INTRODUCTION

International Capital Movements have played an important role in the economic

development of several countries. They provide an outlet for savings for the
lending countries which help to smooth out business cycles and lead to a more
stable pattern of economic growth. On the other hand, they help to finance
development of under- developed countries. They also help to ease the balance
of payments problems of developing economies. Thus, international capital
movement have an important role to play in the balance of payments adjustment
mechanism.

As compared to developed countries of the world, the developing countries

suffer from scarcity of capital and poor technology. Therefore, they rely in

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international capital flows to finance their investment opportunities and hence,
to raise income and employment.

The term international capital movement refers to borrowing and lending

between countries. These capital movements are recorded in the capital account
of the balance of payments.

One of the most important developments in the world economy in the 1990s has
been the spectacular surge in international capital flows. These flows have
emanated from a greater financial liberalisation, improvement in information
technology, emergence and proliferation of institutional investors such as
mutual and pension funds, and spectra of financial innovations.

With the increase in capital flows and participation of foreign investors and
institutions in the financial markets of developing countries, the capital account
has been the focus of attention since the late 1980s and especially so in the
1990s. The expansion of capital flows has been much larger than that of
international trade flows. The process has been reinforced by the on-going
abolition of impediments and capital controls and the widespread liberalisation
of financial markets in the developing countries during the 1990s.

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SOURCES

Capital movement can be classified by instrument into debt or equity and by

maturity into short-term and long-terms.

Capital movement can be divided in to short-term and long-terms flows.

Depending upon the nature of credit instruments involved.

A capital movement is short-term if it is embodied in a credit instruments of

less than a years maturity. If the instruments has duration of more than a year
or consist of the title to ownership, such as the share of stock or a deed to
property, the capital movement is long-term.

Short-Term Capital Movement

They can take place through changes in claims of domestics residents on
foreign residents or in liabilities of domestics residents owed to foreign
residents. Short-term capital instruments are demand deposits, bills, overdraft,
commercial and financial papers and acceptances, loan and commercial banks
credits, and items in the process of collection. They are mostly speculative in
nature. Short-terms capital movements may take the form of hot money
movements which refers to capital movements to take advantages of
international difference in interest rate.

Long-Term Capital Movement

They are generally for long-term investments. They may be further classified in
to direct investment, portfolio investment and assistance from governments and
institutions.

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FOREIGN DIRECT INVESTMENT

Foreign direct investment (FDI) is a direct investment into production or

business in a country by an individual or 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.

Defination
Broadly, foreign direct investment includes "mergers and acquisitions, building
new facilities, reinvesting profits earned from overseas operations and intra
company loans". In a narrow sense, foreign direct investment refers just to
building new facilities. The numerical FDI figures based on varied definitions
are not easily comparable.

As a part of the national accounts of a country, and in regard to the GDP

equation;
Y=C+I+G+(X-M)
[Consumption + Domestic investment + Government spending + (exports -
imports]
I is investment plus foreign investment, FDI is defined as the net inflows of
investment (inflow minus outflow) to acquire a lasting management interest (10
percent or more of voting stock) in an enterprise operating in an economy other
than that of the investor. FDI is the sum of equity capital, other long-term
capital, and short-term capital as shown the balance of payments. FDI usually
involves participation in management, joint-venture, transfer of technology and
expertise. There are two types of FDI: inward and outward, resulting in a net
FDI inflow (positive or negative) and "stock of foreign direct investment",

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which is the cumulative number for a given period. Direct investment excludes
investment through purchase of shares. FDI is one example of international
factor movements.

Types of FDI
Horizontal FDI arises when a firm duplicates its home country-based
activities at the same value chain stage in a host country through FDI.
Platform FDI is FDI from a source country into a destination country for
the purpose of exporting to a third country.
Vertical FDI takes place when a firm through FDI moves upstream or
downstream in different value chains i.e., 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.

Forms of FDI
low corporate tax and individual income tax rates
tax holidays
other types of tax concessions

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 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 & expatriation
infrastructure subsidies
R&D support
derogation from regulations (usually for very large projects)

Barriers To FDI
The rapid growth of world population since 1950 has occurred mostly in
developing countries. This growth has been matched by more rapid increases in
gross domestic product, and thus income per capita has increased in most
countries around the world since 1950. While the quality of the data from 1950
may be of question, taking the average across a range of estimates confirms this.
Only war-torn and countries with other serious external problems, such as Haiti,
Somalia, and Niger have not registered substantial increases in GDP per capita.
The data available to confirm this are freely available.

An increase in FDI may be associated with improved economic growth due to

the influx of capital and increased tax revenues for the host country. Host
countries often try to channel FDI investment into new infrastructure and other
projects to boost development. Greater competition from new companies can
lead to productivity gains and greater efficiency in the host country and it has

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been suggested that the application of a foreign entitys policies to a domestic
subsidiary may improve corporate governance standards. Furthermore, foreign
investment can result in the transfer of soft skills through training and job
creation, the availability of more advanced technology for the domestic market
and access to research and development resources. The local population may be
able to benefit from the employment opportunities created by new businesses.

