What are Capital Flows?

What are Capital Flows?

Capital flows measure the movement of money across international borders for investment, trade, or speculation. These flows are a fundamental driver of currency values because investors must buy the local currency to purchase domestic assets. Sustained capital inflows create persistent demand that supports and strengthens a currency, while outflows weaken it.

Types of Capital Flows

• Foreign Direct Investment (FDI): Long-term investments where companies build factories, acquire businesses, or establish operations in foreign countries. FDI is sticky and signals confidence in the economy
• Portfolio flows: International investors buying and selling stocks, bonds, and other securities. More volatile than FDI but still substantial
• Hot money: Short-term speculative capital that moves rapidly chasing yield differentials, rate changes, or momentum. Highly sensitive to interest rate expectations
• Official flows: Central bank reserve management and diversification, sovereign wealth fund investments
• Remittances: Workers sending money home, providing steady inflows for emerging markets

Monitoring Capital Flows

• Balance of payments: Review quarterly current account and capital account data to assess net flow direction
• Bond auctions: Track foreign participation rates in government debt sales—high foreign demand signals confidence
• Equity market performance: Global funds rotate into markets with strong earnings growth and positive outlook
• Policy changes: Tax reforms, capital controls, or regulatory shifts can redirect billions overnight
• TIC data (US): Treasury International Capital reports show foreign purchases of US securities

Flow Reversals and Currency Crashes

Sudden capital flow reversals—when inflows turn to outflows—can trigger currency crashes. This often happens when carry trades unwind, emerging market crises spread, or central banks surprise with unexpected policy shifts. The 1997 Asian Financial Crisis and 2013 Taper Tantrum are classic examples of flow reversals causing violent currency moves.