Internatnal kconomies Dr Sowjanva S Sheus

ve Dr Prokasha R A
Chapter 5 International Capital Movements
chapter Outline

51Meaning &Types
5.2 Factors affecting International Capital
Movements
63 Advantages and Disadvantages
5.1 Introduction, Meaning &Types
Clobalisation integrates various economies of the
encourages the free flow of goods &services, capital, world. It
and free technology
movement of labour among the nations. International
pxchange transactions are not restricted only to
goods and
cervices, italso includes international movement of
capital. The
Aow of financial resources from one country
to another for the
adjustment of BOP disequilibrium or for expanding the
is called international capital movement.
production
international capital
movements however, should not be identified with movement of
goods or payments for imports or exports between the countries.
Capital flows internationally asafactor of production for thesake
of suitable investments and also as aids to LDCs.
They take place
through government, private and international organisations or
agencies.
lypes of International Capital Movemnts
1. Direct andPortfolio Capital- Foreign Direct Investment (FDI)
Telers to the investment in aforeign country where the investors
lelain control over the investment. It refers to an investment in
e Toreign country that involves some deg ee of control and
participation in management. The essence of foreign direct
Vestment is that the ownership, control and management of
Dusiness are vested with the investors.
roreign Direct lnvestments can take in different forms:

61
 Inernational Fconomies -Dr Sawanya SShety Af& Dr 'rakestre R A
(a) Greenfield Investment- Establishing an
enterprise in the foreign country or setting up of an
entirely
corporationintthe host country. Example- McDonald's, autonomo
are US firms that have invested around the world. Coca-Co
(b) Setting up aSubsidiary- FDI may take in the form ofof acme
acquif
astake in the existing firm orthe formation of a subsidiary
host country.
(c) Mergers and Acquisition- Merging with existing firm
acquiring the existing firm of the host country. Example- Gon
and Android, Vodafone ldea merger, Walmart acquisition
Flipkart, Tata and Corus steel etc.
(d) Horizontal FDI- It means investment in the same indush
abroad as the firm operates at home. In other words, it is 2
investment of a firm in a foreign country to produce the san
product which it produces in the home country. Example- Toydd
assembles cars both in Japan and the UK.
(e) Vertical FDI- It refers to integration of different proce
production. There may be backward vertical integration (BVI) ard
forward vertical integration (FVI)
BVI implies that a firm directly invests in foreign countries
produce intermediate goods that are meant to be used as inpu
in the domestic production process. While FVI firms invest
foreign countries to produce final goods.
() Joint Ventures- FDImay take the form of joint ventures elt
with a host country firm or with a government institution or w
another company which is foreign to the host country. Exan
Vistard
Indian corporate Tata Sons and| Singapore Airlines (SIA)
(g) Platform FDI - It refers to the expansion of a business
foreign country, but everything manufactured that is exporteFO
aathird country. This is referred to as the export platform of
Example- Ford purchased plants in Ireland
w
manufacturing
62
 International Economics Dr
Sowjomu SSheny M& IDr
etheprimarY purpose of exporting cars to other cOuntries Prakasha Rao A
in the

Capital or Foreign Indirect Investment-The

ofindirect capital is known as Portfolio investment movement
P o r t o l i o

or rentier
It consistss mainly of investment in
investment.
theform of
securities, shares or debentures (issued holding
o ft r a n s f e r a b l e

by the government
guaranteed by
by or
of a capital importing country) by
theforreign investors. lt refers to the investment by individuals,
firms, and public bodies. In Portfolio investment, the foreign
investorsS have only the ownership of capital, the control and
of the funds rests with the capital-importing
management
country.
The foreign investors are entitled todividends or interests on their
holdings of equities, bonds or debentures. Portfolio investments
are influenced by short term gains.
In recent years multilateral indirect capital investment is
increasing due to the development of technology (online trading),
modernisation, floatingexchange rates etc.
2. Home and Foreign Capital: Home capital is concerned with
investment made abroad by the residents of the country. It refers
to outflow of capital as there is a movement of capital from home
cOuntry to abroad. While foreign capital implies investment made
of capital as
Dy foreigners in the country. It refers to the inflow
home country.
nere is a capital movement from abroad to the
capital is made with
Inis distinction of home capital and foreign
Tererence to balance of payment entries.
Private capital refers to
Private and Government Capital:
by private individuals and
lending and borrowing from abroad
from one country to another
institutions. Private capital transfers
bank of the
are often the government or central
guaranteed by
movementstake the form
of FDI,
borrowing country. Such capital
FPl which are motivated by profit.
63
 Prukasha Run
nematinal lconomiCs Dr Sowjanu S Sheny A/ & Dr

