What is Capital Inflow?

Published by Thomas Herold in Corporate Finance, Investments, Trading

'Capital Inflow' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Capital Inflow refers to money (in the form of investments) moving into a certain benefitting nation. The country which is the recipient of the inflow is best known as the host country. The source countries are the ones sending or investing the initial funds. Host nations often have a range of causes for attracting such capital inflows.

Direct foreign investment occurs when multinational corporations purchase literal tangible assets in the host country. This could come in the form of purchasing a local company outright or building a manufacturing plant locally. There could also be portfolio investment in the host nation’s financial securities. This might include bonds and stocks which may be bought by international banks, foreign residents, insurance companies, pension funds, hedge funds, or other cross-border groups.

A third way that this occurs is when host governments are forced to borrow money off of international governments or foreign banks in order to pay their deficit on the balance of payments. It also occurs when domestic corporations or citizens elect to borrow from foreign banks. Finally inter-company transfers can finance investment and consumption in this category of capital inflow.

A last form of capital inflow happens when the host country has higher interest rates than the source nations’ own corresponding rates. In this scenario, shorter term deposits will often flock to the banks’ and money market instruments of the host nation. This could be straight up investment or speculation that the host national exchange rate will increase and so lead to a capital gain. This is the opposite of capital outflows. Outflows occur as funds move out of the host nation into other competing countries for the same reasons detailed above.

There are many beneficial effects to a country which receives capital inflows. As money comes into the host country via a business or stock purchase on the nation’s stock market exchange, the recipient firm will deploy the funds either for startup purposes or to expand their existing business products and lines. This is really good for the companies which receive the funds. Such expansion of the companies in question then leads both job creation and employment growth in the host nation. Businesses will finally realize profits utilizing the original capital investment and the projects they subsequently fund with it. With these profits, the company is able to pay for additional expansion or investment in other projects and/or financial investments.

In the last few decades, foreigners have invested literally hundreds of billions worth of foreign capital into the United States economy. This has massively advantaged the American economy and workers (besides just creating countless jobs) as it boosted the international value of the dollar, lowered interest rates for American individuals and businesses, and grew the capital supply for loans which banks could make to residents and companies alike. With the onset of the catastrophic Global Financial Crisis from 2007-2009, the capital inflows to the United States dropped considerably. The subsequent Sovereign Debt Crisis in Europe dramatically decreased the capital inflow to Europe as well.

Years later by 2012, China finally surpassed the U.S. to capture the spot as the globe’s greatest host of direct foreign investment . At the conclusion of 2012, the United States managed to recapture this coveted top spot. China had several reasons to steal the American thunder this way. The Chinese economy grew quicker than the United States as well as the other developed nations. Besides this, China has finally matured into a country that does not appear to be a high risk investment any longer. This has helped to draw in direct foreign investment by the hundreds of billions over the decades.

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The term 'Capital Inflow' is included in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.