Learn the Dynamics of Capital Flows to Reign the Financial Market

Learn the Dynamics of Capital Flows to Reign the Financial Market
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Chandana

Last updated November 2, 2016


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Definition of 'Capital Flows'

Capital flow is the movement of money for the purpose of investment, trade or business production. This occurs within corporations in the form of investment capital and capital spending on operations as well as research and development. On a larger scale, governments direct capital flows from tax receipts into programs and operations and through trade with other nations and currencies. Individual investors direct savings and investment capital into securities such as stocks, bonds and mutual funds.

Types and Magnitude of Capital Flows

FDI: Foreign Direct Investment (FDI) is a direct investment into production or business in a country by a company in another country, either by buying a company in the target country or by expanding operations of an existing business in that country. Foreign direct investment is in contrast to portfolio investment, which is a passive investment in the securities of another country such as stocks and bonds.

Types:

  1. Horizontal FDI arises when a firm duplicates its home-country-based activities at the same value chain stage in a host country through FDI.
  2. Platform FDI
  3. Vertical FDI takes place when a firm through FDI moves upstream or downstream in different value chains that is, when firms perform value-adding activities stage by stage in a vertical fashion in a host country.

Horizontal FDI decreases international trade as the product of them is usually aimed at host country; the two other types generally act as a stimulus for it.

Methods

The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:

  • by incorporating a wholly owned subsidiary or company anywhere
  • by acquiring shares in an associated enterprise
  • through a merger or an acquisition of an unrelated enterprise
  • participating in an equity joint venture with another investor or enterprise

Foreign direct investment incentives may take the following forms:

  • low corporate tax and individual income tax rates
  • tax holidays
  • other types of tax concessions
  • preferential tariffs
  • special economic zones
  • EPZ – Export Processing Zones
  • Bonded Warehouses
  • Maquiladoras
  • Investment Financial Subsidies
  • Soft Loan or Loan Guarantees
  • Free Land or Land Subsidies
  • Relocation and Expatriation
  • Infrastructure Subsidies
  • R&D Support
  • Derogation from Regulations (usually for very large projects)

Importance and Barriers of FDI

The rapid growth of world population since 1950 has occurred mostly in developing countries. This growth has not been matched by similar increases in per-capita income and access to the basics of modern life, such as education, health care, sanitary water and waste disposal.

Foreign Direct Investment and the Developing World

A meta-analysis of the effects of foreign direct investment on local firms in developing and transition countries, conducted in the year 2011, suggests that foreign investment robustly increases local productivity growth. The Commitment to Development Index ranks the "development-friendliness" of rich country investment policies.

Foreign Institutional Investor - FII

The term is used most commonly in India to refer to outside companies investing in the financial markets of India. International institutional investors must register with the Securities and Exchange Board of India to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies.
 
FDI vs FII

  1. FDI is an investment that a parent company makes in a foreign country. On the contrary, FII is an investment made by an investor in the markets of a foreign nation.
    2. FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily.
    3. Foreign Direct Investment targets a specific enterprise. The FII increasing capital availability in general.
    4. The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor.


Portfolio Flows
In the early 1990s, India opened up to portfolio inflows through “Foreign Institutional Investors” (FIIs). This policy framework was largely in place by the year 2000. Equity investment by foreign institutional investors involves the following constraints:

  • The aggregate foreign holding in a company is subject to a limit that can be set by the shareholders of the company. This limit is, in turn, subject to “sectorial limits”, which apply in certain sectors only.
  • A single foreign portfolio investor can never own more than 10% of a company. Foreign ownership in certain sectors (telecom, insurance and banking) is capped at various levels.

 
Sovereign Debt (Government Debt)
 
Government debt (also known as public debt and national debt) is the debt owed by a central government. (In the U.S. and other federal states, "government debt" may also refer to the debt of a state or provincial government, municipal or local government). By contrast, the annual "government deficit" refers to the difference between government receipts and spending in a single year, that is, the increase of debt over a particular year.

About the Author

Chandana is working as a Senior Content Writer in Simplilearn.com and handles variety of creative writing jobs. She has done M.A. in English Literature from Gauhati University. A PRINCE2 Foundation certified, she has a unique and refreshing style of writing which can engross the readers to devour each sentence of her write-ups.


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