On the other hand, government capital refers to the len. lending

and borrowing between governments. Governments are important
international lenders. It may be in the form of a loan from the
Govt of adeveloped country to the Govt of LDCs for developmenta
projects. Similarly, loans provided to a Govt by internationa
monetary institutions like IME. IBRD, ADB etc.
4. Short-Term and Long-Term Capital- Short- term capita
movements are for a period of less than one year maturity. Tha
short-term capital movements can take in the form of currency,
demand deposits, bills of exchange, commercial papers and tima
deposits up to a maturity of one year. They are undertaken by the
central bank and commercial banks of the [Link] shor.
term capital movements are referred to as 'hot money' movements
they are due the international differentials in the rates of interest
The long-term capital movements are for the credit
instruments having a maturity of more than one year. It takes
place in the form of purchase or sale of long-term securities or
bonds. These sales or purchases may be undertaken by the
individuals or corporatiors in the foreign countries or by foreign
individuals or corporations in the home country. The long- term
capital movements may also take place in the form of loans
procured from the international financial institutions such as IMF
and IBRD.
5. Foreign Aid- Aidrepresents unilateral [Link] are gifts
or grants which need not be repaid. An advanced country may
give aid to developing countries to assist certain developmental
programmes. Sometimes aid is also given for military purposes
Foreign aid can be tied' or 'untied'.
Aid may be tied by source, project or commodities, Such a ty
of aid is known as specifiC aid. In other words, if aid is given to
specific purpose, the recipient has to use it for that purpose ony
64
 International Eeonomics - Dr
aid isalso called as SowjanyaS Sheur M& Dr
lrakasha Ro A
Untied

general aid or non-

ofuntied aid, the receiving project
case

country can use the grant aid. in

pupose,
for any
Ptors Influencing
6 2Factors

nternational
International
capital flows are Gapital Movements- The
influenced by the following
factors:
main
1. Rate t 0fInterest- The most significant
mational capital movement is the factor which affects
interest. Bertil
difference in the current rates
of Ohlin acknowledged that the
otes between courntries is difference in interest
the most important
f capital between inducement to flow
nationS. The capital tends to mOve
rountry where the rate of interest is from a
low to those countries where
einterest rates are relatively high as capital
yields higher returns
there.

[Link]- Speculation refers to expected variations

in the
exchange rates or the interest rates affecting the
cei short-term capital
movements. When speculators anticipate a rise in
interest rates
in the home country in future, they invest in
short term foreign
securities to earn profit from the possibility of bond
prices. This
lBads to out flow of capital as the speculators transfer
funds from
fome country to abroad.
On the other hand, if speculators expect a fall in the interest
ees in the home country in future, they will transfer funds from
Ue foreign countries to the home country causing an inflow of
capital.
Expectations of Profit-Aforeign investor has the profit motive
in his
mind at the time of making capital investment in another
ry. Capital flows to that country where the possibility of
tarning profit is more. Aforeign entrepreneur keeps expected
65
 Internaional I:conomies -Dr Sowjanm SShety M&Dr Prakusha Rav A
profit in view while investing in projects and invests in that wher
the expected profits are more.
4. Bank Rate- The variations in bank rate bythe central bank e
a country influences capital movements because market intera
rates depend on it. An increase in bank rate in the home COuntr.
will cause arise in interest rates which will attract foreign capita
and prevent the flight of capital. On the contrary, reduction in
bank rate will lower interest rates causing outflow of capital to
foreign countries.
5. Production Costs- Capital movements depend on production
Costs in other Countries. In countries where labour, raw materials
etc. are cheap and easily available, more private capital flows
into them. One of the foremost reasons for huge capital investment
in Korea, Singapore, Hong Kong and other developing countries
by MNCs is lowproduction costs.
6. Economic Conditions- The economic conditions in acountry
like size of the population, availability of infrastructure facilites.
means of transport and communication, power, market structures
financial institutions, efficient labour etc. encourage the inflow of
capital.
7. Marginal Efficiency of Capital (MEC)- MEC is the expected
profitability of an additional capital. MEC is positively linked with
the inflow of capital. Foreign investors generally compare margina
efficiency of capital with the interest rate in different countries
They prefer to invest in that country where the rate of retun
high.
8. Foreign Capital Policy- The capital movements are alsso
affected by the foreign capital policy ofa
policy of the government
country. If the government facilitates transferring profit, dlv dividend

