BOP Financial account

Long-term direct investments

Long-term direct investments or long-term capital flows are foreign direct investments (FDIs). As the word suggests, it refers to the investment made in foreign countries. FDIs can either be inward or outward direct investments. When a foreign MNC invests in the country, it is known as inward direct investment, and when the country’s MNC invests in a foreign country, such as when they open a subsidiary, it is known as outward direct investment.

FDIs also acquired in the form of mergers and takeovers or acquisitions are also examples of outward direct investments. Other examples of direct investments include the acquisition of shops, restaurants, hotels, offices, and other such assets in foreign countries.

When the inward direct investments increase, the country receives more money, thereby resulting in a positive financial account. This will result in positive economic growth in the country.

Long-term portfolio investments

Long-term portfolio investments consist of portfolio investments and other financial assets. Portfolio investments are the purchase of a country’s securities.

This is typically the purchase of securities issued by foreign governments or shares from companies abroad.

Short-term ‘hot-money’ capital flows

Hot money starts when interest rates rise. For example, if the Bank of England increased the rate for the Pound (£), investors would move their money into UK banks for a higher return on their savings and investments. This would appreciate the value of the £. An appreciation of the currency results in cheaper imports, increasing the volume of imported goods. The country will now become a less competitive exporter, as their domestic products cost more in the foreign market. This will lead to a trade deficit in the country.

It is called short term because investors move their money between financial markets based on the countries’ economic activities. They will continue to move their money to the country with a higher exchange rate.

Financial account balance formula

The balance of the financial account can be calculated using this formula:

$$\begin{gathered} Balanceoffinancialaccount=Netdirectinvestment+Netportfolioinvestment+Assetfunding \\ +Errorsandomissions \end{gathered}$$

Table 1 shows an example of a country’s positive financial account.

What is the capital account?

The capital account is a small part of the Balance of Payments.

It mainly records the transfers of immigrants and emigrants and other government transfers such as debt forgiveness. The capital account represents the balance of payments for the country.

The balance of the current account can be calculated using this formula:

$$\begin{gathered} Balanceofcapitalaccount=Surplusesordeficitsofnetnon-produced+Non-financialassets \\ +Netcapitaltransfers \end{gathered}$$