Capital Flight

Capital flight is an economic situation when investor pull their capital out from one country to another country by selling their financial assets that they own. Investors’ lack of confidence on the country’s system is the main reason of capital fight. Investors always want the minimum security of their investment. Whenever they feel unsecured and wish to protect their investment, capital flights occur. Political or economic instability, currency devaluation, the imposition of capital controls, high taxations are some common phenomena that force investors to do the capital flight. 

Capital flights have the following effects on economy of the affected country:

1. Many businesses will be closed and people will loss their jobs.

2. Wealth disappeared which lead depreciation in a variable exchange rate regime, or a forced devaluation in a fixed exchange rate regime.

3. Assets will loss much of their nominal value.

4. Dramatically decreases in the purchasing power of the country's assets and makes it increasingly expensive to import goods and acquire any form of foreign facilities.

5. Government’s tax revenue will be dropped.

If governments have the huge dependency on foreign capital, the effect of capital flight will be extreme. The Asian crisis of 1997 is an example of extreme effect due to capital flight. Rapid currency devaluation was happened during the crisis and it triggered the capital flight which resulted in a domino effect of collapsing stock prices across the world. International stocks fell by as much as 60 percent due to the crisis. 

Now-a-days, almost all countries use multiple strategies to stop or reduce the capital flight. The common examples are shown below:

1. Government should attract foreign direct investment (FDI) rather than foreign portfolio investment (FPI). This is because FDI involves long-term investments in factories and enterprises in a country. And this will not be easy to liquidate their assets at short notice.

2. Imposing strict capital control for restricting the flow of their currency to other countries. Although this is not always ideal due to the panicking nature, it works on general investors.

3. Creating tax treaties with other jurisdictions. If transferring funds does not result in tax penalties, capital flight will be attractive. By creating mandatory tax liabilities on transferring funds, government can control the capital flight.

According to the Fraser Institute (2018), Canadians have increasingly looked to other countries to invest, with the amount Canadians invest abroad rising 74 per cent from 2013 to 2017. At the same time, foreign direct investment—investment from other countries into Canada—dropped a staggering 55.1 per cent from 2013 to 2017. However, Canada also received $43.6 billion (Canadian Dollars) via electronic fund transfers (EFT) recorded by FINTRAC in 2019 from Hong Kong due to China’s crack down. 

In Canada, we need to upgrade our tax systems which will attract more foreign investments and restrict capital flight to other countries. 


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