Types of International Capital Flows

International Capital Flows (Financial flows) means the inflow and outflow of capital from one nation to another nation. Following are the different types (forms) of International Capital Flows:

1. Foreign investment can be of two types. One is direct and the other is portfolio. Foreign direct investment (FDI) takes place when a company moves in another country for the production of goods or services and takes part in the management of that company. Foreign Direct Investment (FDI) is generally regarded as the most stable type of capital flows, both during normal and turmoil times. Foreign direct investment is composed primarily of fixed assets and is highly illiquid and hard to sell during crises. FDI is also influenced more by long term profitability expectations associated with a country’s fundamentals rather than speculative forces and interest rate differentials.

Quite the opposite, foreign portfolio investment (FPI) purpose is to earn a return by way of investment in foreign securities with no purpose of grabbing the voting power in the company whose stocks it purchases. Portfolio flows include both bond and equity investments. Portfolio investors can sell their shares or bonds without difficulty and quickly than FDI and these flows are usually regarded as the hottest of the numerous major types of capital flows. Portfolio flows are also more prone to informational problems and herding behavior.

Inflow of funds takes place when an overseas investor makes investment in the country. On the other hand, outflow of funds happen when the domestic investor invests abroad.

Although most of the fundamental variables which determine FDI usually do not shift abruptly during normal times, an abrupt change in perceptions of these fundamentals in a crisis could interrupt these flows of funds. Direct investors can bring about a crisis by speeding up profit remittances or lowering the liabilities of affiliates toward their mother companies.

2. Trade Flows: Trade could possibly be associated with goods. On the other hand, it maybe linked to services. The merchandise trade has two sides. While the first is export, the opposite is import. If a country exports different goods, it will get convertible currencies which will be an inflow of funds. On the other hand, it has to make payments in convertible currencies for the imports it makes. Hence export and import of items result in international financial flows.

3. Invisibles consist of trade in services, investment income and unilateral transfers. If a shipping company has products of a foreign exporter/importer and receives the freight charges, it will likely be treated as inflow of funds because of trade in services. In the same way, if a foreign shipping company carries merchandise of an Indian exporter, it will be outflow of funds in form of freight charges. There are plenty of examples of international flow of funds resulting from trade in services.

Investment income refers to the receipt and payment of dividend, technical service, royalty, etc. If an international business operating in India remits dividend to its home country it will represent an outflow of funds.

Unilateral transfers stand for international financial flows with virtually no services rendered. If an Indian gifts something to his/her friend in USA, it will be an example of outflow of funds resulting from unilateral transfer.

4. External assistance and external commercial borrowings are different. While External assistance normally flows from an official institution, external commercial borrowings flow from international banks or other private lenders. The rate of interest in the former is generally minimal as well as a longer maturity period. The latter has market interest rate and a faster maturity.

5. Private loan flows include all kinds of bank loans as well as other sector loans such as loans to finance trade, mortgages, financial leases, repurchase agreements, etc. They’ve been a fairly ignored category.