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What is Capital Outflow?

2017-07-22T14:57:02+00:00

The term 'Capital Outflow' is included in the Corporate Finance edition of the Financial Dictionary. It's available on mazon in Kindle or Paperback version. See more details here.

Capital Outflow is a phenomenon where financial assets and money move away from a given nation. All countries of the world consider this to be a negative action. It typically occurs as a result of economic and/or political instability or at least the perception of it. Such asset flight results from domestically and especially foreign-based investors choosing to sell their stakes within a certain nation. They do this as they see potential weakness in the economy or political establishment of a country. They begin to feel that greater and safer opportunities for investment lie overseas.

When such Capital Outflows become too fast and great, it is a serious indicator that economic and political turmoil is present and a primary cause of the asset and capital flight. Many governments will begin to set limitations for capital choosing to exit. The connotation of such actions tends to warn still other investors who have not left that the condition of the host nation and economy is rapidly deteriorating.

Abnormal capital outflow creates increasingly severe pressure on the macroeconomics of a country and its economy. It tends to dissuade domestic and foreign investors alike from investing in the state and its companies. There are a range of valid explanations for why such capital flight actually occurs. Among them are unnaturally low national interest rates and growing political unrest.

It often helps to look at a real world example to better understand a difficult concept. Japan chose to decrease its interest rates to actual negative levels back in 2016. This applied to all government bonds and securities. They simultaneously began unprecedented aggressive stimulatory measures to boost the growth of the GDP Gross Domestic Product at the same time. The economic problems in Japan started after massive capital outflows from the island nation throughout the decade of the 1990s kicked off two long decades of sub-par stagnated growth in the country which formerly boasted the position of second greatest economy in the world.

Often times, governments impose severe restrictions on capital flight in a valiant effort to stop the fleeing money and financial assets. This is in an endeavor to shore up the capital markets and especially domestic banking institutions and system which can fail if all the money is simultaneously withdrawn. Too few bank deposits often cause banks to crater into insolvency when a great number of assets depart all at once. Subsequently, many banks find it difficult if not outright impossible to call back in existing issued loans in order to make good on customer withdrawal demands.

Consider the sad case study of Greece. Back in 2015, the government of the world’s first democracy had no other choice than to instate a week long bank holiday. Wire transfers became restricted only to those recipients with Greek bank accounts. When such events occur in developing (or sometimes third world) countries, the weakness it institutes can create a vicious downward spiral that leads to domestic public panic and foreign investment fear and resistance.

There are also dramatic effects on exchange rates. The supply of a given country’s currency rises dramatically as investors cash out of the state. Investors in China have periodically sold off the Yuan in order to obtain American dollars. This drives down the value of the Chinese Yuan, which has the additional side benefit of reducing the costs of Chinese exports while simultaneously boosting the costs to import foreign goods. It unfortunately also leads to inflation since import demand will fall while exported goods demand increases. During the second half of the year 2015, Chinese assets to the tune of $550 billion departed China looking for a higher ROI return on investment. This caused not only Chinese government fears but ensuing worldwide government worries.

Similarly Argentina suffered from sudden, unexpected, and runaway capital outflows back in the decade of the 1990s following a dramatic currency realignment. Their new fixed exchange rate created a resulting recession. The nation has now become the popular example and poster country for fledgling economies and the difficulties they all too often encounter in boosting their economic development.

The term 'Capital Outflow' is included in the Corporate Finance edition of the Financial Dictionary. You can get your copy on mazon in Kindle or Paperback version. See more details here.