What is 'Capital Outflow'
Capital outflow is the movement of assets out of a country. Capital outflow is considered undesirable and results from political or economic instability. The flight of assets occurs when foreign and domestic investors sell off their holdings in a particular country because of perceived weakness in the nation's economy and the sense that better opportunities exist abroad.
BREAKING DOWN 'Capital Outflow'Excessive capital outflows from a nation indicate that political or economic problems exist beyond the flight of assets itself. Some governments place restrictions on exiting capital, but the implications of tightening often send up red flags regarding the state of the host economy.
Capital outflow exerts pressure on macroeconomic dimensions within a nation, discouraging both foreign and domestic investment. Reasons for capital flight include political unrest and low domestic interest rates.
For example, in 2016, Japan lowered interest rates to negative levels on government bonds and implemented measures to stimulate expansion of gross domestic product (GDP). Extensive capital outflow from Japan in the 1990s triggered two decades of stagnant growth in the nation that once represented the world's second-largest economy.
Governmental restrictions on capital flight seek to stem the tide of outflows, effectively supporting the banking system that can run aground in numerous ways. A lack of deposits may force a bank toward insolvency if significant assets exit and the financial institution is unable to call loans to cover the withdrawals.
Greek turmoil in 2015 forced government officials to declare a week-long banking holiday while restricting consumer wire transfers solely to recipients who owned accounts in Greece. Capital controls in developing nations, meant to protect the economy, signal weakness that spurs domestic panic and resistance to foreign investment.
Effect on Exchange Rates
As capital exits, a nation's currency supply increases as individuals, as in the case of China, sell yuan to acquire U.S. dollars. The resultant increase in the supply of yuan decreases the value of that currency, decreasing the cost of exports and increasing the cost of imports. The subsequent depreciation of the yuan triggers inflation as export demand rises and import demand falls.
In the last six months of 2015, $550 billion of Chinese assets left the country in search of a better return on investment (ROI). While government officials expect modest amounts of capital outflows, the large amount of capital flight warranted both Chinese and global concerns. A more detailed analysis of the asset departures in 2015 revealed that about 45% of the $550 billion served to pay down debt and finance purchases of foreign business competitors.