Capital Inflow

Capital inflow is a balance of payment that allows foreign investment to flow into a country through various means. The main reason for inflows is either an economic boom or an increased domestic demand economy. A high level of capital inflow positively benefits the domestic economy.

They can lead to real asset appreciation within the economy. It enables an increase in the demand for domestic products. Also, it encourages and stimulates the country's growth and development. In addition, it neutralizes income fluctuations and eases smooth functioning. However, an excess capital inflow can increase financial crises leading to inflation.

• Capital inflows are a form of investment activity from a foreign investor to a domestic economy for which an inflow of assets occurs.
• Three major factors affect the inflows- pull, push, and change in financial integration. 
• The concept grew popular in the early 20th century (the 1920s and 1978) during the financial crisis of the Great Depression and World War. 
• Capital inflow can be calculated by adding the sum of Foreign Direct Investment (FDIs) inflows, inflows of portfolio investment liabilities, and other investment liabilities.

Capital inflows refer to an investment activity where one country or business receives capital through stocks, mutual funds, or bonds. The origin of this concept can be traced back to the mid-20th century. In addition, it provides several benefits, including the increased value of goods and assets and consumer demand. However, it differs hugely from foreign direct investment or FDIs. 

Capital inflows refer to net purchases of assets from one country to another. In other words, one country performs investment activity in another country. Because the latter receives capital, it is considered a foreign capital inflow. In contrast, for the lending country, it is termed "capital outflow." As a result, capital inflows are the total inflows of FDIs, portfolio investments, and other investments acting as liabilities. However, there are certain factors affecting it.

Three main factors that affect the net capital inflow are - pull, push, and changes in financial integration.

1. Pull factors are those that attract foreign investors living abroad. It can happen due to the risk-return improvements made by the developing country.
2. Push factors make the lending country less attractive than the receiver.
3. However, the third factor differs from the other two. The net capital inflow can fluctuate if the lending or receiving country's government makes financial policies. For example, if country A tries to remove barriers between country B, there would be financial integration between both.

The origin of the foreign capital inflow concept dates back to the early 20th century in Latin America. However, the major reason these inflows occurred was the economic crisis in the World. It includes the Great Depression of the 1920s and the World War crisis. Many countries were suffering from a financial crisis. As a result, the developed or less affected countries induced capital in these nations.

Later, from 1978 to 1981, similar inflows occurred in Latin America. There was a short-term financial bubble, so they received a large amount of capital from abroad. Thus, an increased inflow became a vital point for growth for long-term investments. 

Let us look at the formula that helps us calculate the capital inflow data of a country:

Capital Inflow = Sum of Foreign Direct Investment (FDIs) inflows + Inflows of Portfolio Investment Liabilities + Other investment liabilities

or 

Capital Inflow = Sum value of other investments + Foreign portfolio investment (FPI) + FDIs. 

where, 

FDIs refer to foreign investment in another country made by an investor, government, or company. And FPIs refer to assets and securities like stocks bonds held by investors and traders.

Let us look at a few examples to understand the concept better:

Example #1

Suppose the majority of countries are suffering from a post-war crisis. After the war, there will be a lack of funds within the economies. However, developed nations will be less affected yet have extra funds themselves. At the same time, the affected countries will need capital to boost their economy.

As a result, the developed ones decide to invest in these countries. There will be an instant flow of capital through stocks, bonds, and other investment options. If, in case, there is an excess flow of capital in any economy, it will give rise to inflation. Likewise, it will also increase the debt levels of the current account.

Another example can include a domestic company earning capital inflow from a foreign company. However, the consequences might be different. 

Example #2

According to the reports, in November 2022, Vanguard production saw a rise in the capital inflow data. The foreign capital inflow rose by 83% compared to 2021. In June 2022, the year-on-year inflow was $457.66 million. Likewise, in 2021, it was $245.22 million invested in the production sector. 

The capital inflow effect has a long-lasting, wider impact on economic growth and development. This is because it plays an important role in impacting the country's economy. As the economy pumps capital, there is an increase in the domestic savings of the investors.

Thus, the deficit is created as a result of fluctuations in balances. Likewise, as capital flows in the country, increased production increases product demand. At the same time, investors earn a higher return than other investment options. 

However, there are certain disadvantages to it. While a country gets capital, the current account access to the money gap widens. The debt level also surges. As a result, the capital inflow effect occurs, which leads to economic crises like inflation.

This has been a guide to what is Capital Inflow. Here, we explain its examples, formula, factors, history, advantages, and disadvantages. You can learn more about it from the following articles –

• Capital Flight
• Capital Expenditure (Capex)
• Capital Maintenance