International Capital Movement

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Information about International Capital Movement
Finance

Published on March 12, 2014

Author: jitenhmenghani

Source: slideshare.net

Page | 1 UNIVERSITY OF MUMBAI PROJECT REPORT ON INTERNATIONAL CAPITAL MOVEMENT BY MR. JITEN H MENGHANI ROLL NO 32 M.COM. (PART-1) ACADEMIC YEAR 2013-2014 PROJECT GUIDE PROF.MRS.RACHANA JOSHI PARLE TILAK VIDYALAYA ASSOCIATION’S M.L.DAHANUKAR COLLEGE OF COMMERCE DIXIT ROAD, VILE PARLE (EAST) MUMBAI-400 057

Page | 2 DECLARATION I, MR. JITEN H MENGHANI OF PARLE TILAK VIDYALAYA ASSOCIATION’S, M.L.DAHANUKAR COLLEGE OF COMMERCE of M.COM (PART-1) (Semester 2) hereby Declare that I have completed this project on INTERNATIONAL CAPITAL MOVEMENT in The Academic year 2013-2014. The information Submitted is true & original to the best of knowledge. ----------------------- (Signature of student) JITEN.H.MENGHANI

Page | 3 ACKNOWLEGEMENT To list who all have helped me is difficult because they are so numerous and the depth is so enormous. I would like to acknowledge the following as being idealistic channels and fresh dimensions in the completion of this project I take this opportunity to thank the University of Mumbai for giving me chance to do this project. I would like thank my Principal, Dr. Madhavi.S.Pethe for providing the necessary facilities required for completion of this project. I would also like to express my sincere gratitude towards my project guide PROF.MRS.RACHANA JOSHI whose guidance and care made the project successful. I would like to thank my college library, for having provided Various reference books and magazines related to my project. Lastly I would like to thank each & every person who directly or indirectly helped me in completion of the project especially my parents & peers who supported me throughout my project.

Page | 4 Content a) Abstract b) International Capital Movement c) Types/Sources Of International Capital Movements d) Foreign Direct Investment [FDI] e) Portfolio Investment f) Official Flows g) External Commercial Borrowing. h) Determinants Of International Capital Flows i) The Important Determinants Of International Capital Movements j) Role Of Foreign Capital k) Impact Of Foreign Capital. l) Drawbacks Of Foreign Capital m) Foreign Capital Flows To Developing And Emerging Economies n) Capital Flows To India o) Conclusion p) Bibliography

Page | 5 Abstract International capital movement have played an important role in the economic development of several countries. They provide an outlet for saving for the lending countries which helps to smooth out business cycles and lead to a more stable pattern of economic growth. On the other hand, they help to finance development of under-developed countries. They also help to ease the balance of payments problems of developing economies. Thus, international capital movement have an important role to play in the balance of payments adjustments mechanism. As compared to developed countries of the world, the developing countries suffering from scarcity of capital and poor technology. Therefore, they rely on international capital floes to finance their investment opportunities and hence, to raise income and payment.

Page | 6 International Capital Movement International capital movement have played an important role in the economic development of several countries. They provide an outlet for saving for the lending countries which helps to smooth out business cycles and lead to a more stable pattern of economic growth. On the other hand, they help to finance development of under-developed countries. They also help to ease the balance of payments problems of developing economies. Thus, international capital movement have an important role to play in the balance of payments adjustments mechanism. As compared to developed countries of the world, the developing countries suffering from scarcity of capital and poor technology. Therefore, they rely on international capital floes to finance their investment opportunities and hence, to raise income and payment. The term international capital movement refers to borrowing and lending between countries. These capital movements are recorded in the capital account of the balance of payment. One of the most important developments in the world economy in the 1990s has been the spectacular surge in international capital flows. These flows have emanated from a greater financial liberalisation, improvement in information technology, emergence and proliferation of institutional

Page | 7 investors such as mutual and pension funds, and the spectra of financial innovation. With the increasing capital flows and participation of foreign investors and institutions in the financial markets of developing countries, the capital account has been the focus of attention since the late 1980s and especially so in the 1990s. The expansion of capital flows has been much larger than that of international trade flows. The process has been reinforced by the ongoing abolition of impediments and capital controls and the widespread liberalisation of financial markets in the developing countries during the 1990s.

Page | 8 Types/Sources Of International Capital Movements Capital movement can be classified by instrument into debt or equity and by maturity into short- term and long-terms. Capital movement can be divided in to short-term and long-terms flows. Depending upon the nature of credit instruments involved. “A capital movement is short-term if it is embodied in a credit instruments of less than a year’s maturity. If the instruments has duration of more than a year or consist of the title to ownership, such as the share of stock or a deed to property, the capital movement is long-term.” 4.1 SHORT-TERM CAPITAL MOVEMENT:- They can take place through changes in claims of domestic’s residents on foreign residents or in liabilities of domestics residents owed to foreign residents. Short-term capital instruments are demand deposits, bills, overdraft, commercial and financial papers and acceptances, loan and commercial banks credits, and items in the process of collection. They are mostly speculative in nature. Short-terms capital movements may take the form of hot money movements which refers to capital movements to take advantages of international difference in interest rate. 4.2 LONG-TERM CAPITAL MOVEMENTS:- They are generally for long-term investments. They may be further classified in to direct investment, portfolio investment and assistance from governments and institutions.