Developing World
A 2010 meta-analysis of the effects of foreign direct investment on local firms
in developing and transition countries suggests that foreign investment robustly
increases local productivity growth. The Commitment to Development Index
ranks the "development-friendliness" of rich country investment policies.

CHINA
FDI in China, also known as RFDI (renminbi foreign direct investment), has
increased considerably in the last decade, reaching $59.1 billion in the first six
months of 2012, making China the largest recipient of foreign direct investment
and topping the United States which had $57.4 billion of FDI.

During the global financial crisis FDI fell by over one-third in 2009 but
rebounded in 2010.

INDIA
Foreign investment was introduced in 1991 under Foreign Exchange
Management Act (FEMA), driven by then finance minister Manmohan Singh.
As Singh subsequently became the prime minister, this has been one of his top
political problems, even in the current times. India disallowed overseas
corporate bodies (OCB) to invest in India. India imposes cap on equity holding

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by foreign investors in various sectors, current FDI limit in aviation sector is
maximum 49%.

Starting from a baseline of less than $1 billion in 1990, a 2012 UNCTAD survey
projected India as the second most important FDI destination (after China) for
transnational corporations during 20102012. As per the data, the sectors that
attracted higher inflows were services, telecommunication, construction
activities and computer software and hardware. Mauritius, Singapore, US and
UK were among the leading sources of FDI. Based on UNCTAD data FDI
flows were $10.4 billion, a drop of 43% from the first half of the last year.

UNITED STATES
Broadly speaking, the U.S. has a fundamentally 'open economy' and low
barriers to foreign direct investment. U.S. FDI totalled $194 billion in 2010.
84% of FDI in the U.S. in 2010 came from or through eight countries:
Switzerland, the United Kingdom, Japan, France, Germany, Luxembourg, the
Netherlands, and Canada. A 2008 study by the Federal Reserve Bank of San
Francisco indicated that foreigners hold greater shares of their investment
portfolios in the United States if their own countries have less developed
financial markets, an effect whose magnitude decreases with income per capita.
Countries with fewer capital controls and greater trade with the United States
also invest more in U.S. equity and bond markets.

White House data reported in July 1991 found that a total of 5.7 million workers
were employed at facilities highly dependent on foreign direct investors. Thus,
about 13% of the American manufacturing workforce depended on such
investments. The average pay of said jobs was found as around $70,000 per
worker, over 30% higher than the average pay across the entire U.S. workforce.

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President Barack Obama said in 2012, "In a global economy, the United States
faces increasing competition for the jobs and industries of the future. Taking
steps to ensure that we remain the destination of choice for investors around the
world will help us win that competition and bring prosperity to our people."

In September 2013, the United States House of Representatives voted to pass

the Global Investment in American Jobs Act of 2013 (H.R. 2052; 113th
Congress), a bill would which direct the United States Department of
Commerce to "conduct a review of the global competitiveness of the United
States in attracting foreign direct investment." Supporters of the bill argued that
increased foreign direct investment would help job creation in the United States.

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PORTFOLIO INVESTMENT

A portfolio investment is a passive investment in securities, none which entails

in active management or control of the securities' issued by the investor.
Portfolio investment is an investment made by an investor who is not
particularly interested in involvement in the management of a company.

It is also the investment in securities that is intended for financial gain only and
does not create a controlling interest in or effective management control over an
enterprise.

It includes investment in an assortment or range of securities, or other types of

investment vehicles, to spread the risk of possible loss due to below
expectations performance of one or a few of them.

Portfolio investment is a mode of investment in the securities and bond of a

company which helps the company to bring up more sources of finance and to
strengthen its financial adequacy. it enables to improve the creditworthiness of
the company in the mind of the general public and they are being prompted to
invest more and earn in accordance with it.

Defination
The term portfolio refers to any collection of financial assets such as stocks,
bonds, and cash. Portfolios may be held by individual investors and/or managed
by financial professionals, hedge funds, banks and other financial institutions. It
is a generally accepted principle that a portfolio is designed according to the
investor's risk tolerance, time frame and investment objectives.

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The monetary value of each asset may influence the risk/reward ratio of the
portfolio and is referred to as the asset allocation of the portfolio. When
determining a proper asset allocation one aims at maximizing the expected
return and minimizing the risk. This is an example of a multi-objective
optimization problem: more "efficient solutions" are available and the preferred
solution must be selected by considering a trade-off between risk and return. In
particular, a portfolio A is dominated by another portfolio A' if A' has a greater
expected gain and a lesser risk than A. If no portfolio dominates A, A is a
Pareto-optimal portfolio. The set of Pareto-optimal returns and risks is called
the Pareto Efficient Frontier for the Markowitz Portfolio selection problem.

Description
There are many types of portfolios including the Market portfolio and the Zero-
Investment Portfolio. A portfolio's asset allocation may be managed utilizing
any of the following investment approaches and principles: equally-weighting,
capitalization-weighting, price-weighting, Risk parity, Capital asset pricing
model, Arbitrage pricing theory, Jensen Index, Treynor Index, Sharpe Diagonal
(or Index) model, Value at risk model, Modern Portfolio Theory and others.

