Capital flight

This describes an outflow of money from one country to another as investors lose faith and confidence in their external investments. Typically it happens when a nation’s currency is under strong downward pressure either because of speculative selling or because of fundamental factors such as a recession, poor trade performance or a steep fall in asset prices or interest rates. Another root cause is weakening faith in the creditworthiness of a national government especially when they are running up large budget deficits that might be unsustainable. Foreign investors may choose to withdraw their money if they expect a hike in taxes on their investments.

When capital flight happens the currency is likely to drop sharply as money leaves an economy and there may be little that the central bank can do about this e.g. by intervening in the markets or by raising short-term interest rates.

• Iceland - why raising interest rates won’t work (BBC, October 2008)
• Hungary – the rise and fall of Hungary (Guardian, October 2008)
• Ireland – record decline hits Ireland’s economy (BBC, March 2009)
• Pakistan – Pakistan asks IMF for rescue loan (BBC, November 2008)
• Ukraine – banking crisis spurred by collapsing price of steel (Guardian, Oct 2008)
• Belarus – Belarus to get $2.5bn IMF loan (BBC, December 2008)

Countries running current account deficits on their balance of payments can finance this by attracting net inflows of capital from overseas investors. One of the effects of the fall-out from the sub-prime crisis was a reversal of capital flows as investors took fright and decided to hedge against financial uncertainty by switching their money into countries with a safe-haven status currency or in investments such as gold. The result was the current account deficit countries faced a run on their currencies that required international intervention by the IMF and by the World Bank among others. This assistance is usually conditional on national governments imposing contractionary fiscal policies to reduce the size of budget and external (BoP) deficits.