Page | 9 Foreign Direct Investment [FDI] Foreign direct investment (FDI) is a direct investment into production or business in a country by an individual or company in another country, either by buying a company in the target country or by expanding operations of an existing business in that country. Foreign direct investment is in contrast to portfolio investment which is a passive investment in the securities of another country such as stocks and bonds. DEFINATION Broadly, foreign direct investment includes "mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans". In a narrow sense, foreign direct investment refers just to building new facilities. The numerical FDI figures based on varied definitions are not easily comparable. As a part of the national accounts of a country, and in regard to the GDP equation Y=C+I+G+(X- M)[Consumption + Domestic investment + Government spending +(eXports - iMports], I is investment plus foreign investment, FDI is defined as the net inflows of investment (inflow minus outflow) to acquire a lasting management interest (10 percent or more of voting stock) in an

Page | 10 enterprise operating in an economy other than that of the investor.FDI is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. FDI usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward and outward, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movements. TYPES OF FDI 1. Horizontal FDI arises when a firm duplicates its home country-based activities at the same value chain stage in a host country through FDI. 2. Platform FDI Foreign direct investment from a source country into a destination country for the purpose of exporting to a third country. 3. Vertical FDI takes place when a firm through FDI moves upstream or downstream in different value chains i.e., when firms perform value-adding activities stage by stage in a vertical fashion in a host country. Horizontal FDI decreases international trade as the product of them is usually aimed at host country; the two other types generally act as a stimulus for it. METHODS The foreign direct investor may acquire voting power of an enterprise in an economy through any of the following methods:  by incorporating a wholly owned subsidiary or company anywhere  by acquiring shares in an associated enterprise  through a merger or an acquisition of an unrelated enterprise  participating in an equity joint venture with another investor or enterprise. FORMS OF FDI  low corporate tax and individual income tax rates  tax holidays  other types of tax concessions  preferential tariffs

Page | 11  special economic zones  EPZ – Export Processing Zones  Bonded Warehouses  Maquiladoras  investment financial subsidies  soft loan or loan guarantees  free land or land subsidies  relocation & expatriation  infrastructure subsidies  R&D support  derogation from regulations (usually for very large projects) IMPORTANT AND BARRIERS TO FDI The rapid growth of world population since 1950 has occurred mostly in developing countries. This growth has been matched by more rapid increases in gross domestic product, and thus income per capita has increased in most countries around the world since 1950. While the quality of the data from 1950 may be of question, taking the average across a range of estimates confirms this. Only war-torn and countries with other serious external problems, such as Haiti, Somalia, and Niger have not registered substantial increases in GDP per capita. The data available to confirm this are freely available. An increase in FDI may be associated with improved economic growth due to the influx of capital and increased tax revenues for the host country. Host countries often try to channel FDI investment into new infrastructure and other projects to boost development. Greater competition from new companies can lead to productivity gains and greater efficiency in the host country and it has been suggested that the application of a foreign entity’s policies to a domestic subsidiary may improve corporate governance standards. Furthermore, foreign investment can result in the transfer of soft skills through training and job creation, the availability of more advanced technology for the domestic market and access to research and development resources. The local population may be able to benefit from the employment opportunities created by new businesses.

Page | 12 DEVELOPING WORLD A 2010 meta-analysis of the effects of foreign direct investment on local firms in developing and transition countries suggests that foreign investment robustly increases local productivity growth. The Commitment to Development Index ranks the "development-friendliness" of rich country investment policies. CHINA FDI in China, also known as RFDI (renminbi foreign direct investment), has increased considerably in the last decade, reaching $59.1 billion in the first six months of 2012, making China the largest recipient of foreign direct investment and topping the United States which had $57.4 billion of FDI. During the global financial crisis FDI fell by over one-third in 2009 but rebounded in 2010. INDIA Foreign investment was introduced in 1991 under Foreign Exchange Management Act (FEMA), driven by then finance minister Manmohan Singh. As Singh subsequently became the prime minister, this has been one of his top political problems, even in the current times. India disallowed overseas corporate bodies (OCB) to invest in India. India imposes cap on equity holding by foreign investors in various sectors, current FDI limit in aviation sector is maximum 49%. Starting from a baseline of less than $1 billion in 1990, a 2012 UNCTAD survey projected India as the second most important FDI destination (after China) for transnational corporations during 2010– 2012. As per the data, the sectors that attracted higher inflows were services, telecommunication, construction activities and computer software and hardware. Mauritius, Singapore, US and UK were among the leading sources of FDI. Based on UNCTAD data FDI flows were $10.4 billion, a drop of 43% from the first half of the last year. UNITED STATES Broadly speaking, the U.S. has a fundamentally 'open economy' and low barriers to foreign direct investment. U.S. FDI totalled $194 billion in 2010. 84% of FDI in the U.S. in 2010 came from or through eight countries: Switzerland, the United Kingdom, Japan, France, Germany, Luxembourg, the Netherlands, and Canada. A 2008 study by the Federal Reserve Bank of San Francisco indicated that foreigners hold greater shares of their investment portfolios in the United States if their own countries have less developed financial markets, an effect whose magnitude decreases with income

Page | 13 per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets. White House data reported in July 1991 found that a total of 5.7 million workers were employed at facilities highly dependent on foreign direct investors. Thus, about 13% of the American manufacturing workforce depended on such investments. The average pay of said jobs was found as around $70,000 per worker, over 30% higher than the average pay across the entire U.S. workforce. President Barack Obama said in 2012, "In a global economy, the United States faces increasing competition for the jobs and industries of the future. Taking steps to ensure that we remain the destination of choice for investors around the world will help us win that competition and bring prosperity to our people." In September 2013, the United States House of Representatives voted to pass the Global Investment in American Jobs Act of 2013 (H.R. 2052; 113th Congress), a bill would which direct theUnited States Department of Commerce to "conduct a review of the global competitiveness of the United States in attracting foreign direct investment."Supporters of the bill argued that increased foreign direct investment would help job creation in the United States.