There are several methods for calculating portfolio returns and performance.
One traditional method is using quarterly or monthly money-weighted returns,
however the true time-weighted method is a method preferred by many
investors in financial markets. There are also several models for measuring the
Performance Attribution of a portfolio's returns when compared to an Index or
Benchmark, partly viewed as investment strategy.

Investopedia explains 'Portfolio Investment'

A portfolio investment may be in the form of stocks or corporate bonds. This
type of investment can be contrasted with direct investments, in which an

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individual actually participates in the business' operation at a high level. It can
also be contrasted with a major purchase of the company's shares for the
purpose of a takeover.

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OFFICIAL FLOWS

They are shown as external assistance, i.e. grants and loans from bilateral and
multilateral flows. Long-term capital movements can also take the form of
government loan grants and loans from international financial institutions like
IBRD, IDA, etc. Sometimes government of advanced countries may give loans
to financial project in a developing country. These are known as bilateral loans.
International financial institution like World Bank, Asian developing bank, etc.
Also give financial assistance to developing countries. These loans are called
multilateral loans. Thus, governments and international institutions play an
important role in international capital movement.

Foreign Aid
A part of the foreign capital is received on concessional term and it is known as
external assistance and foreign aids. It may be received by way of loans and
grants. Grants are in a form of outright gift which do not have to be repaid.
Loans qualify as aid only to the extent that they bear a concessional rate of
interest and have longer maturity period than commercial loans. Foreign aids
have mostly been given by foreign governments and international financial
institutions like IMF, WORLD BANK, ASIAN DEVELOPMENT BANK and
so on.

Official flows were about 75-80 percent of capital flow till 1991. By 1994, this
has come down to about 20 percent and has further fallen to below 5 percent by
late 1990s.

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EXTERNAL COMMERCIAL BORROWING

An external commercial borrowing (ECB) is an instrument used in India to

facilitate the access to foreign money by Indian corporations and PSUs (public
sector undertakings). ECBs include commercial loans, buyers' credit, and
suppliers' credit, securitised instruments such as floating rate notes and fixed
rate bonds etc., credit from official export credit agencies and commercial
borrowings from the private sector window of multilateral financial Institutions
such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc.
ECBs cannot be used for investment in stock market or speculation in real
estate. The DEA (Department of Economic Affairs), Ministry of Finance,
Government of India along with Reserve Bank of India, monitors and regulates
ECB guidelines and policies. For infrastructure and Greenfield projects, funding
up to 50% (through ECB) is allowed. In telecom sector too, up to 50% funding
through ECBs is allowed. Recently Government of India has increased limits on
RBI to up to $40 billion and allowed borrowings in Chinese currency Yuan.

Borrowers can use 25 per cent of the ECB to repay rupee debt and the
remaining 75 per cent should be used for new projects. A borrower cannot
refinance its existing rupee loan through ECB. The money raised through ECB
is cheaper given near-zero interest rates in the US and Europe, Indian
companies can repay their existing expensive loans from that.

The ministry has not put any ceiling on individual companies for using
Renminbi as currency for ECB. Even though the overall limit for permitting it
under ECB is only $1 billion, the officials denied possibilities of a single
company using the entire amount as it would come under approval route.

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The cost of borrowing in Renminbi is far less, said a finance ministry official.
Companies go for it as it is on easier terms. We are getting their (Chinas)
money cheap.

The limit for automatic approval has also been increased from $100 million to
$200 million for the services sector (hospitals, tourism) and from $5 million to
$10 million for non-government organisations and microfinance institutions.
The decisions will come into effect through a notification by RBI.

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DETERMINANTS OF INTERNATIONAL CAPITAL FLOWS

The pace, magnitude, direction and composition of international capital flows

have crucial implication for the recipient countries. The surge in private capital
inflows to developing economies in the 1990s coincided with the period of low
international interest rate in the advanced economies and domestic policy
reform in the developing world. The literature on determinants of cross-
countries capital flow has identified various factors which, inter alia, include the
overall macroeconomic scenario, political risk perception, regulatory regimes,
fiscal concessions and business strategy of the entity from which the capital
flow originates. The literature usually distinguishes between two broad sets of
factors affecting capital movements.

Country-Specific Pull Factors

They reflect domestic opportunity and risk. The evidence on this issue
highlights that PULL OR DOMESTIC FACTORS operating at project and
country levels, reflects essentially the improved policies that increase the long
run expected returns or reduced the perceived risk on real domestic investments.
These includes measures that increase the openness of the domestic financial
market to foreign investors; liberalisation of FDI; credible structural or
macroeconomic policies; sustainable debt and debt service reduced ensuring
timely repayments; stabilisations policies that affect the aggregate efficiency of
resource allocation; policies that affect the level of domestics absorption relative
to income; and the ability of the economy to absorb shocks from changes in
international terms of trade. Pull factors like rebuts economic reforms in
emerging economies are internal to an economy.

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Global Push Factors
They are stimulus provided by the decline of US interest rate that has taken
place in recent years. FDI may be attracted by the opportunity to use local raw
material or employ a local labour force that are relatively cheap. The PUSH OR
EXOGENOUS FACTORS includes lower foreign interest rates, recession
abroad and herd mentality in international capital markets. Push factors are
external to an economy and include parameters like low interest rates abundant
liquidity, slow growth, or lack of investment opportunities in advanced
economies.