royalty, interest etc., to foreign investors leads to an inflow O

66
 International Economies Dr
the foreign countries. Sowjonya SShety M&Dr Prakasa Kens A
from
capital
On the
estrictions on
the inflow ofcontrary, if there are
remain clogged. foreign capital wil
9, Political Conditions-
Political stability, peace, law and
friendly relations with other order,
investment. On the other hand, countries encourage foreign
political instability, violence,
oflaw
and order, lack of internal lack
capital.
security etc. will result in flight
(out flow) of
10. Exchange Control Measures- The existence of stiff
measures tends to exchange
control
prevent the inflow of capital from abroad
and impose automatic restriction on the outflow
of capital to
abroad. A liberal policy in this respect can be more helpful in
the
inflowof capitalto the home country and also capital flows among
nations.
5.3 Advantages and Disadvantages of International Capital
Movements

Advartagrsof International Capital Movements

International capital movements play an important role in
economicdevelopment. The role of capital transfer can be well
understood irom their benefits or advantages:
capital has
1. Increase in World Output- Large inflow of foreign
employment, income and
led to increase in global production,
of the world economy
rade. This has led to internationalisation
among the nations.
leading to more flow of capital
Consumption- Capital flows among the nation helps
Optimum consumers by
production. It benefits
inreducing the cost of
International capital
products at low prices.
aclitating better quality benefits the Consumers
competition which
movement increases
products.
y providing a variety of
67
 Iternatimal lconomics 1Dr Sowjanya S ShenyM& Dr Prakashk Run A
3. Advancement of Technology- The inflow of capital fron
advanced countries, apart from removing thecapital deficiencies
brings in advanced technology and skills, organizational expertise
and market management. The capital movements, thus, contribute
in filling up the technological gaps in the developing countries
4. Creationof Employment Opportunities- foreign capital builds
up infra-structure, assists in the setting up of heavy, basic and
key industries. There is substantial expansion of employment
opportunities in developing countries. The expansion of economic
activities through foreign capital absorbs a large part of surplus
labour and helps in reducing the problem of unemployment.
5. Beneficial for Labour- Foreign capital causes expansion of
economic activities, increased demand for labour ensures an
increase in the real wages of the workers. The expanded
production andcreation of newvarieties of goods at lower prices
affects the qualitative improvement in the standard of living of
workers.
6. Modern Value System- The flow of international capital and
enterprise to the traditional societies of developing countries starts
infusing in them hard work, scientific temper, modernisation of
outlook. Furthe, it contributes to greater innovativeness and
increased self-reliance. These changes in the value system pave
the way for an uninterrupted process of growth.
7. Checks Inflationary Pressures- The strong inflationary
pressures in the developing countries result from excessie
demand, rigidity in the structure of production etc. Inflow of foreign
capitalcan rapidly expand production of consumer goods through
the import of machinery, equipment and contribute in relieving
the inflationary pressures.
8. Creation of Economic and Social Overheads- International
capital movements help in creating economic and social
68
 International iconomics - Dr Sowjanya SShey M& Dr
Prukasha RanA
It
includes means of transport and communications,
overheads.
power,
education and training, research institutions
1and
andhealth,services. Foreign capital and technical assistance have
imigation

key
role in creation of economic overheads that require
a
played
investment
leadingto faster economic growth.
tof Heavy and Basic Ir
Industries- The industrial
heavy

9 ,D e v e l o p m e n t

tansformation
in developing countries requires the development

heavy
and basic industries such as steel, heavy electricals,
of
machine tools, heavy engineering, oil-refining, chemicals, mining,
transport
and defense equipment industries. These industries
andda long gestation period. A
capital-intensity
have high developing countries
sihstantial inflow of foreign capital helps the
industries which stimulate the
future
to develop heavy and basic
developing countries.
industrial expansion in
stages of
Undertaking of Initial Risk- In the early
10. involves
investment in developing countries
development, the labour,
infra-structure, skilled
of absence of
huge risk onaccount investors hesitate
technology etc, The indigenous
advancement of
foreign investors or The
enterprise.
investment and unspecified risks
and
10
however, venture
to bear
entrepreneurs, of the economy.
different sectors
Ser up enterprises in countries are
frequently
Developing
11. Removal of BOP Deficit- capacitytoexportis limited
deficit as their inflow of
foreign
facedIwith chronic BOP
import. A large
and have a strong to
propensity
servicing of
external
imports and
paymentsfor
aid can take care of
complete
debts. therefore,
capable of
is, developing

