes and the reduction of illicit financial flows in developing countries.

Project purpose and objectives

The purpose of the study is two-fold. First, to develop and validate a globally applicable Trade Fraud Risk Index (TFRI) that detects the frequency of import undervaluation across countries, industries and time, and to use it together with trade volumes and tariff rates to quantify the resulting trade gaps and potential customs revenue loss. Second, through facilitating detailed, industry-by-industry assessments of CIF-FOB differences at HS 4-digit level, to provide aid for customs administrations in targeting their risk assessment programmes and inspections at the industries with the highest fraud risk, and for ministries of finance in monitoring the effectiveness of anti-fraud and trade facilitation reforms.