Page | 14 Portfolio Investment A portfolio investment is a passive investment in securities, none which entails in active management or control of the securities' issued by the investor. Portfolio investment is an investment made by an investor who is not particularly interested in involvement in the management of a company. It is also the investment in securities that is intended for financial gain only and does not create a controlling interest in or effective management control over an enterprise. It includes investment in an assortment or range of securities, or other types of investment vehicles, to spread the risk of possible loss due to below expectations performance of one or a few of them. portfolio investment is a mode of investment in the securities and bond of a company which helps the company to bring up more sources of finance and to strengthen it's financial adequacy. it enables to improve the creditworthiness of the company in the mind of the general public and they are being prompted to invest more and earn in accordance with it.

Page | 15 DEFINATION The term portfolio refers to any collection of financial assets such as stocks, bonds, and cash. Portfolios may be held by individual investors and/or managed by financial professionals, hedge funds, banks and other financial institutions. It is a generally accepted principle that a portfolio is designed according to the investor's risk tolerance, time frame and investment objectives. The monetary value of each asset may influence the risk/reward ratio of the portfolio and is referred to as the asset allocation of the portfolio. When determining a proper asset allocation one aims at maximizing the expected return and minimizing the risk. This is an example of a multi-objective optimization problem: more "efficient solutions" are available and the preferred solution must be selected by considering a tradeoff between risk and return. In particular, a portfolio A is dominated by another portfolio A' if A' has a greater expected gain and a lesser risk than A. If no portfolio dominates A, A is a Pareto-optimal portfolio. The set of Pareto-optimal returns and risks is called the Pareto Efficient Frontier for the Markowitz Portfolio selection problem. DESCRIPTION There are many types of portfolios including the Market portfolio and the Zero-Investment Portfolio. A portfolio's asset allocation may be managed utilizing any of the following investment approaches and principles: equally-weighting, capitalization-weighting, price-weighting, Risk parity, Capital asset pricing model, Arbitrage pricing theory, Jensen Index, Treynor Index, SharpeDiagonal (or Index) model, Value at risk model, Modern Portfolio Theory and others. There are several methods for calculating portfolio returns and performance. One traditional method is using quarterly or monthly money-weighted returns, however the true time-weighted methodis a method preferred by many investors in financial markets. There are also several models for measuring the Performance Attribution of a portfolio's returns when compared to an Index or benchmark. partly viewed as investment strategy. Investopedia explains 'Portfolio Investment' A portfolio investment may be in the form of stocks or corporate bonds. This type of investment can be contrasted with direct investments, in which an individual actually participates in the business' operation at a high level. It can also be contrasted with a major purchase of the company's shares for the purpose of a takeover.

Page | 16 Official Flows OFFICIAL FLOWS: They are shown as external assistance, i.e. grants and loans from bilateral and multilateral flows. Long-term capital movements can also take the form of government loan grants and loans from international financial institutions like IBRD, IDA, etc. Sometimes government of advanced countries may gives loans to financial project in a developing country. These are known as bilateral loans. International financial institution like world bank, Asian developing bank, etc. Also give financial assistance to developing countries. These loans are called multilateral loans. Thus, governments and international institutions play an important role in international capital movement. FOREIGN AID: A part of the foreign capital is received on concessional term and it is known as external assistance and foreign aids. It may be received by way of loans and grants. Grants are in a forms of out right gift which do not have to be repaid. Loan qualify as aid only to the extent that they bear a concessional rate of interest and have longer maturity period than commercial loans. Foreign aids has mostly been given by foreign governments and international finantial institutions like IMF, WORLD BANK, ASIAN DEVELOPMENT BANK AND SO ON. Official flow were about 75-80 percent of capital flow till 1991. By 1994, this has come down to about 20 percent and has further fallen to below 5 percent by late 1990s.

Page | 17 External Commercial Borrowing An external commercial borrowing (ECB) is an instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs (public sector undertakings). ECBs include commercial loans, buyers' credit, suppliers' credit, securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export credit agencies and commercial borrowings from the private sector window of multilateral financial Institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC, etc. ECBs cannot be used for investment in stock market or speculation in real estate. The DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with Reserve Bank of India, monitors and regulates ECB guidelines and policies. For infrastructure and Greenfield projects, funding up to 50% (through ECB) is allowed. In telecom sector too, up to 50% funding through ECBs is allowed. Recently Government of India has increased limits on RBI to up to $40 billion and allowed borrowings in Chinese currency yuan. Borrowers can use 25 per cent of the ECB to repay rupee debt and the remaining 75 per cent should be used for new projects. A borrower can not refinance its existing rupee loan through ECB. The money raised through ECB is cheaper given near-zero interest rates in the US and Europe, Indian companies can repay their existing expensive loans from that. The ministry has not put any ceiling on individual companies for using renminbi as currency for ECB. Even though the overall limit for permitting it under ECB is only $1 billion, the officials denied possibilities of a single company using the entire amount as it would come under ‘approval’ route. The cost of borrowing in Renminbi is far less,” said a finance ministry official. “Companies go for it as it is on easier terms. We are getting their (China’s) money cheap.” The limit for automatic approval has also been increased from $100 million to $200 million for the services sector (hospitals, tourism) and from $5 million to $10 million for non-government organisations and microfinance institutions. The decisions will come into effect through a notification by RBI.