Push and Pull factors explains international capital flows. The Pull factors
determine the geographic distribution of the flows amongst the recipient
economies.

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DETERMINANTS OF INTERNATIONAL CAPITAL
MOVEMENTS

Rate of Interest
An important factor which has a bearing on the international capital movements
is differences in the rate of interest. According to L.M.Bhole, Like population
migration, capital migration can be and has been explained in terms of the
PULL and PUSH factors. As far as the recent increase in capital flows is
concerned, greater weight has to be given to the push factors, particularly the
falling interest rates in the US and some other countries.

Integration of Financial and Other Markets

The various forms of foreign capital movements depend upon the degree of
openness of the financial and other markets and the extent of their international
integration. In the recent years most of the countries have adopted the policy of
deregulation, liberalisation, privatisation and structural adjustments. They have
also dismantled various control related to trade, foreign exchange, foreign
investment, ownership and capital flows. All these changes have contributed to
recent increase in capital flows.

Rapid improvements in technologies for collecting, processing, and

disseminating information, along with the opening of domestic financial
markets, the liberalisation of capital account transactions, and increased private
savings for retirements have stimulated financial innovation and created a larger
pool of internationally mobile capital. At the same time, consolidation in the
global banking industry and competition from non-bank financial institution
[including mutual funds] have lured new players to the international financial
area. These trends accelerated in the 1990s, expanding investments

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opportunities for saver and offering borrowers a wide array of sources of
capital. The same trends are expected to continue into the 21st century.

Growing Pool International Financial Capital

Over the last two decades, the financial markets of leading industrial countries
have transformed into a global financial system, permitting larger amounts of
capital to be allocated not only to theirs economies, but also to developing
economies. Firm in developing and industrial countries alike are raising more
funds from international securities markets. Multinational corporations are
registering their equity on more than one countrys stock exchange and raising
funds from financial markets in different economies. Mutual funds, hedge
funds, pension funds, insurance companies and other investments and asset
managers now compete with banks for national savings. Even though this
phenomenon has been confined so far primarily to developed economies, it has
started to spread to some developing countries too. Institutional investors have
taken advantages of the easing of restrictions in many developed countries to
diversify their portfolios internationally, enlarging the pool of financial capital
potentially available to developing economies. According to world development
report of 1999-2000, in 1995 these investors controlled 20trillion dollars, 1980
of which only 2 percent was invested abroad. Thus, there was a tenfold increase
in the funds and a fortyfold increase investments abroad.

Liberalisation of Capital Account Transactions and move towards Flexible

Exchange Rate Regime
The 1990s have seen a consistent trend toward more flexible exchange rate
regimes and the liberalisation of capital account transactions. The latter involves
changes in policies toward different types of private capital flows, such as
foreign direct investments, foreign bond and equity investments, and short term
borrowing from abroad. Most countries have moved towards capital account

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convertibility as part of wide-ranging gradual economic reform program that
includes measuring to strengthen the financial sector.

Stability
Relative stability of economics factors especially rates of inflation, external
value of different currencies, etc. Also determine foreign capital flows. Along
with economic stability, political stability is an important factors which
determines international capital movements.

Government Policies
Policies of governments with respect to privatisation, foreign investment,
foreign exchange, liberalisation, taxation, etc. Are like to influence the capital
inflows. If the governments adopt a policy of liberalisation, deregulation and
dismantling of control related to investments as being undertaken in India since
1991 it will encourage foreign capital inflows to the countries.

Social and Economic Overheads

Infrastructural facilities, availability of skilled labour, advances in computer and
telecommunication technologies, etc. will influence private capital investment
into the country. Labour policies will also have a bearing on the foreign
investments. The market potential, i.e. the ability of the market to absorb the
whole range of new products, is also likely to influence the inflow of foreign
capital.

Credit Rating
The credit rating and credit standing of nation, which depend on economic,
political and social stability, also influence foreign capital flows.

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Speculation
Short-term capital movement may be influenced by speculation relating to
expected changes in interest rates or rate of return or foreign exchange rates.

Profitability
Foreign capital movement are also influenced by profitability considerations of
investments.

It is noteworthy that an overwhelming proportion of international capital flows

towards developing countries is directed towards middle-income countries.
Notwithstanding fluctuation over the year, this concentration has increased,
especially with regard to FDI and portfolio flows. In particular, share of East
Asia and Pacific region in portfolio investment has increased. Inflow of debt-
creating capital toward developing countries declined sharply in the wake of the
East Asian crisis.

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ROLE OF FOREIGN CAPITAL

Foreign Capital had played an important role in the early stages of

industrialisation of most of the advanced countries of today like countries of
Europe and North America. There is a general view that foreign capital, if
property diverted and utilised, can assist economic development of developing
countries. These countries need resources to finance investment in health,
education, infrastructure and so on. It can supplement a countrys domestic
saving effort and foreign exchange earnings.

A number of studies have confirmed that international capital flows can

contribute significantly to promote growth in developing countries by
augmenting domestic savings, reducing cost of capital, transferring technology,
developing domestic financial sector and fostering human capital formation.

