Capital Outflow: Causes, Effects & What to Know

What is Capital Outflow?

Capital outflow is the movement of assets out of a country. Capital outflow is considered undesirable as it is often the result of 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 belief that better opportunities exist abroad.

Understanding Capital Outflow

Excessive capital outflows from a nation indicate that political or economic problems exist beyond the flight of the assets themselves. Some governments place restrictions on capital outflow, but the implications of tightening restrictions is often an indicator of instability that can exacerbate the state of the host economy. Capital outflow exerts pressure on macroeconomic dimensions within a nation and discouraging both foreign and domestic investment. Reasons for capital flight include political unrest, introduction of restrictive market policies, threats to property ownership and low domestic interest rates.

For example, in 2016, Japan lowered interest rates to negative levels on government bonds and implemented measures to stimulate the expansion of gross domestic product. 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.

Capital Outflows and Restrictive Controls

Governmental restrictions on capital flight seek to stem the tide of outflows. This is usually done to support a banking system that could collapse 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.

The turmoil in Greece in 2015 forced government officials to declare a week-long bank holiday and restrict consumer wire transfers solely to recipients who owned domestic accounts. Capital controls are also used in developing nations. These are often designed to protect the economy, but they can also end up signaling weakness that spurs domestic panic and freeze on foreign direct investment.

Capital Outflow and Exchange Rates

A nation's currency supply increases as individuals sell currency to other nations. For example, China sells 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 because the demand for exports rises and the demand for imports falls.

In the latter half of 2015, $550 billion in Chinese assets left the country seeking a better return on investment. While government officials expected modest amounts of capital outflows, the large amount of capital flight raised both Chinese and global concerns. A more detailed analysis of the asset departures in 2015 revealed that approximately 45 percent of the $550 billion paid down debt and finance purchases of foreign business competitors. So, in this particular case, the concerns were largely unfounded.