Page | 18 Determinants Of International Capital Flows The pace, magnitude, direction and composition of international capital flows have crucial implication for the recipient countries. The surge in private capital inflows to developing economies in the 1990s coincided with the period of low international interest rate in the advanced economies and domestic policy reform in the developing world . The literature on determinants of cross- countries capital flow has identified various factors which, inter alia, include the overall macroeconomic scenario, political risk perception, regulatory regims, fiscal concessions and business strategy of the entity from which the capital flow originates. The literature usually distinguishes between two broad sets of factors affecting capital movements. COUNTRY-SPECIFIC “PULL” FACTORS:- They reflects domestic opportunity and risk. The evidence on this issue highlights that PULL OR DOMESTIC FACTORS operating at project and country levels, reflects essentially the improved policies that increase the long run expected returns or reduced the perceived risk on real domestic investments. These includes measures that increase the openness of the domestic financial market to foreign investors; liberalisation of FDI; credible structural or macroeconomic policies; sustainable debt and debt service reduced ensuring timely repayments; stabilisations policies that affect the aggregate efficiency of resource allocation; policies that affect the level of domestics absorption relative to income; and the ability of the economy to absorb shocks from changes in international terms of trade. Pull factors like rebuts economic reforms in emerging economies are internal to an economy. GLOBAL OR “PUSH” FACTORS:- They are stimulus provided by the decline of US interest rate that has taken place in recent years. FDI may be attracted by the opportunity to use local raw material or employ a local labour force that are relatively cheap. The PUSH OR EXOGENOUS FACTORS includes lower foreign interest rates, recession abroad and herd mentality in international capital markets. Push factorsare external to an economy and include parameters like low interest rates abundant liquidity, slow growth, or lack of investment opportunities in advanced economies. Push and Pull factors explains international capital flows. The Pull factors determine the geographic distribution of the flows amongst the recipient economies.

Page | 19 The Important Determinants Of International Capital Movements RATE OF INTEREST: An important factors which has a bearing on the international capital movements is differences in the rate of interest. According to L.M.Bhole ,” Like population migration, capital migration can be and has been explained in terms of the “PULL” and “PUSH FACTORS”. As far as the recent increase in capital flows is concerned, greater weight has to be given to the push factors, particularly the falling interest rates in the US and some other countries. INTEGRATION OF FINANCIAL AND OTHER MARKETS:- The various forms of foreign capital movements depends upon the degree of openness of the financial and other markets and the extent of their international integration. In the recent years most of the countries have adopted the policy of deregulation, liberalisation, privatisation and structural adjustments. They have also dismantled various control related to trade, foreign exchange, foreign investment, ownership and capital flows. All these changes have contributed to recent increase in capital flows. Rapid improvements in technologies for collecting, processing, and disseminating information, along with the opening of domestic financial markets, the liberalisation of capital account transactions, and increased private savings for retirements have stimulated financial innovation and created a larger pool of internationally mobile capital. At the same time, consolidation in the global

Page | 20 banking industry and competition from non-bank financial institution [ including mutual funds ] have lured new players to the international financial area. These trends accelerated in the 1990s, expanding investments opportunities for saver and offering borrowers a wide array of sources of capital. The same trends are expected to continue into the 21st century. GROWING POOL INTERNATIONAL FINANCIAL CAPITAL:- Over the last two decades, the financial markets of leading industrial countries have transformed into a global financial system, permitting larger amounts of capital to be allocated not only to theirs economies, but also to developing economies. Firm in developing and industrial countries a like are raising more funds from international securities markets. Multinational corporations are registering their equity on more than one country’s stock exchange and raising funds from financial markets in different economies. Mutual funds, hedge funds, pension funds, insurance companies and other investments and asset managers now compete with banks for national savings. Even though this phenomenon has been confined so far primarily to developed economies, it has started to spread to some developing countries too. Institutional investors have taken advantages of the easing of restrictions in many developed countries to diversify their portfolios internationally, enlarging the pool of financial capital potentially available to developing economies. According to world development report of 1999-2000, in 1995 these investors controlled 20trillion dollars, 1980 of which only 2 percent was invested abroad. Thus, there was a tenfold increase in the funds and a fortyfold increase investments abroad. LIBERALISATION OF CAPITAL ACCOUNT TRANSACTIONS AND MOVE TOWARDS FLEXIBLE EXCHANGE RATE REGIME:- The 1990s have seen a consistent trend toward more flexible exchange rate regimes and the liberalisation of capital account transactions. The latter involves changes in policies toward different types of private capital flows, such as foreign direct investments, foreign bond and equity investments, and short term borrowing from abroad. Most countries have moved towards capital account convertibility as part of wide-ranging gradual economic reform program that includes measuring to strengthen the financial sector. STABILITY:- Relative stability of economics factors especially rates of inflation, external value of different

