Question

Why is capital flight a problem in most developing countries and what can be done to mitigate it?

word count is 1000 words

Answer 1

Capital flight is the uncertain and rapid movement of financial assets and capital from a country which is motivated by negative fiscal policy , poltical and economic uncertainty. It can be legal when foreign investors send back their capital to hone country or can be illegal when economies imposing capital control to restrict transfer of capital out of the economy .

     It can be occurs through country specific reason or macroeconomic developments that triggered large scale shift in investment.
     one of the reason for this is low interest rate environment . Low interest rates can trigger 'Carry Forward' which means borrow from this low interest rate environment and invest in potentially high return assets like equities and junk bonds . But maintaining higher interest rate can't guarantee the absence of capital flight because their are several more reason for this .

1 . Currency devaluation : foreign investors flee from such nations before their assets lose too much value

2. Political and economic turmoil : Due to political and economical turmoil, the companies lose their confidence in the economy and they are afraid of sinking their money, due to which they start pulling their money from there market.

3. Threats of hyperinflation : Hyperinflation could decrease the value of asset , So because of hyperinflation companies also afraid of lose , so they choose to capital flight.

4. Threat of imposed nationalisation : Due to Imposed Nationalisation at a quarter of the cost, companies may have to lose their business.

5. Balance of payment crisis : larger BoP cause depreciation in exchange rates which could lead capital flight

6. Lack of confidence in economy

7. Fear of rising income or capital gain tax

For Preventing Capital Flight -

1. Capital Control Policies - Capital control policies should be made by the government to mitigate the detrimental effects of capital flight.

2. Capital Monitoring Institutions - The government should set up institutions to monitor the status of capital in the country so that preparations can be made in advance to deal with the situation of capital flight.

3. Ensuring Political stability :- Government and policy makers should work on developing well functioning political and judicial setups that will promote political stability .

4. Curb on Corruption :- A large part of the capital flight is done illegally, so by curbing corruption this illegal capital flight can be stopped.

5. Confidence Building :- The government should work to promote trade and commerce in our country, should improve the ease of doing business, and help the corporate as well as insure the freedom to do their work so that they can provide speed to the economy without any pressure .