Essay About Transnational Capital Flows And Foreign Exchange

Should Rigorous Controls Be Imposed On Transnational Capital Flows?
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I. INTRODUCTION
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 Ð- 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
Crisis
1) A period of high overvaluation followed by sudden devaluation of the national
currency.
2) Episodes of currency instability due to a sharp increase in capital inflows
followed by an equally sharp reversal. Such swings due to internal or external
policy changes that produce divergences in domestic financial conditions relative
to those of the rest of the world, often initially reflected in interest-rate
differentials and prospects of capital gains.
Mexican
Crisis
1) Sudden decline in commodity prices on economies heavily dependent on export
of raw materials.
2) Reversals of capital flows associated with deterioration in the macroeconomic
conditions