Page | 21 currencies, etc. Also determine foreign capital flows. Along with economic stability, political stability is an important factors which determines international capital movements. GOVERNMENT POLICIES:- Policies of governments with respect to privatisation, foreign investment, foreign exchange, liberalisation, taxation, etc. Are like to influence the capital inflows. If the governments adopt a policy of liberalisation, deregulation and dismantling of control related to investments as being undertaken in India since 1991 it will encourage foreign capital inflows to the countries. SOCIAL AND ECONOMIC OVERHEADS:- Infrastructural facilities, availability of skilled labour, advances in computer and telecommunication technologies, etc. Will influence private capital investment into the country. Labour policies will also have a bearing on the foreign investments. The market potential, i.e. the ability of the market to absorb the whole range of new products, is also likely to influence the inflow of foreign capital. CREDIT RATING:- The credit rating and credit standing of nation, which depend on economic, political and social stability, also influence foreign capital flows. SPECULATION:- Short-term capital movement may be influenced by speculation relating to expected changes in interest rates or rate of return or foreign exchange rates. PROFITABILITY:- Foreign capital movement are also influenced by profitability considerations of investments. It is noteworthy that an overwhelming proportion of international capital flows towards developing countries is directed towards middle-income countries. Notwithstanding fluctuation over the year, this concentration has increased, especially with regard to FDI and portfolio flows. In particular, share of East Asia and Pacific region in portfolio investment has increased. Inflo of debt-creating capital toward developing countries declined sharply in the wake of the East Asian crisis

Page | 22 Role Of Foreign Capital Foreign Capital had played an important role in the early stages of industrialisation of most of the advanced countries of today like countries of Europe and North America. There is a general view that foreign capital, if property diverted and utilised, can assist economic development of developing countries. These countries need resources to finance investment in health, education, infrastructure and so on. It can supplement a country’s domestic saving effort and foreign exchange earnings. A number of studies have confirmed that international capital flows can contribute significantly to promotr groth in developing countries by augmenting domestic savings, reducing cost of capital, transferring technology, developing domestic financial sector and fostering human capital formation. Foreign capital can contribute to economics development of developing countries in following ways: SUPPLEMENTS DOMESTIC CAPITAL FORMATION:- Economic development depends on , among other things, capital formation. The domestic capital formation is inadequate in LDCs. The foreign capital can supplements the domestic resources to achieve the critical minimum investment to break the vicious circle of loe income-low saving-low investment. If more domestic capital is to be created by country’s own efforts, resources will have

Page | 23 to be diverted from the production of goods requirements for current consumption. This may lead to a cut in present living standards. Thus, foreign capital can help to supplement the domestic capital. ACCELERATES ECONOMIC DEVELOPMENT:- Foreign capital helps to accelerate the pace of economies development by faciliting imports of capital goods, technical know-how and other imports which are required for carrying out development programmes. IMPROVE TRADE BALANCE:- Foreign capital inflow may help to increase a country’s exports and reduced the imports requirements if such capital flows into export oriented and import competing industries. TRANSFER OF TECHNOLOGY:-The foreign capital may facilited transfer of technology to LDCs. It may helps to modernise the production techniques in industry, agriculture and other sector. REALISATION OF EXTERNAL ECONOMIES:- If the foreign capital is allowed to flow into the development of infrastructure it may lead to realisation of external economies which may stimulate domestic investments in the country. INCOME AND EMPLOYMENT:- If foreign capital flow into real sectors in the form of direct investments it helps toi increase productivity, income and employment in the economy. BALANCE OF PAYMENTS ADJUSTMENT:- Inflow of foreign capital, especially the short-term, may be able to provide a breathing space to a deficit country to cover the deficit until a complete adjustments is achieved to correct the balance of payments deficit,. However, such capital movement should be seen as a temporary phenomenon.

Page | 24 Impact Of Foreign Capital ECONOMIC GROWTH:- Capital flow and economic growth are positively related to each other. High surge of capital flow influences the domestic saving, investments and productivity of the country. Impacts of international capital flows on economic growth during post liberalisation into India are very significant. It is argued that capital inflow influences growth and growth influences capital flows. International capital flows make a direct contribution to economic growth. The potential benefits from the flows are realized from improving productivity. Globalisation allows capital to move to attractive destination and it can fuel higher growth. AFFECT A RANGE OF ECONOMIC VARIABLES:- Capital flow affects the range of economic variable such as exchange rate, interest rate, foreign exchange reserve, domestic monetary condition and financial system in the country. Capital inflow induces real exchange rate appreciation, stock markets and real estate boom, and monitory expansion. Appreciation of exchange rate can lead to loss of competitiveness. Inflow of foreign capital has a significant impact on domestic money supply and stock market growth, liquidity and volatility.

Page | 25 INFLATION:- Larger capital flows can spark off inflation due to its impact of monetory expansion. TRIGGER BUBBLES:- Capital inflow may trigger bubbles in asset market and stock market. VOLATILITY:- Portfolios flows are likely to render the financial market more volatile through increase linkage between the domestic and foreign financial markets. Capital flows expose the potential vulnerability of the economy to sudden withdrawals of foreign investor from the financial market, which will affect liquidity and contribute to financial market volatility. BALANCE OF PAYMENTS:- Foreign direct investment inflow tend to worsen the current account in the short run. The ong-term effects on the balance of payments depends, among other things, on the operating characteristics of FDI enterprises, notably their export propensity, the extent to which they rely on imports inputs, including technology imports, and on the volume of profit-repatriation. Of course, there are indirect effect too. Multinationals can conceivably increase the export propensity of domestic firms through spill over effects. Further, if domestic production by multinational substitutes for previously imported goods, FDI can reduce the total import bill.

Page | 26 Drawbacks Of Foreign Capital Foreign capital may give raise to serious problems in the recent countries. It has been recognised that sudden and large surges in capital flows cause several problems. Large capital flows could push up monetary aggregates, engender inflationary pressures, destabilise exchange rates, exacerbate the current account position, adversely affect the domestic financial sector and distrupt domestic growth trajectories if and when such flow get reversed or drastically reduced. Some of the drawbacks associated with international capital flows are discussed below. INEFFICIENT ALLOCATON OF RESOURCE AND PRODUCTION DISTORTION:- Foreign capital has a tendency to flow to high profit areas rather than the priority areas. The international capital inflows may be devoted to consumption which has a low social value or may be invested in project that generates low social returns. Thus, the use of foreign capital may involve inefficient allocation of resources and may create distortion in production structure. Therefore, it may not help to increase productivity, output and employment.