Foreign capital can contribute to economic development of developing

countries in following ways:

Supplements Domestic Capital Formation

Economic development depends on, among other things, capital formation. The
domestic capital formation is inadequate in LDCs. The foreign capital can
supplements the domestic resources to achieve the critical minimum investment
to break the vicious circle of low income-low saving-low investment. If more
domestic capital is to be created by countrys own efforts, resources will have to
be diverted from the production of goods requirements for current consumption.
This may lead to a cut in present living standards. Thus, foreign capital can help
to supplement the domestic capital.

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Accelerates Economic Development
Foreign capital helps to accelerate the pace of economies development by
facilitating imports of capital goods, technical know-how and other imports
which are required for carrying out development programmes.

Improve Trade Balance

Foreign capital inflow may help to increase a countrys exports and reduced the
imports requirements if such capital flows into export oriented and import
competing industries.

Transfer of Technology
The foreign capital may facilitate transfer of technology to LDCs. It may help to
modernise the production techniques in industry, agriculture and other sector.

Realisation of External Economies

If the foreign capital is allowed to flow into the development of infrastructure it
may lead to realisation of external economies which may stimulate domestic
investments in the country.

Income and Employment

If foreign capital flow into real sectors in the form of direct investments it helps
to increase productivity, income and employment in the economy.

Balance of Payments Adjustment

Inflow of foreign capital, especially the short-term, may be able to provide a
breathing space to a deficit country to cover the deficit until a complete
adjustment is achieved to correct the balance of payments deficit. However,
such capital movement should be seen as a temporary phenomenon.

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IMPACT OF FOREIGN CAPITAL

Economic Growth
Capital flow and economic growth are positively related to each other. High
surge of capital flow influences the domestic saving, investments and
productivity of the country. Impacts of international capital flows on economic
growth during post liberalisation into India are very significant. It is argued that
capital inflow influences growth and growth influences capital flows.
International capital flows make a direct contribution to economic growth. The
potential benefits from the flows are realized from improving productivity.
Globalisation allows capital to move to attractive destination and it can fuel
higher growth.

Affect a Range of Economic Variables

Capital flow affects the range of economic variable such as exchange rate,
interest rate, foreign exchange reserve, domestic monetary condition and
financial system in the country. Capital inflow induces real exchange rate
appreciation, stock markets and real estate boom, and monitory expansion.
Appreciation of exchange rate can lead to loss of competitiveness. Inflow of
foreign capital has a significant impact on domestic money supply and stock
market growth, liquidity and volatility.

Inflation
Larger capital flows can spark off inflation due to its impact of monetary
expansion.

Trigger Bubbles
Capital inflow may trigger bubbles in asset market and stock market.

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Volatility
Portfolios flows are likely to render the financial market more volatile through
increase linkage between the domestic and foreign financial markets. Capital
flows expose the potential vulnerability of the economy to sudden withdrawals
of foreign investor from the financial market, which will affect liquidity and
contribute to financial market volatility.

Balance of Payments
Foreign direct investment inflows tend to worsen the current account in the
short run. The long-term effects on the balance of payments depends, among
other things, on the operating characteristics of FDI enterprises, notably their
export propensity, the extent to which they rely on imports inputs, including
technology imports, and on the volume of profit-repatriation. Of course, there
are indirect effects too. Multinationals can conceivably increase the export
propensity of domestic firms through spill over effects. Further, if domestic
production by multinational substitutes for previously imported goods, FDI can
reduce the total import bill.

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DRAWBACKS OF FOREIGN CAPITAL

Foreign capital may give rise to serious problems in the recent countries. It has
been recognised that sudden and large surges in capital flows cause several
problems. Large capital flows could push up monetary aggregates, engender
inflationary pressures, destabilise exchange rates, exacerbate the current account
position, adversely affect the domestic financial sector and disrupt domestic
growth trajectories if and when such flow get reversed or drastically reduced.
Some of the drawbacks associated with international capital flows are discussed
below.

Inefficient allocation of Resource and Production Distortion

Foreign capital has a tendency to flow to high profit areas rather than the
priority areas. The international capital inflows may be devoted to consumption
which has a low social value or may be invested in project that generates low
social returns. Thus, the use of foreign capital may involve inefficient allocation
of resources and may create distortion in production structure. Therefore, it may
not help to increase productivity, output and employment.

Destabilise the Economies

Since the international capital flows are generally unstable, uncertain,
unsustainable and quickly reversible they have a tendency to destabilise the
economies of recipient countries. The volume, timing and composition of
capital flow are uncertain. Changes in internal factors such as loss of credit
worthiness, etc. May tend to stop the inflows or even lead to outflows. The
inflow may tend to increase the money supply and lead to domestic inflation.
When the capital inflows are reversed there may be rise in interest rates, fall in
liquidity, depreciation of currency, etc. All of this may leads to serious balance
of payments crisis.

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Highly Volatile in Nature
International capital flows are inherently unsustainable, volatile and unstable in
nature. They are subject to external shocks and internal policies. This increase
instability in the recipient countries.

