Capital Account: FDI, FPI, ECB & International Capital Flows
External Sector • Capital & Financial Account • FDI • FPI • ECB • NRI Deposits • ODA
1. Capital & Financial Account – Overview
The capital and financial account of the Balance of Payments records cross-border transactions that change the ownership of financial assets and liabilities between residents and non-residents. It answers the question: “How is the economy financing its current account gap and building external assets?”
- Includes FDI, FPI, loans, ECBs, banking capital, NRI deposits, ODA and other investments.
- Determines the quality of financing for any current account deficit.
- Shapes external vulnerability or resilience via debt, equity and reserve accumulation.
Core idea:
The current account shows the gap; the capital account shows how that gap is financed—through
debt, equity or reserves.
flowchart TB WM[IASNOVA.COM]:::wm A["Capital & Financial Account"]:::root --> B["FDI"]:::n1 A --> C["FPI / FII / QFI"]:::n2 A --> D["Loans & ECBs"]:::n3 A --> E["NRI Deposits & Banking Capital"]:::n4 A --> F["ODA / Foreign Aid"]:::n5 A --> G["Other Investments"]:::n6 classDef root fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef n1 fill:#E8F8F5,stroke:#148F77,color:#0E6251; classDef n2 fill:#EBF5FB,stroke:#2874A6,color:#1B4F72; classDef n3 fill:#FEF9E7,stroke:#D68910,color:#7E5109; classDef n4 fill:#FDEDEC,stroke:#C0392B,color:#7B241C; classDef n5 fill:#F4ECF7,stroke:#7D3C98,color:#512E5F; classDef n6 fill:#FDF2E9,stroke:#CA6F1E,color:#7E5109; classDef wm fill:#FFFFFF,stroke:#FFFFFF,color:#FF0000,font-weight:900,font-size:11px;
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2. Foreign Direct Investment (FDI)
FDI is a cross-border investment where an investor acquires a lasting interest and a significant degree of management control in an enterprise in another country.
2.1 Key Features of FDI
- Long-term horizon: Investors commit capital for extended periods.
- Control & management: Often associated with ownership of 10% or more of voting power.
- Non-debt creating: Classified as equity; does not increase external debt.
- Brings more than money: Technology, management skills, market access, global value-chain linkages.
FDI = “patient capital” – slower to come in, slower to leave.
2.2 Advantages & Concerns
| Dimension | Advantages | Concerns |
|---|---|---|
| Growth & Investment | Boosts capital formation, infrastructure and productive capacity. | May concentrate in a few sectors/regions. |
| Technology & Skills | Transfers technology, management practices, training. | Risk of limited domestic spillovers if linkages are weak. |
| Balance of Payments | Stable non-debt creating inflows. | Future income outflows (profits, dividends) on BoP. |
| Competition | Improves efficiency, product quality. | May hurt small domestic firms if not prepared. |
flowchart TB WM[IASNOVA.COM]:::wm A["FDI – Key Characteristics"]:::root --> B["Long-term & stable"]:::n1 A --> C["Control & management role"]:::n2 A --> D["Technology & know-how"]:::n3 A --> E["Future income outflows"]:::n4 classDef root fill:#E8F8F5,stroke:#148F77,color:#0E6251; classDef n1 fill:#EBF5FB,stroke:#2874A6,color:#1B4F72; classDef n2 fill:#FEF9E7,stroke:#D68910,color:#7E5109; classDef n3 fill:#FDEDEC,stroke:#C0392B,color:#7B241C; classDef n4 fill:#FDF2E9,stroke:#CA6F1E,color:#7E5109; classDef wm fill:#FFFFFF,stroke:#FFFFFF,color:#FF0000,font-weight:900,font-size:11px;
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3. Foreign Portfolio Investment (FPI/FII) & Qualified Foreign Investors (QFI)
Foreign Portfolio Investment (FPI/FII) refers to investment by non-residents in a country’s equity and debt securities without seeking management control. Qualified Foreign Investors (QFI) were introduced in some jurisdictions as a category of diversified, regulated foreign investors (e.g., individuals, pension funds) allowed to invest directly in local markets under specified rules.
3.1 Main Characteristics of FPI/FII
- No control: Typically small shareholdings with no management influence.
- Market-driven: Influenced by global liquidity, interest differentials, risk appetite.
- Highly liquid: Can be withdrawn quickly, creating volatility.
- Important for capital markets: Supports equity and bond market development.
3.2 Role of QFI
- Allows diversified foreign investors (beyond large institutions) to access domestic markets.
- Broadens investor base, deepens capital markets.
