Capital Flight


DEFINITION of 'Capital Flight'

A large-scale exodus of financial assets and capital from a nation due to events such as political or economic instability, currency devaluation or the imposition of capital controls. Capital flight may be legal, as is the case when foreign investors repatriate capital back to their home country, or illegal, which occurs in economies with capital controls that restrict the transfer of assets out of the country. Capital flight can impose a severe burden on poorer nations, since the lack of capital impedes economic growth and may lead to lower living standards. Paradoxically, the most open economies are the least vulnerable to capital flight, since transparency and openness improve investors’ confidence in the long-term prospects for such economies.

BREAKING DOWN 'Capital Flight'

The term “capital flight” encompasses a number of situations. It can refer to an exodus of capital either from one nation, from an entire region or from a group of countries with similar fundamentals. It can be triggered by a country-specific event, or by a macroeconomic development that causes a large-scale shift in investor preferences. It can also be short-lived or carry on for decades.

Illegal capital flight generally takes place in nations that have strict capital and currency controls. For example, India’s capital flight amounted to billions of dollars in the 1970s and 1980s due to stringent currency controls. Liberalizing the economy from the 1990s onward reversed this capital flight as foreign capital flooded into the resurgent economy.

Capital flight can also occur in smaller nations beset by political turmoil or economic problems. Argentina, for instance, has endured capital flight for years due to a high inflation rate and a sliding domestic currency.

Currency devaluation is often the trigger for large-scale – and legal – capital flight, as foreign investors flee from such nations before their assets lose too much value. This phenomenon was evident in the Asian crisis of 1997, although foreign investors returned to these countries before long as their currencies stabilized and economic growth resumed.

Because of the specter of capital flight, most nations prefer foreign direct investment (FDI) rather than foreign portfolio investment (FPI). After all, FDI involves long-term investments in factories and enterprises in a country, and can be exceedingly difficult to liquidate at short notice. On the other hand, portfolio investments can be liquidated and the proceeds repatriated in a matter of minutes, leading to this capital source often being regarded as “hot money.”

In a low-interest rate environment, “carry trades” – which involve borrowing in low-interest rate currencies and investing in potentially higher-return assets such as emerging market equities and junk bonds – can also trigger capital flight. This would occur if interest rates look like they may head higher, which causes speculators to engage in large-scale selling of emerging market and other speculative assets, as was seen in the late spring of 2013.

  1. Inflation

    The rate at which the general level of prices for goods and services ...
  2. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment ...
  3. Systematic Risk

    The risk inherent to the entire market or entire market segment. ...
  4. Devaluation

    A deliberate downward adjustment to the value of a country's ...
  5. Currency Carry Trade

    A strategy in which an investor sells a certain currency with ...
  6. Country Risk

    A collection of risks associated with investing in a foreign ...
Related Articles
  1. Investing Basics

    Investing in Foreign Stocks: ADRs and GDRs

    Depositary Receipts are easy ways to invest in foreign stocks, regardless of what part of the world you live in.
  2. Options & Futures

    Evaluating Country Risk For International Investing

    Investing overseas begins with determining the risk of the country's investment climate.
  3. Forex Fundamentals

    What Causes A Currency Crisis?

    Find out what can cause a currency to collapse, and what central banks can do to help.
  4. Economics

    Exploring The Current Account In The Balance Of Payments

    Learn how a country's current account balance reflects the country's economic health.
  5. Economics

    Why Governments Issue Foreign Bonds

    Government bonds issued in foreign currency have drawn a growing amount of interest in recent years. This article explores why governments, particularly those in emerging markets, choose to denominate ...
  6. Mutual Funds & ETFs

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  7. Taxes

    Get A Tax Credit For Your Foreign Investments

    The foreign tax credit provides a break on investment income made and taxed in a foreign country.
  8. Forex Education

    Currency Carry Trades 101

    This strategy can provide returns even if the currency pair doesn't move a cent.
  9. Investing Basics

    Why Country Funds Are So Risky

    High returns come at a price, but country funds may still be a good bet.
  10. Stock Analysis

    The 5 Biggest Russian Oil Companies

    Discover the top Russian oil companies by production volume and find out more about their domestic and international business operations.
  1. What are some historic examples of hyperinflation?

    Hyperinflation is an extreme case of monetary devaluation that is so rapid and out of control that the normal concepts of ... Read Full Answer >>
  2. What is "hot money"?

    "Hot money" refers to funds that are controlled by investors who actively seek short-term returns. These investors scan the ... Read Full Answer >>
  3. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  4. What does marginal utility tell us about consumer choice?

    In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction ... Read Full Answer >>
  5. What is the difference between JIT (just in time) and CMI (customer managed inventory)?

    Just-in-time (JIT) inventory management focuses solely on the need to replenish inventory only when it is required, reducing ... Read Full Answer >>
  6. What are some examples of Apple and Google's best-selling product lines?

    There are many good examples of product lines in the technology sector from some of the largest companies in the world, such ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!