Capital account

What is the capital account?
EIU capital account presentation
Foreign direct investment
Portfolio flows
IMF credits
Medium & long term debt inflows (disbursements)
What is capital flight?
Other capital flows (net)

What is the capital account?
The capital account records international capital flows.

Short-term capital movements
Short-term flows into liquid assets such as bank deposits and Treasury bills are easily reversed and are sometimes characterised as "hot money". Since flows can change direction at the drop of an interest rate, they can cause severe volatility in the currency markets.

Long-term capital movements
Long-term capital includes portfolio investment (stocks and shares) and direct investment (such as building a factory overseas). However, it is perhaps increasingly unrealistic to distinguish between investment in stocks and shares (long-term capital) and the acquisition of Treasury bills (short-term capital).

An outflow today implies current-account income in the future. Indeed, with global deregulation, it is easier for companies to raise their market share by setting up production facilities overseas. The initial direct investment shows as a capital-account outflow. Subsequently remitted profits add to current-account inflows and boost GNP relative to GDP. The value of goods sold, however, does not show up in external trade or increase GDP in the way that exports from home would.

EIU capital account presentation
Most economists think of the capital account like this:

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But the Economist Intelligence Unit forecasts debt stocks and flows, and needs to make the link between these flows and the capital account more explicit. This demands a different presentation:

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So the Economist Intelligence Unit rearranges debt flows - but in underlying terms the two presentations are the same. The red text shows how the current and capital accounts equate in each presentation. The blue text show how debt flows are rearranged in each presentation.

The table below shows all the series used to construct the current and capital account on WorldData. The blue text corresponds to the blue text in the summary table above.

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Foreign direct investment
Direct investment into a country (or flows out of a country). Includes "greenfield" investment and purchases of existing operations. Acquiring a 10% equity stake in a company also counts as direct investment.

Portfolio flows
Financial investment into (or out of) an economy, except where a 10% stake in a company is acquired (which is then counted as direct investment). The Economist Intelligence Unit nets off foreign currency bonds from inflows as these are medium- and long-term debt in our presentation. For inflows, netting off bonds leaves equity investment and foreign activity in the local currency bond markets.

IMF credits
Obtaining finance from the IMF. Purchases and disbursements of loans including transactions within the General Resources Account and loans relating to any Structural Adjustment Facility (SAF), Enhanced Structural Adjustment Facility (ESAF) or Trust Fund Loan (TFL).

Medium & long term debt inflows (disbursements)
Capital inflows generating medium- and long-term debt, consisting of commercial bank loans, official guaranteed loans and international (foreign currency) bond issues.

In the Economist Intelligence Unit presentation of trade and capital flows and debt, this is the crucial line - it's the point at which the IMF current and capital account numbers are married up with the World Bank debt numbers.

What is capital flight?
The relationship between the capital and current accounts is defined as:

cur a/c = -(?res + fdi + ?debt + capital flight)

where:

cur a/c is the current account balance (positive is in surplus)

?res is the change in international reserves (positive is an decrease in reserves, as running down reserves is an equivalent to obtaining a capital inflow)

fdi is net FDI inflows (positive is an inflow)

?debt is the change in the external debt stock (positive is an increase in debt)

capital flight is all other capital flows (positive is an inflow, negative is capital flight)

To define capital flight, rearrange the equation to give:

capital flight = - cur a/c - ?res - fdi - ?debt

This implies that capital flight is all the flows on the capital account not accounted for by changing foreign exchange reserves, net FDI and changes in external debt.

Using China (1998) as an example:
capital flight =  - cur a/c  - ?res  - fdi  - ?debt   
capital flight =  - (28,696)  - (-6,449)  - (41,809)  - (5,190)  = -69,246 

Capital flight in WorldData is -72,277 (note: these figures may change because of subsequent revisions to official figures). The difference can be explained by the way the change in the debt stock is calculated.

The change in the debt stock should be measured before allowing for revaluations due to currency movements. Hence it should be calculated by adding up each individual type of net debt inflow (rather than be looking at the change in the aggregate debt stock).

Net medium and long term debt inflows (inflows less repayments) = (21,131 - 12,031) = 9,100
Net IMF credits = (0 - 0) = 0
Net short term debt inflows = short term debt stock in 1998-short term debt stock in 1997 = 43,112 - 43,992 = -880

Hence the change in the debt stock before allowing for revaluations due to current movements is (9,100 + 0 - 880) = 8,220

So capital flight = -(28,696) - (-6,449) - (41,809) - (8,220) = -72,276

This implies that, once the current account position and sustainable capital flows are taken into account, China suffered from a leakage of capital of $72,276m in 1998.

Other capital flows (net)
Balancing item. Some of this is short-term debt flows, but there are also a host of other flows such as counterparts to valuation changes, exceptional financing and net errors and omissions (statistical discrepancy).

Related topics:
Trade and the current account
Debt