Reduces the Effectiveness of Monetary Policy

International capital flows reduced the effectiveness of monetary policy. The
pressures against the exchange rate can quickly become very large and the
central banks may be faced with the possibility of a run on their currencies. The
central banks may not be effective to prevent it.

High Cost of Foreign Capital

Foreign currency borrowing may imply a lot of uncertainties due to floating
interest rates. There are many non-economics cost associated with foreign
capital such as problems related to foreign ownership and control, dumping of
out-dated technology, loss of autonomy of domestic policies dependence, and so
on. Foreign equity capital also gives rise to drain of resources in the form of
dividends and so on. Foreign borrowing give rise to the problem of debt trap.

Inappropriate Technology
The technologies brought in by the foreign capital may not be adaptable to the
consumption needs, size of domestic market, availability of resources and stage
of economic development in the country and so on.
Hence, it becomes a clear from above analysis that undue dependence on
foreign capital of whatever type [i.e. equity, debt, short-term and long-term
capital] is bound to create large number of harmful consequences in the
recipient countries.

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FOREIGN CAPITAL FLOWS TO DEVELOPING AND
EMERGING ECONOMIES

Gross capital flows at global level have increased substantially since the late
1980s. Net capital flows to developing countries increased sharply during early
1990s and reached a peak at us 298 billion dollar in 1997. Under recent global
crisis it has experienced a sharp decline.

The Trends in the Past

In the past World War 2 period upto the 1970s, international capital flows were
primarily confined among industrial economics. Net capital inflows towards
developing countries started picking up in the early 1970s. In the aftermath of
the 1st oil price shock. Such flows were mainly debt flows in the forms of
syndicated banks leading. This phase continued unabated until the early
countries increase significantly- at a compound annual rate of 24 percent until
the Latin American debt crisis of 1982 Hurst the bubble. These led to a
considerable slowdown in capital flow particularly in respects of commercial
bank leading to developing countries. Between 1983 and 1989, capital flows
decline to less than a third of their level in 1977-82.

With resending commercial bank lending, foreign direct investment inflows to

developing countries started picking up in the early 1980s. The quantum of FDI,
however, continued to remain lower that debt flow. By the end of the 1980s,
direct investment inflows to developing countries were only one-eighth of the
flow to developed countries, while portfolio flows to developing countries were
virtually non-existent. Net FDI inflows toward developing countries, however,
increased at a sustained and high pace between 1987 and 1997. In 1994, these
flows surpassed net debt flow for the 1st time. Net external debt flow as well as

28
inflows in the form of portfolio capital also gathered momentum in the early
1990s.

Change in the Structure

The pattern of foreign capital flows into developing countries and economies in
transition has changed in the 1990s unlike most of the 1980s, when foreign
capital follow to developing countries and economies were strongly depressed
because of the external debt crisis. The 1st half of the 1990s had been
characterised by more than a doubling of the inflow of external capital into
developing economies. It has increased from us 86.6 billion dollar in 1990 to us
277.3 billion dollar in 1995 and thereafter it has fallen to us 159.6 billion dollar
in 2002. The increase in net total foreign capital inflow has-been accompanies
by substantial changes in their structure. The most striking structural change is
that virtually all the net increased in financial flow has come from private flow.

Flows to Emerging Markets

Among the developing country some are termed as Emerging Market
Economies. They are those developing countries which carry distinct features
and are more developed than the rest. Such economies are featured as
showcases for high economic performance and quickly labelled [by the late
1980s] as emerging market economies [EMEs]. The world market in the above
label was given emphasis for the preference of the identified countries to be
market oriented in their policy pursuit.

The composition of flow in respect of emerging markets economies also altered

significantly, with private flow exceeding official flows by the end of the 1980s.
Furthermore, while bank lending was the major components of capital flows to
emerging markets in the 1970s. Equity and bond investors become dominant in
starting in the early 1990s. Portfolio investment exceeded bank lending in eight

29
years of the last decades. The range of investors purchasing emerging market
securities broadened. Specialised investors such as hedge funds and mutual
funds accounted for a bulk of portfolio inflow up to mid-1990s. In the
subsequent years, pension funds, insurance companies and other institutional
investors increased their presence in emerging markets. Although portfolio flow
became important, it was FDI which accounted for the bulk of private capital
flows to emerging markets economies witness a six-fold jump between 1990
and 1997. International bank lending to developing countries also increased
sharply during this period, and was most pronounced in Asia, followed by
Eastern Europe and Latin America. Much of the increasing in bank lending was
in the form of short-terms claims, particularly on Asia.

Volatility of Capital Flows

The volatility and possibility of reversal associated with capital flow were
brought out quite strikingly by the East Asian and the subsequent financial
crisis. In the late 1990s, capital flows to developing countries received several
shocks first from the Asian crisis of 1997-98, then by the turmoil in global
fixed income markets, more recently by the collapse of the argentine currency
board peg in 2001 and spate of corporate failures and accounting irregularities
in the US in 2002. Net flow to developing countries decline in the immediate
aftermath of East Asian finance crisis. The fall was particularly sharp in the
form of bank lending and bonds, reflecting uncertainty and risk aversion. On the
other hand FDI inflows to EMEs were relatively stable over the period 1997-
2002. This highlights the stabilising feature of FDI inflows vis-a-vis other
private capital flows [both debts and equity].

