International capital movements may be classified as follows:
(i) Home and foreign capital;
(ii) Government and private capital;
(iii) Foreign Aids;
(iv) Short-term and long-term capital; and
(v) Foreign direct investment (FDI)
(I) Home and Foreign Capital:
On the balance of payments of a country an explicit distinction is made between home capital and foreign capital. Home capital refers to investments made abroad by the residents of the country concerned, while foreign capital refers to the investments made by foreigners in this country.
Thus, the former implies outflow of capital and the latter implies inflow of capital funds in the balance of payments account of the country under consideration. Apparently, the net investment position of the country can be known by the algebraic difference between the debits and credits of both types of capital investments.
(ii) Government and Private Capital:
When in investing capital abroad, the investor (whether government or private body) keenly participates in organisational matters, it is referred to as direct investment. For instance, direct ownership and organisation of a foreign factory, mines, sales agency, etc., are cases of direct investment.
If, however, the investor has only a sort of property interest in investing the capital funds in buying equities, bonds, securities or depositing with commercial banks abroad or so, it is referred to as portfolio investment.
Under portfolio investment, the investor does not migrate with his capital and his basic interest remains in the earning of interest or dividends abroad or to make speculative gains in buying foreign bonds, equities and securities. While, under direct investment of capital, investor’s migration is also very frequent. Usually, borrowing countries prefer portfolio investment while lending countries prefer direct investment because it entails management rights and control.
Further in an inflationary situation, the real value of fixed interest earnings of portfolio investment deteriorates while money value of real property in direct investments increases.
(Iii) Foreign Aids:
Foreign aids refer to transfer payments which are unilateral gifts for aid. The receiving country has no obligation whatsoever, to repay the grants made by the donor country. Usually, developed countries give such aids to developing countries for their development planning. The aid may sometimes be given for military purposes also. Generally, aids are given for a specific use and it must be fulfilled by the recipient country.
(iv) Short-term and Long-term Capital:
A short-term capital is embodied in a credit instrument which is redeemable within a year. For example, chequable bank deposits in a bank abroad is a short-term capital. Similarly, foreign bonds which mature within a year also constitute short-term capital. Short-term capital movements are usually speculative in nature.
Long-term capital, however, refers to such credit instruments which have a maturity period of more than one year or no maturity at all but consist a title to ownership, such as share of stock and other equities or a deed to property. Long-term capital flow is perpetual and stable over a period of time.
Foreign Investment has two dimensions:
1. Portfolio Investment
2. Direct Investment
It refers to short term and long term investment devoid of any managerial control. It refers to pure financial investment.
It implies primarily an international movement of capital. Interest Rate differentiation remain the factor in determining the flow of port folio investment as direction or capital mobility.
(v) Foreign Direct Investment (FDI):
It refers to long-term real business investment of a firm abroad. It involves transfer of capital with the extension of a business enterprise from its home country into a foreign host country. The flow of FDI is least determined by the interest rate differentials.
1. Portfolio investment (PI) refers to an investment in securities without participation in the management or operations of a firm. Under PI. The investors have no control over decisionmaking.
2. Foreign direct investment is the investment combined with some degrees of ownership and management.
In comparison to FDI
3. PI has certain advantages such as:
1. A relatively low transactions cost
2. Lesser investment
3. Greater probability for diversification of investment.
4. There are investment constraints such as:
1. Unfavourable tax rates and taxation laws (which may result into double taxation, over taxation, bureaucratic red tape)
2. Foreign exchange controls (e.g., ban on purchase of securities by foreigners or purchase in foreign markets)
3. Government regulations over the capital markets (e.g., ceilings on the maximum number of securities purchased by foreign investors).
5. From a country’s view point, there are inflows and outflows of investments. Inflow of investments means that foreigners are investing in the country. Outflow implies that the country’s nationals are investing into the foreign country. Thus, outflow of FDI means the flow of FDI out of the country. Inflow of FDI obviously means the flow of FDI into the country.
6. The flow of FDI is observed as the amount of FDI over a period of time, usually a year.
7. The stock of FDI is measured as the total accumulated value or foreign owned assets at a given point of time.