Page | 27 DESTABILISE THE ECONOMIES:- Since the international capital flows are generally unstable, uncertain, unsustainable and quickly reversible they have a tendency to destabilise the economies of recipient countries. The volume, timing and composition of capital flow are uncertain. Changes in internal factors such as loss of credit worthiness, etc. May tend to stop the inflows or even lead to outflows. The inflow may tend to increase the money supply and lead to domestic inflation. When the capital inflows are reversed there may be rise in interest rates, fall in liquidity, depreciation of currency, etc. All of this may leads to serious balance of payments crisis. HIGHLY VOLATILE IN NATURE:- International capital flows are inherently unsustainable, volatile and unstable in nature. They are subject to external shocks and internal policies. This increase instability in the recipient countries. REDUCES THE EFFECTIVENESS OF MONETARY POLICY:- International capital flows reduced the effectiveness of monetory policy. The pressures against the exchange rate can quickly become very large and the central banks may be faced with the possibility of a run on their currencies. The central banks may not be effective to prevent it. HIGH COST OF FOREIGN CAPITAL:- foreign currency borrowing may imply a lot of uncertainties due to floating interest rates. There are many non-economics cost associated with foreign capital such as problems related to foreign ownership and control, dumping of outdated technology, loss of autonomy of domestic policies dependence, and so on. Foreign equity capital also gives rise to drain of resources in the form of dividends and so on. Foreign borrowing give rise to the problem of debt trap. INAPPROPRIATE TECHNOLOGY:- the technologies brought in by the foreign capital may not be adaptable to the consumption needs, size of domestic market, availability of resources, stage of economic development in the country and so on. it become a clear from above analysis that undue dependence on foreign capital of whatever type [ i.e. equity, debt, short-term and long-term capital ] is bound to create large number of harmful consequences in the recipient countries.

Page | 28 Foreign Capital Flows To Developing And Emerging Economies Gross capital inflow at global level have increased substantially since the late 1980s. Net capital flows to developing countries increased sharply during early 1990s and reached a peak at us 298 billion dollar in 1997. Under recent global crisis it has experienced a sharp decline. THE TRENDS IN PAST:- in the past world war 2 period upto the 1970s, international capital flows were primarily confined among industrial economics. Net capital inflows towards developing countries started picking up in the early 1970s. In the aftermath of the 1st oil price shock. Such flows were mainly debt flows in the forms of syndicated banks leading. This phase continued unabated until the early countries increase significantly- at a compound annual rate of 24 percent – until the Latin American debt crisis of 1982 Hurst the bubble. These led to a considerable slowdown in capital flow particularly in respects of commercial bank leading to developing countries. Between 1983 and 1989, capital flows decline to less that a third of their level in 1977-82. With resending commercial bank lending, foreign direct investment inflows to developing countries started picking up in the early 1980s. The quantum of FDI, however, continued to remain lower that ebt flow. By the end of the 1980s, direct investment inflows to developing countries were only one- eight of the flow to developed countries, while portfolio flows to developing countries were virtually non-existent. Net FDI inflows toward developing countries, however, increased at a sustained and high pace between 1987 and 1997. In 1994, these flows surpassed net debt flow for

Page | 29 the 1st time . Net external debt flow as well as inflows in the form of portfolio capital also gathered momentum in the early 1990s. CHANGE IN THE STRUCTURE:- The pattern of foreign capital flows into developing countries and economies in transition has changed in the 1990s unlike most of the 1980s, when foreign capital follow to developing countries and economies were strongly depressed because of the external debt crisis. The 1st half of the 1990s had been characterised by more than a doubling of the inflow of external capital into developing economies. It has increased from us 86.6 billion dollar in 1990 to us 277.3 billion dollar in 1995 and thereafter it has fallen to us 159.6 billion dollar in 2002. The increase in net total foreign capital inflow has-been accompanies by substantial changes in their structure. The most striking structural change is that virtually all the net increased in financial flow has come from private flow. FLOWS TO EMERGING MARKETS:- Among the developing country some are termed as Emerging Market Economies. They are those developing countries “which carry distinct features and are more developed than the rest. Such economies are featured as showcases for high economic performance and quickly labelled [ by the late 1980s ] as emerging market economies [ EMEs ]. The world market in the above label was given emphasis for the preference of the identified countries to be market oriented in their policy pursuit.” The composition of flow in respect of emerging markets economies also altered significantly, with private flow exceeding official flows by the end of the 1980s. Furthermore, while bank lending was the major components of capital flows to emerging markets in the 1970s. Equity and bond investors become dominant in starting in the early 1990s. Portfolio investment exceeded bank lending in eight years of the last decades. The range of investors purchasing emerging market securities broadened. Specialised investors such as hedge funds and mutual funds accounted for a bulk of portfolio inflow up to mid-1990s. In the subsequent years, pension funds, insurance companies and other institutional investors increased their presence in emerging markets. Although portfolio flow became important, it was FDI which accounted for the bulk of private capital flows to emerging markets economies – witness a six-fold jump between 1990 and 1997. International bank lending to developing countries also increased sharply during this period, and was most pronounced in Asia, followed by Eastern Europe and Latin America. Much of the increasing in bank lending was in the form of short-terms claims, particularly on Asia.

