What is the difference between capital flows and capital outflows

Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Capital outflow is the movement of assets out of a country. Capital outflow is considered undesirable as it is often the result of political or economic instability.

The flight of assets occurs when foreign and domestic investors sell off their holdings in a particular country because of perceived weakness in the nation's economy and the belief that better opportunities exist abroad.

Excessive capital outflows from a nation indicate that political or economic problems exist beyond the flight of the assets themselves. Some governments place restrictions on capital outflow, but the implications of tightening restrictions is often an indicator of instability that can exacerbate the state of the host economy. Capital outflow exerts pressure on macroeconomic dimensions within a nation and discouraging both foreign and domestic investment.

Reasons for capital flight include political unrest, introduction of restrictive market policies, threats to property ownership and low domestic interest rates. For example, in , Japan lowered interest rates to negative levels on government bonds and implemented measures to stimulate the expansion of gross domestic product.

Extensive capital outflow from Japan in the s triggered two decades of stagnant growth in the nation that once represented the world's second-largest economy. Governmental restrictions on capital flight seek to stem the tide of outflows. This is usually done to support a banking system that could collapse in numerous ways. A lack of deposits may force a bank toward insolvency if significant assets exit and the financial institution is unable to call loans to cover the withdrawals.

The turmoil in Greece in forced government officials to declare a week-long bank holiday and restrict consumer wire transfers solely to recipients who owned domestic accounts.

The financial account records the flow of assets from one country to another. It is composed of foreign direct investment, portfolio investment, other investment, and reserve account flows.

The capital account is typically much smaller than the other two and includes miscellaneous transfers that do not affect national income. Debt forgiveness would affect the capital account, as would the purchase of non-financial and non-produced assets such as the rights to natural resources or patents.

The balancing item is simply an amount that accounts for any statistical errors and ensures that the total balance of payments is zero. The current account represents the sum of the balance of trade net earnings on exports minus payments for imports , factor income earnings on foreign investments minus payments made to foreign investors , and cash transfers.

A nation has a trade deficit if its imports exceed its exports. Because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports. This, however, is not always the case. Secluded economies like Australia are more likely to feature income deficits larger than their trade surplus.

Income refers not only to the money received from investments made abroad note: the investments themselves are recorded in the capital account but income from investments is recorded in the current account but also to the money sent by individuals working abroad, known as remittances, to their families back home.

If the income account is negative, the country is paying more than it is taking in interest, dividends, etc. Cash transfers take place when a certain foreign country simply provides currency to another country with nothing received as a return.

Typically, such transfers are done in the form of donations, aids, or official assistance. Normally, the current account is calculated by adding up the 4 components of current account: goods, services, income and cash transfers.

Goods are traded by countries all over the world. When ownership of a good is transferred from a local country to a foreign country, this is called an export. In calculating the current account, exports are marked as a credit inflow of money and imports are marked as a debit outflow of money.

Services can also be traded by countries. This happens frequently in the case of tourism. When a tourist from a local country visits a foreign country, the local country is consuming the foreign services and this is counted as an import. Likewise, when a foreign tourist comes and enjoys the services of a local country, this is counted as an export.

Other services can also be transferred between countries, such as when a financial adviser in one country assists clients in another. A credit of income happens when a domestic individual or company receives money from a foreign individual or company. This would typically take place when a domestic investor receives dividends from an investment made in a foreign country, or when a worker abroad sends remittances back to the local country.

Likewise, a debit in the income account takes place when a foreign entity receives money from an investment in the local economy. Finally, a credit in the cash transfers column would be a gift of aid from a foreign country to the domestic country.

Similarly, a debit in the cash transfers column might be the provision of official assistance by the local economy to a foreign economy. When the sum of these four components is positive, the current account has a surplus. Global Current Accounts : The map shows the per capita current accounts surpluses and deficits of countries around the world from to Deeper red implies a higher per capita deficit, while deeper green implies a higher per capita surplus.

The financial account also known as the capital account under some balance of payments systems measures the net change in ownership of national assets. When financial account has a positive balance, we say that there is a financial account surplus. Likewise, we say that there is a financial account deficit when the financial account has a negative balance.

This occurs when domestic buyers are purchasing more foreign assets than foreign buyers are purchasing of domestic assets. The financial account has four components: foreign direct investment, portfolio investment, other investment, and reserve account flows.

Foreign direct investment FDI refers to long term capital investment such as the purchase or construction of machinery, buildings, or even whole manufacturing plants. If foreigners are investing in a country, that is an inbound flow and counts as a surplus item on the financial account. After the initial investment, any yearly profits not re-invested will flow in the opposite direction, but will be recorded in the current account rather than the financial account.

FDI in Austria : Austria has experienced a surplus of foreign direct investment: more foreign investors invest in Austria than Austrian investors do in the rest of the world.

This contributes to a financial account surplus. Portfolio investment refers to the purchase of shares and bonds. As with FDI, the income derived from these assets is recorded in the current account; the financial account entry will just be for any buying or selling of the portfolio assets in the international financial markets.

Mutual fund flows track the net cash additions or withdrawals from broad classes of funds. Capital-spending budgets are examined at the corporate level to monitor growth plans, while federal budgets follow government spending plans. The relative strength or weakness of capital markets can be shown through analyzing such capital flows, especially in contained environments like the stock market or the federal budget. Investors also look at the growth rate of certain capital flows, such as venture capital and capital spending, to find any trends that might indicate future investment opportunities or risks.

As part of standard business operations, companies may look to purchase commercial real estate to house production activities. Additionally, many individuals see the purchase of real estate as an investment that produces rental income.

These may classified as investment or business capital flows depending on the analysis. In emerging economies, capital flows can be particularly volatile as the economy may experience periods of rapid growth followed by subsequent contraction. Increased capital inflows can lead to credit booms and the inflation of asset prices, which may be offset by losses due to depreciation of the currency based on exchange rates and declines in equity pricing. Emerging economies also are quite sensitive to flows of foreign direct investment FDI , which takes place when an investor, corporation, or foreign government invests directly in, or establishes foreign business operations or acquires foreign business assets abroad.

Often, FDI is a large source of capital flows to a country and greatly supports the economy. In India, for instance, periods of fluctuation have been noted beginning in the s.

Capital flows during the earlier period, from the s into the early s, was marked by steady growth, transitioning to a rapid influx of funds between the early s and This rapid growth eventually shifted, partially due to the implications of the financial crisis in , leading to a high level of volatility regarding capital flows. One of the biggest investing trends of the past several years involves the massive amounts of capital flow from active management into passive strategies such as exchange-traded funds ETFs.

The path of capital flows also moved to other asset classes. Investing Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.