In 2000, there was, in fact, a net out flows from developing countries on
account of debt flows. In 2002, net capital flows fell again, remaining far below
the 1997 peak due to the global economic slowdown and a series of accounting

30
and corporate failure which severely undermined investors confidence. Global
FDI inflows into developing countries fell by 41percent in 2001, followed by
the decline of another 20percent in 2002. This was attributable to weak
economic growth, large sell-offs in equity markets, lower corporate profits,
slowdown in corporate restructuring and a plunge in cross-border mergers and
acquisitions. The USA and the UK accounted more than half of the decline.

Flowing to Small Group of Developing Countries

A small group of developing countries has consistently attracted most foreign
investment. Brazil, Indonesia, Malaysia, Mexico and Thailand have been among
the top 12 recipients in each of the past three decades. China [including Hong
Kong] joined this group in 1990 and India in the late 1990s.

Recent Trends in Capital Flows to Emerging Markets

During the financial crisis, capital flows to emerging markets plummeted as
investors fled riskier markets for us and European safe heavens. As emerging
market have recovered, many of them faster than advanced economies,
investors are moving capital back to developing economies. However, flow
remaining significantly depressed relative to 2007. Asia and Latin America have
benefit from stabilizing market and recovering portfolio inflows.

According to institute of international finance [IIF] forecasts net private flow to

emerging Asia to rise 191 billion dollar in 2009 and 273 billion dollar in 2010,
from 171 billion dollar in 2008 and 422 billion dollar in 2007. The main
turnaround has occurred in investment in equities, from sizable net outflows in
2008 [57 billion dollar] to net inflows in 2009 [51 billion dollar].

Net private inflows in emerging Latin American markets will be about 100
billion dollar in 2009, with five countries Brazil, China, Colombia, Mexico

31
and Peru accounting for 92 percent of the net inflow.Net private flows to this
region were 132 billion dollar in 2008 and 228 billion dollar in 2007. The net
private capital flow to emerging market and developing countries were 700
billion dollar in 2007, came down to 259.5 billion dollar in 2008 and rose 521
billion dollar in 2011. The net private direct investment was 440billion in 2007,
rose to 479.6billion dollar in 2008 and fell to 418 in 2011.

Financial condition in emerging markets began to tighten during the 2011.

Funding condition worsened for banks, contributing to a tightening of lending
standards, and capital inflows diminished, however this flows are now returning
with new vigour, and risk spreads have come down again.

Emerging Market and Developing Countries Capital Flows

US $ billion

Average 2001-03 2007 2008 2011

Private capital flows
Net 110.1 700.1 259.5 521
Private Direct
Investment - Net 155.6 440.2 479.6 418.3
Private Portfolio
Flows - Net -32.1 105.9 -72.9 101.1
Other Private Capital
Flows Net -13.4 154.1 -147.1 1.6

Official Flows Net -10.1 -92.6 -97.8 -109.8

Changes In Reserve -189 -1210.0 -724.9 -831.6

Source: IMF World Economic Outlook, April 2012

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CAPITAL FLOWS TO INDIA

Following liberalisation and structural adjustment since 1991, India had

embarked on a policy of encouraging capital flows in cautious manner. The
strategy has been to encourage long-term capital inflows and discourage short-
term and volatile flows. Broadly speaking, Indias approach towards external
capital flows could be divided into three main phases.

First Phase
In the first phase, starting at the time of independence and spanning up to the
early 1980s. Indias reliance of external flows was mainly restricted to
multilateral and bilateral concessional finance.

Second Phase
The second phase mainly refers to late 1980s. In the context of the widening of
the current account deficit during the 1980s, India supplemented the traditional
external sources of financing with resource to commercial loans including short-
term borrowing and deposits from non-resident Indians. As a result, the
proportion of short-term debt in Indias total external debt increased
significantly by the late 1980s.

Third Phase
The third phase refers to the period since 1991. Until the 1980s, Indias
development strategy was focused on self-reliance and import substitution.
There was a general disinclination towards foreign investment and private
commercial flows. Since the initiation of the reform process in the early 1990s,
however, Indias policy stance has changed substantially. India has encouraged
all major forms of capital flows. The broad approach to reform in the external
system after the Gulf crisis was delineated in the report of the high level

33
committee on balance of payments under the chairman ship C. Rangarajan. It
recommended, inter alia, a compositional shift in capital flows away from debt
to non-debt creating flows; strict regulation of external commercial borrowing,
especially short-term debt; discouraging volatile elements of flows from non-
residents Indians; gradual liberalisation of outflow; and disintermediation of
government in the flow of external assistance. In the 1990s, foreign investment
has accounted for the major part of capital inflows to the country. The broad
approach towards foreign direct investment has been through a dual route i.e.,
automatic and discretionary, with the ambit of the automatic route progressively
enlarged to many sectors, coupled with higher sector caps stipulated for such
investments. Portfolio investments are restricted to selected players, viz.,
Foreign Institutional Investors [FIIs].