The foreign
assistance
structureinthe
s o c i o - e c o n o m i c

transformation of the
Countries. 69
 InternatIonalicomomy - Dr Sowmu S Sheuy Af Dr P'rukusha Rao A

Disadvantages of International Capital

International capital flows have certain dangers
or the problems that are associated with them,
Movement
inherent s.
in Iherm
unea

I t
h a

1. Not Indispensable- The inflow of capital and ttransfer of 6.A

advanced technology are growth-stimulating factors. But itis foreign Con

no
indispensable. There are instances which show that the
of
c

growth
procesS can take place even in the absence of foreign capital,
a n

That happened in the earlier stages of development of

Soviet 7.
Union and China. In the words of Prof Bauer, "Foreign aidi is plairly for
neither a generally necessary nor a sufficient Condition for
in
emergence from poverty."
2. Wasteful use of International Capital- when foreign canit 8
is available easily or at the concessional interest rate it is ikelvts th
be misutilised on the low priority projects. lt can be in the fom of C

production of luxury goods or other wasteful products ike

cosmetics, deodorant, shampoo
3. Problem of Tied Foreign Capital- Generally, the aid-giving
countries impose arbitrary and undesirable conditions upon the
recipient countries to purchase capital goods and raw materias
from the specified suppliers. The aid-seeking countries have to
comply with unfair conditionality when purchasing these inputs a
the prices higher than the competitive prices.
4. Unsuited Technology- The technology offered by the
developed countries is either outdated or it is not in conformily
with their resource endowments. The import of western techniques
of capital-intensive and labour-saving technology in the capital
deficient and labour-surplus poor countries causes serious

problems like unemployment, poverty etc.

5. Financing of Conspicuous Consumption - The foreign aid
in the form of loans, is frequently used in the financing o

70
 Imermational loomies Dr Sowtuve SShciy M&
Dr P'rukasha Ro d
uneconomic activities. It has resulted in
*has encouraged production and conspicuous consumption.
consumption of luxury goods.
[Link] Effect on Domestic Saving-
consumption has reduced
Increase in conspicuous
domestic saving. The increased import
ofConsumer goods and greater
and semni-Uxury goods causes
priority to the production of luxury
an increase in consumption
consequent decline in and
domestic savings.
Increase in External Debt Burden- Foreign
for unproductive purposes or for capital
employed
financing
increase the burden of external debt. Huge consumption will
has made many countries fall into debt trap.
external borrowing
g Political Domination- The aid-receiving
countries have faced
the political pressure from the donor countries. The
donor
countries start dictating the economic and political policies
according to their vested interests. The LDCs have the painful
experience of foreign subjugation by the western imperialism.
9. Danger of Dependence- Dependence on developed countries
for developmental requirements involves risk and uncertainty both
in war and peace time. Reliance on foreign capital has its grave
risks and dangers
10. Domination of MNCs- foreign capital flows lead to emergence
of international monopolies in the form of MNCs. Domination of
MNCs affects the domestic industries. In the view of Haberler
Such monopolies developedwith the spreadof multinationals are
farmnful to the domestic interests'. Such MNCs have been involved
dominate the domestic
many unethical trade practices and
market.
International capital movements
have risks and several
its benefits to the development
drawbacks but at the same time,
overlooked. The policies should be
process in LDCs cannot be adverse
capital does not have
made in such a way that foreign
developing countries.
epercussions upon the
71
 Iternatinal EeoomiCsDr Soyumu S Sheny Af& Dr 'rakasha Rao A

Questions
Section-A (ONE Mark Each)
A. What do youmean by international capital movement
B. What is horizontal FDI?
C. What is vertical FDI?
D. What is platform FDI?
E. What is a joint venture?a
10
F. What is home capital?
G What is meant by foreign capital?
H. What is tied aid?
I. What is untied aid?
Section-B (FIVE Marks Each)
1. Explain the types of foreign direct capital.
2. Write anote on factors influencinginternational capital
movement.

3. Briefly explain the merits of international capital movement.

4. Briefly explain the demerits of international capital
movement.

Section-C (TEN Marks Each)

1. Explain the different types of international capital
movement.

2. Explain the factors influencing international capital

movement.

3. Explain the advantages of international capital movement

4. Examine the disadvantages of international capital
movement.

72