Long Term Capital Flows

Long Term Capital Flows 

While explaining the book-keeping of the balance of payments a reference has been made to capital flows. You will now learn that the long-term capital flows are caused by the development needs of the various countries. Presently the world can be broadly divided into the capital surplus countries and the capital deficit countries. Most developed countries are the capital surplus countries, while almost all developing countries are the capital deficit countries. Since the countries falling in the latter category have not been able to save adequately for their investment requirements they import foreign capital from the capital surplus countries. 

Foreign capital usually takes two main forms :

 i) private foreign investment, and

ii) foreign aid. 

Before World War II, private foreign investment was used by the colonial powers to exploit the market

of the colonies. Since these colonies have become independent, the penetration of private foreign investment in its earlier form has stopped. 

Currently private foreign investment assumes two forms : i) direct foreign investment, and ii) indirect foreign investment. The bulk of the direct foreign investment is now made by the multi-national corporations (MNCs), These MNCs provide substantial amount of financial resources to the countries where they set up branches and subsidiaries. The capital recipient countries thus get substantial help in meeting their needs of capital for growth. But these countries subsequently face problems when repatriation of profits by MNCs starts or the production plans of these companies start causing distortions in their industrial structure,

Indirect foreign investment takes place when nationals of a country make investments in the shares and debentures of the foreign companies. At present most of the private foreign investment is'made in the direct rather than indirect form. Foreign aid, refers to official loans and grants given in currency or in kind from developed countries and international financial institutions to less developed countries.

These loans and grants are provided for development purposes. In international finance only those loans and grants are relevant which are provided in currency. The chief characteristic of such aid is that it is made available on concessional terms implying that the rate of interest is lower and the maturity period is longer. Foreign aid rarely involves any foreign exchange problems when it is provided. Since aid is given by the developed countries in their own currencies and by the international financial institutions in the currencies of the developed countries,it can be used easily to buy capital equipment and technology in the international markets. However, the problem arises when debt servicing obligations are to be met.

For this purpose aid recipient ,countries would need foreign exchange which they can acquire only by having surpluses in their balance of payments. This in most cases is quite difficult to accomplish. As a result most countries inviting foreign capital are now in tight corner. They have either already fallen in the debt trap or are facing the risk of falling into it.