Commercial Borrowings
The approach to external commercial borrowings has been one of prudence,
with self-imposed ceilings on approvals and a careful monitoring of the cost of
raising funds as well as their end use. External commercial borrowing are also
subject to a dual route; these can be accessed without any discretionary
approvals up to a limit, beyond which specific approval are needed from the
reserve bank/government. Short-term credits above us 20 billion dollar require
prior approval of the reserve bank. In respect of NRI deposits, some control
over inflows is exercised through specification of interest rate ceilings.

External Assistance
As regards external assistance, both bilateral and multilateral flows are
administered by the government of India and the significance of official flows
has decline over the years. Thus, in managing the external account, there is
limited reliance on external debt, especially short-term external debt. Non-debt
creating capital inflows in the form of FDI and portfolio investment through

34
FIIs, on the other hand, are encouraged. India has adopted a cautious policy
stance with regard to short term flows. Especially in respect of the debt-creating
flows.

Capital Outflows
In respect of capital outflows, the approach has been to facilitate direct overseas
investment through joint venture and wholly owned subsidiaries and provision
of financial support to promote export, especially projects exports from India.
Resident corporate and registered partnership firm have been allowed to invest
up to 100percent of their net worth in overseas joint venture or wholly owned
subsidiaries, without any separate monetary ceiling. Exporter and exchange
earners have also been given permission to maintain foreign currency account
and use them for permitted purpose which facilitates their overseas business
promotion and growth. Thus, over time, both inflows and outflows under capital
account have been gradually liberalised.

Capital Flow to India

Since the introduction of reforms in the early 1990s, India has witnessed a
significant in cross border capital flows. The net capital inflows have more than
doubled from an average of us 4billion dollar during the 1980s to an average of
about us 9billion dollar during 1993-2000. The proportion of non-debt flows in
total capital flows has increased from about 5 percent in the later half of the
1980s to about 43 percent in 1990s. Net capital flows rose from a level of us
25.0 billion dollar in 2005-06 to reach us 107.9 billion dollar in 2007-08. The
impressive growth in 2007-08 was due to:
A quantum jump in external commercial borrowing net;
A significant rise in foreign direct investment inflows with a simultaneous
rise in outward investment;
Large inflows in the form of non-resident Indians deposits;

35
 An initial fall in portfolio investment which was compensated by
recovery in the latter half of the years. Notwithstanding a significant
increase in overall capital inflows, particularly foreign investment during
the 1990s, these remain smaller than other countries of similar economic
size.

In 2009-10, the net capital inflow was us 1.6billion and rose to us 62billion in
2010-2011 mainly on account of trade credit and loans [ECBs and banking
capital]. The net non-debt flows i.e. the net foreign investment comprising FDI
and portfolio investment [ADRs/GDRs and FIIs] declined from us 50.4billion
dollar in 2009-10 to us 39.7 billion in 2010-11.

Inward FDI showed a declining trend while outward FDI showed an increasing
trend in 2010-11. Inward FDI declined from us 33.1 billion in 2009-10 to us
25.9 billion dollar in 2009-10. The net portfolio investments flows witnessed
marginal decline to us 30.3 billion dollar during 2010-11 as against us 32.4
billion dollar in 2009-10.

Other categories of capital flows, namely debt flows of ECBs, banking capital,
and short-term credit recorded significant increase in 2010-11.

36
 2007-08 2009-10 2010-11
Net capital inflows 106585 51634 61989
1. External assistance [ net ] 2114 2890 4941
22609 2000 12506
2. External commercial borrowing [ net ]
3. Short-term debt 15930 7558 10990
4. Banking capital [ net ] of which 11759 2083 4962
Non-resident deposits [ net ] 179 2922 3238
5. Foreign investment [ net ] of which 43326 50362 39652
FDI [ net ] 15893 17966 9360
Portfolio [ net ] 27433 32396 30293
6. Rupee debt service -122 -97 -68
7. Other flows [ net ] 10969 -13162 -10994

Effect of Policy Measure

Capital flows have witnessed sharp occasional swing in response to policy
measures. The policy measure include changes in reserve requirements for
financial entities, variation in the pace and sequencing of the reform measures
and revisions in conditions governing end-use of external funds. Co-ordination
and sterilisation of foreign inflows were also undertaken to prevent undue
pressure on the exchange rate. Measures have also been to maintain orderly
condition in the financial markets and to ensure that capital flows promote
efficiency without having an adverse impact on economy stability.

37
CONCLUSION

International Capital Movements have played an important role in the economic

development of several countries. They provide an outlet for savings for the
lending countries which help to smooth out business cycles and lead to a more
stable pattern of economic growth. It has an important role to play in the
balance of payments adjustment mechanism.

International Capital flows have emanated from a greater financial

liberalisation, improvement in information technology, emergence and
proliferation of institutional investors such as mutual and pension funds, and
spectra of financial innovations.

The expansion of capital flows has been much larger than that of international
trade flows. The process has been reinforced by the on-going abolition of
impediments and capital controls and the widespread liberalisation of financial
markets in the developing countries during the 1990s.

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BIBLIOGRAPHY

Websites
www.google.com
www.wikipedia.com
www.ask.com
www.alexa.com
www.biographies.com

Book
Economics of Global Trade and Finance by Johnson & Mascarenhas

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