Page | 30 VOLATILITY OF CAPITAL FLOWS:- The volatility and possibility of reversal associated with capital flow were brought out quite strikingly by the East Asian and the subsequent financial crisis. In the late 1990s, capital flows to developing countries received several shocks – first from the Asian crisis of 1997-98, then by the turmoil in global fixed income markets, more recently by the collapse of the argentine currency board peg in 2001 and spate of corporate failures and accounting irregularities in the us in 2002. Net flow to developing countries decline in the immediate aftermath of East Asian finance crisis. The fall was particularly sharp in the form of bank lending and bonds, reflecting uncertainty and risk aversion. On the other hand FDI inflows to EMEs [ emerging market economics ] were relatively stable over the period 1997-2002. This highlights the stabilising feature of FDI inflows vis-a-vis other private capital flows [ both debts and equity ] In 2000, there was, in fact, a net out flows from developing countries on account of debt flows. In 2002, net capital flows fell again, remaining far below the 1997 peak due to the global economic slowdown and a series of accounting and corporate failure which severely undermined investors confidence. Global FDI inflows into developing countries, fell by 41percent in 2001, followed by the decline of another 20percent in 2002. This was attributable to weak economic growth, large sell- offs in equity markets, lower corporate profits, slowdown in corporate restructuring and a plunge in cross-border mergers and acquisitions. The usa and the uk accounted more than half of the decline. FLOWING TO SMALL GROUP OF DEVELOPING COUNTRIES:- A small group of developing countries has consistently attracted most foreign investment. Brazil, Indonesia, ,Malaysia, Mexico and Thailand have been among the top 12 recipients in each of the past three decades. China [ including honkong ] joined this group in 1990 and India in the late 1990s. RECENT TRENDS IN CAPITAL FLOWS TO EMERGING MARKETS:- During the financial crisis, capital flows to emerging markets plummeted as investors fled riskier markets fo us and European safe heavens. As emerging market have recovered, many of them faster than advanced economies, investors are moving capital back to developing economies. However, flow remaining significantly depressed relative to 2007. Asia and Latin America have benefit from stabilizing market and recovering portfolio inflows.

Page | 31 According to institute of international finance [IIF ] forecasts net private flow to emerging Asia to rise 191 billion dollar in 2009 and 273 billion dollar in 2010, from 171 billion dollar in 2008 and 422 billion dollar in 2007. The main turnaround has occurred in investment in equities, from sizable net outflows in 2008 [57 billion dollar ] to net inflows in 2009 [51 billion dollar ] Net private inflows in emerging Latin American markets will be about 100 billion dollar in 2009, with five countries – Brazil, China, Colombia, Mexico and Peru – accounting for 92 percent of the net inflow.Net private flows to this region were 132 billion dollar in 2008 and 228 billion dollar in 2007. The net private capital flow to emerging market and developing countries were 700billion dollar in 2007, came down to 259.5 billion dollar in 2008 and rose 521 billion dollar in 2011. The net private direct investment was 440billion in 2007, rose to 479.6billion dollar in 2008 and fell to 418 in 2011. Financial condition in emerging markets began ti tighten during the 2011. Funding condition worsened for banks, contributing to a tightening of lending standards, and capital inflows diminished, However this flows are now returning with new vigour, and risk spreads have come down again. EMERGING MARKET AND DEVELOPING COUNTRIES CAPITAL FLOWS Average 2001-03 2007 2008 2011 Private capital flows – Net 110.1 700.1 259.5 521 Private Direct Investment - Net 155.6 440.2 479.6 418.3 Private Portfolio Flows - Net -32.1 105.9 -72.9 101.1 Other Private Capital Flows – Net -13.4 154.1 -147.1 1.6 Official Flows – Net -10.1 -92.6 -97.8 -109.8 Changes In Reserve -189 -1210.0 -724.9 -831.6 IMF World Economic Outlook, April 2012.

Page | 32 Capital Flows To India Following liberalisation and structural adjustment since 1991, India had embarked on a policy of encouraging capital flows in cautious manner. The strategy has been to encourage long-term capital inflows and discourage short-term and volatile flows. Broadly speaking, India’s approach towards external capital flows could be divided into three main phases. FIRST PHASE:- In the first phase – starting at the time of independence and spanning up to the early 1980s. India’s reliance of external flows was mainly restricted to multilateral and bilateral concessional finance. SECOND PHASE:- The second phase mainly refers to late 1980s. In the context of the widening of the current account deficit during the 1980s, India supplemented the traditional external sources of financing with resource to commercial loans including short-term borrowing and deposits from non-resident Indians [ NRIs ]. As a result, the proportion of short-term debt in indias total external debt increased significantly by the late 1980s.

