We know the influence the IMF brings to bear on central bankers and policy makers in the developing world and we also know of the various banking regulations and compliance measures that are currently in vogue especially with regard to taxation using the tax to GDP ratio benchmarks imposed on developing economies, which does not take into account many developing countries having state sector operations in business which are subsidized hence distorting the private sector’s actual tax to GDP contributions.
But leaving aside this matter and OECD recommendations which find very eager reception in the developed world there is even more serious matter for consideration by central banks, international policy makers, governments and international accounting firms as they are all equally as important as they are influential and powerful in terms of policy recommendation and implementation.
This particular matter is the inadvertent suppression of bringing on to the books immovable fixed assets (land) value of not only corporate but also individuals. It is well known in the developing world that many local companies and in some cases even multinational companies acquired premises for their various industrial and commercial undertakings decades ago.
Now these very same assets in the form of immovable land/properties have gained tremendously in value, in some cases especially in urban areas by thousands of percents or even more almost bordering on ridiculously huge values in comparison to their historical cost.
This is not only by virtue of demand but also decades of inflation and diminution of currency values. Yet in many or most cases for local businesses these increased valuations are not indicated on their balance sheets and the reason for this vary from country to country.
In some countries revaluation of immovable fixed assets are provided for within the SEC rules and regulations entailing an above-the-line entry to the capital reserve account on the balance sheet but in some cases precluding them from issuing any equity there against.
In some cases they may allow the issuance of equity albeit not always at the full market rate but to agreed to percentages; however, despite the latter many local companies in the developing world choose not to go through with the exercise simply because if they were to bring this value on the books after decades and a vast magnitude of difference in valuation there is no guarantee of the degree of taxation they may be subjected to simply because in many cases such immovable fixed assets are subject to property taxes by local/state/provincial governments what to mention federal governments hence even if the federal governments were to grant an amnesty there is no guarantee of the local governments doing the same.
Until and unless across the board amnesty is provided true values and its equity will remain off the books. The business sector itself in individual cases may have no requirements to sell these immovable fixed assets but just to reflect its valuation on its balance sheet could become a costly affair owing to potential taxability because in effect no funds were received there against but rather it was just an entry to reflect the true value of its immovable fixed assets.
This exercise would be done by a business to reflect its equity and its official bankability to finance the expansion of its business without being officially overleveraged. Granted there are cases which may provide immunity for immovable fixed assets held over a certain period of time but again these would be applicable only for the capital gains were the business to divest these assets.
Once again here it is very interesting to note that the thousands of percents increase of valuation of the immovable fixed assets opens the door for offshore capital transfer even if capital gain tax immunity is applicable in so far as the developing world is concerned because the difference between historical cost and current value is so disproportionately vast and literally ignored for decades.
Not only is it a issue of valuation but in fact it is a numerical issue because the numbers have been so widely distorted over decades because of currency diminution that it is not just a marginal case it is a major oversight of a pending numerical adjustment as well not only within our own system but also because any country is a member of the international community of nations whose importance is also a multiple of its size and population which further enhances the gap.
To demonstrate an actual finding in a case like this where the US Treasury actually sent a representative to one such developing country of substantial size with the objective to raise money within the country itself to finance its development by looking to develop the private property mortgage market was astounded by the fact in that particular country the private property mortgage level was just 0.025%.
It should be shocking for anybody because the problem is the international community and their nominated financial managers in many of these developing countries have failed to understand the locked up potential of this capital which requires one-time adjustment (or the now more popular terminology ‘Reset’, well this should be part of any so-called reset) to bring this valuation to the balance sheet in the equity account because there is no money received it is just an equalization of its current valuation of the immovable historical capital fixed assets on the balance sheet.
Undoubtedly, some criteria will need to be created and perhaps even if necessary a mitigated nominal margin may be assigned. If cognizance is not taken of this issue then there has to be some other logical explanation as to why not because under the current circumstances it defies logic and is disadvantageous to private sectors in the developing countries as well as for the countries themselves in terms of their sovereign standing. Furthermore as there is a international effort to do away with illicit sources of funds the recognition of this type of existing anomalies become very important and necessary.
How do the policymakers intend to address this issue because although on book valuation may not exist for many immovable fixed assets were businesses instead to choose to pledge these for loans to the same institutions/ banks which are in turn governed by central banks they would be ready to recognize the market value and disburse loans at a percentage there against.
The same value is not however facilitated in terms of recognizing this value to create equity. This then is a matter for the international experts who pay lip service for the cause of SME development. How can it be possible to finance growth without protecting the enhanced equity valuation from having a tax imposed on the revaluation amount and therefore extending the same immunity to the ultimate equity holder directly in view of his/her increased equity. Hence it may make more sense to transfer the ownership equity in case of revaluation to a tax free jurisdiction just the same as and when one were to dispose of the asset in hand.
The actual scenario is that many countries in the developing world do suffer from the lack of productivity and one among many such indicators of this is the flow of funds for intellectual property which by a vast majority goes to the developed world reflecting their productivity hence affording them high levels of leverage whereas in the developing world where productivity is low and demand rising in view of growing populations one can observe clearly the immovable fixed assets value accumulation and much lower levels of leveraging in private businesses.
It is in fact the state in many developing countries which is leveraging more than the private sector. It is well known in some countries where banks take deposits from the public and lend most of it to governments, earn interest on it from the government and pay back a portion from that as taxes to the government.
Where does this leave the entrepreneur and private business in terms of financing their growth at an affordable cost because bank borrowing is costly as interest rates are higher in the developing world and therefore too much leveraging in most cases renders an enterprise non-viable and therefore making many genuine private enterprises averse to borrowing from banks?
We hope the policy makers especially those in the IFIs and governments may have the time to reflect upon the above and let us know that either we are misinformed or perhaps we have overlooked something and if this is not the case then how do they intend to address this matter.
If this remains unresolved large scale capital transfer from the developing world will continue to take place. This assumingly inadvertent oversight by both national and international policy makers is becoming increasingly apparent to businesses in the developing world and regardless of their dismissal as to its significance it will become even more apparent when policymakers find themselves almost like flustered flamingoes on the back of a beast of burden having risen from the water.
Copyright Business Recorder, 2023
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