Should Rigorous Controls Be Imposed on Transnational Capital Flows?

Topics: Economics, International economics, Investment Pages: 8 (2156 words) Published: February 3, 2008
Transnational capital flow is a term coined to describe the movement of capital across national boundaries. International financial and capital flows have experienced a phenomenal upsurge during the late twentieth century. According to the latest estimates, foreign exchange to the tune of one to two trillion US dollars is transacted internationally every day. Significantly, exchanges in trade and services constitute only a tiny fraction of these transactions, while the majority is composed of movement of shortterm capital and foreign investment. While the benefits of such flows are manifold, there are negative side-effects too. Unfettered movement of capital in developing countries has triggered off several economic crises in recent history and there is a compelling case for tempering such flows through imposition of adequate controls.

I.i Types of Global Capital Flows
Transnational capital flows can be broadly classified into the following categories: 1) Foreign Direct Investment (FDI): Acquisition of companies, physical investment in plants and equipment.
2) Foreign Portfolio Investment: Investments in capital markets. 3) Loans and credit issued by International Banks to local lenders. 4) Currency transactions, primarily as part of currency hedging strategies. 5) Global insurance.

I.ii Benefits of Free Capital Flows
Free Capital Flows lead to greater flexibility in international financial markets and financial transactions across national boundaries, contributing to overall development of the economy and a rise in living standards, because of increased foreign investment and financing. In such an environment, investors also enjoy higher returns and better portfolio diversification. This translates into deepening efficiency and sophistication of domestic financial markets, by letting the most efficient investors earn profit and ensuring removal of inefficient investors, leading to efficient resource allocation. II. TRANSNATIONAL FLOWS – CONCERNS AND APPREHENSIONS

Developing countries face a much greater risk of financial instability due to free capital flows and unregulated transnational flows.
1. Developing-country financial markets are smaller, so entry or exit of even medium-sized investors from industrial countries is capable of causing considerable price fluctuations, even though their placements in these markets account for a small percentage of their total portfolios. 2. The domestic financial system is more vulnerable because external debt is typically owed by the private sector rather than by sovereign governments and also a higher share is denominated in foreign currencies.

3. Differences in environmental standards causes investment flow to developing countries having less stringent environmental standards to reduce production costs, which adversely affects the environment.

II.i Problems Associated with Free Capital Flows
International capital flows are highly sensitive to domestic macro-economic policies, the soundness of banking systems, and other economic and political developments. 1. Short-term capital flows are often volatile and subject to surges and sudden withdrawals, adversely affecting developing countries.

2. They might also result in loss of autonomy in fiscal policy decision-making national governments II.ii Pointers to Impending Financial Crisis
Pointers Examples
1) Liberalization of the economy with very weak regulation.
2) Crony Capitalism i.e. the nexus between politics and investors, as well as hiding or misrepresentation of facts.
3) Lack of regulatory institutions allowing external short-term borrowings for speculative purposes and long term domestic financing
4) High interest rates and robust economic growth attract foreign banks and hedge funds
5) Foreign fund inflows, rather than FDI, being encouraged
East Asian
1) A period of high overvaluation followed by sudden devaluation of the national currency.
2) Episodes of currency instability due to a...
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