Page | 33 THIRD PHASE:- The third phase refers to the period since 1991. Until the 1980s, India’s development strategy was focused on self-reliance and import substitution. There was a general disinclination towards foreign investment and private commercial flows. Since the initiation of the reform process in the early 1990s, however, India’s policy stance has changed substantially. India has encourage all major forms of capital flows. The broad approach to reform in the external system after the Gulf crisis was delineated in the report of the high level committee on balance of payments under the chairman ship C. Rangarajan. It recommended, inter alia, a compositional shift in capital flows away from debt to non-debt creating flows; strict regulation of external commercial borrowing, especially short-term debt; discouraging volatile elements of flows from non-residents Indians; gradual liberalisation of outflow; and disintermediation of government in the flow of external assistance. In the 1990s, foreign investment has accounted for the major part of capital inflows to the country. The broad approach towards foreign direct investment has been through a dual route i.e., automatic and discretionary, with the ambit of the automatic route progressively enlarged to many sectors, coupled with higher sector caps stipulated for such investments. Portfolio investments are restricted to selected players, viz., Foreign Institutional Investors [ FIIs ]. COMMERCIAL BORROWINGS:- The approach to external commercial borrowings has been one of prudence, with self imposed ceilings on approvals and a careful monitoring of the cost of raising funds as well as their end use. External commercial borrowing are also subject to a “dual route”; these can be accessed without any discretionary approvals up to a limit, beyond which specific approval are needed from the reserve bank/government. Short-term credits above us 20 billion dollar require prior approval of the reserve bank. In respect of NRI deposits, some control over inflows is exercised through specification of interest rate ceilings. EXTERNAL ASSISTANCE:- As regards external assistance, both bilateral and multilateral flows are administered by the government of India and the significance of official flows has decline over the years. Thus, in managing the external account, there is limited reliance on external debt, especially short-term external debt. Non-debt creating capital inflows in the form of FDI and portfolio investment

Page | 34 through FIIs, on the other hand, are encourage. India has adopted a cautious policy stance with regard to short term flows. Especially in respect of the debt-creating flows. CAPITAL OUTFLOWS:- In respect of capital outflows, the approach has been to facilitate direct overseas investment through joint venture and wholly owned subsidiaries and provision of financial support to promote export, especially projects exports from india. Resident corporate and registered partnership firm have been allowed to invest up to 100percent of their net worth in overseas joint venture or wholly owned subsidiaries, without any separate monetary ceiling. Exporter and exchange earners have also been given permission to maintain foreign currency account and use them for permitted purpose which facilitate their overseas business promotion and growth. Thus, over time, both inflows and outflows under capital account have been gradually liberalised. CAPITAL FLOW TO INDIA:- Since the introduction of reforms in the early 1990s, india has witnessed a significant in cross border capital flows. The net capital inflows have more than doubled from an average of us 4billion dollar during the 1980s to an average of about us 9billion dollar during 1993-2000. The proportion of non debt flows in total capital flows has inceased from about 5 percent in the later half of the 1980s to about 43 percent in 1990s. Net capital flows rose from a level of us 25.0 billion dollar in 2005-06 to reach us 107.9 billion dollar in 2007-08. The impressive growth in 2007-08 was due to i. A quantum jump in eternal commercial borrowing net; ii. A significant rise in foreign direct investment inflows with a simultaneous rise in outward investment; iii. Large inflows in the form of non-resident Indians [ NRI ] deposits; iv. An initial fall in portfolio investment which was compensated by recovery in the latter half of the years. Notwithstanding a significant increase in overall capital inflows. Particularlu foreign investment during the 1990s, these remain smaller than other countries of similar economic size. In 2009-10, the net capital inflow was us 1.6billion and rose to us 62billion in 2010-2011 mainly on account of trade credit and loans [ ECBs and banking capital ]. The net non-debt flows i.e. the net foreign investment comprising FDI and portfolio investment [ADRs/GDRs and FIIs ] declined from us 50.4billion dollar in 2009-10 to us 39.7 billion in 2010-11.

Page | 35 Inward FDI showed a declining trend while outward FDI showed an increasing trend in 2010-11. Inward FDI declined from us 33.1 billion in 2009-10 to us 25.9 billion dollar in 2009-10. The net portfolio investments flows witnessed marginal decline to us 30.3 billion dollar during 2010.11 as against us 32.4 billion dollar in 2009-10. Other categories of capital flows, namely debt flows of ECBs, banking capital, and short-term credit recorded significant increase in 2010-11 2007-08 2009-10 2010-11 Net capital inflows 106585 51634 61989 1.External assistance [ net ] 2114 2890 4941 2.External commercial borrowing [ net ] 22609 2000 12506 3.Short-term debt 15930 7558 10990 4.banking capital [ net ] of which Non-resident deposits [ net ] 11759 179 2083 2922 4962 3238 5.Foreign investment [ net ] of which FDI [ net ] portfolio [ net ] 43326 15893 27433 50362 17966 32396 39652 9360 30293 6.Rupee debt service -122 -97 -68 7.Other flows [ net ] 10969 -13162 -10994 Effect Of Policy Measure:- Capital flows have witnessed sharp occasional swing in response to policy measures. The policy measure include changes in reserve requirements for financial initities, variation in the pace and sequencing of the reform measures and revisions in conditions governing end-use of external funds. Co-ordination and sterilisation of foreign inflows were also undertaken to prevent undue pressure on the exchange rate. Measures have also been to maintain orderly condition in the financial markets and to ensure that capital flows promote efficiency without having an adverse impact on economy stability.

Page | 36 Conclusion International capital movement have played an important role in the economic development of several countries. They provide an outlet for saving for the lending countries which helps to smooth out business cycles and lead to a more stable pattern of economic growth. On the other hand, they help to finance development of under-developed countries. They also help to ease the balance of payments problems of developing economies. Thus, international capital movement have an important role to play in the balance of payments adjustments mechanism. As compared to developed countries of the world, the developing countries suffering from scarcity of capital and poor technology. Therefore, they rely on international capital floes to finance their investment opportunities and hence, to raise income and payment.

Page | 37 Bibliography Websites referred: www.google.com www.wikipedia.com www.ask.com www.alexa.com www.biographies.com BOOK:- Economics Od Global Trade And Finance Author:- Johnson

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