- Subject to KYC, registration and limits to manage systemic risk.
| Feature | FDI | FPI/FII | QFI (concept) |
|---|---|---|---|
| Objective | Control, long-term presence. | Financial returns from securities. | Diversified medium-/long-term investment. |
| Time Horizon | Long-term. | Short- to medium-term. | Varies; often more stable than pure speculative flows. |
| Volatility | Low (relatively). | High; can reverse quickly. | Moderate; subject to regulatory filters. |
| Impact on BoP | Stable non-debt inflows; future income outflows. | Can strengthen reserves in good times; may trigger stress in reversals. | Helps diversify inflows; reduces concentration risk. |
flowchart TB WM[IASNOVA.COM]:::wm A["Types of Equity Capital Flows"]:::root --> B["FDI"]:::n1 A --> C["FPI / FII"]:::n2 A --> D["QFI-type Investors"]:::n3 B --> B1["Control + long-term"]:::note1 C --> C1["Liquid, market-driven"]:::note2 D --> D1["Regulated, diversified foreign investors"]:::note3 classDef root fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef n1 fill:#E8F8F5,stroke:#148F77,color:#0E6251; classDef n2 fill:#EBF5FB,stroke:#2874A6,color:#1B4F72; classDef n3 fill:#FEF9E7,stroke:#D68910,color:#7E5109; classDef note1 fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef note2 fill:#D6EAF8,stroke:#1F618D,color:#1B2631; classDef note3 fill:#FDF2E9,stroke:#CA6F1E,color:#7E5109; classDef wm fill:#FFFFFF,stroke:#FFFFFF,color:#FF0000,font-weight:900,font-size:11px;
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4. External Commercial Borrowings (ECB)
External Commercial Borrowings (ECBs) are loans raised by domestic entities from non-resident lenders in foreign currency or sometimes in local currency under specific regulations.
4.1 Who Borrows & From Whom?
- Borrowers: Corporates, infrastructure companies, sometimes financial institutions and government-related entities.
- Lenders: International banks, export credit agencies, multilateral institutions, capital markets (bonds).
4.2 Advantages & Risks
| Aspect | Advantages | Risks |
|---|---|---|
| Funding | Access to large, long-tenor funds for infrastructure & investment. | Over-borrowing can create repayment pressure. |
| Cost | May be cheaper than domestic credit in some periods. | Exposed to interest rate changes and global conditions. |
| Currency | Useful when revenues are in foreign currency (exporters). | Currency risk if revenues are domestic but debt is in foreign currency. |
Key risk:
ECBs add to external debt. If not matched with productive investment or hedged properly,
they can worsen vulnerability during exchange rate shocks.
flowchart LR WM[IASNOVA.COM]:::wm A["ECBs"]:::root --> B["Borrowers"]:::n1 A --> C["Lenders"]:::n2 A --> D["Benefits"]:::n3 A --> E["Risks"]:::n4 B --> B1["Corporates, infra firms"]:::note1 C --> C1["Global banks, markets"]:::note2 D --> D1["Large, long-term funding"]:::note3 E --> E1["Debt & currency vulnerability"]:::note4 classDef root fill:#FEF9E7,stroke:#D68910,color:#7E5109; classDef n1 fill:#E8F8F5,stroke:#148F77,color:#0E6251; classDef n2 fill:#EBF5FB,stroke:#2874A6,color:#1B4F72; classDef n3 fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef n4 fill:#FDEDEC,stroke:#C0392B,color:#7B241C; classDef note1 fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef note2 fill:#D6EAF8,stroke:#1F618D,color:#1B2631; classDef note3 fill:#E8F8F5,stroke:#17A589,color:#0E6251; classDef note4 fill:#FADBD8,stroke:#922B21,color:#641E16; classDef wm fill:#FFFFFF,stroke:#FFFFFF,color:#FF0000,font-weight:900,font-size:11px;
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5. NRI Deposits & Banking Capital
NRI deposits are deposits made by non-resident individuals in domestic banks. They are an important source of foreign currency and rupee funding for the banking system.
5.1 Economic Role
- Provide foreign currency resources to banks.
- Help finance current account deficits and support reserves.
- Often respond to interest rate differentials and exchange rate expectations.
5.2 Risk Considerations
- If a large stock of NRI deposits is short-term, there is a rollover risk.
- Sudden withdrawals can pressure reserves and the exchange rate.
Essence:
NRI deposits are a valuable but potentially interest-sensitive source of external funding,
requiring prudent limits and monitoring.
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6. Official Development Assistance (ODA) / Foreign Aid
Official Development Assistance (ODA) refers to concessional financial flows from governments and multilateral agencies to support development objectives in recipient countries.
6.1 Features of ODA
- Concessional terms: Below-market interest, long maturities, grace periods.
- Development focus: Infrastructure, social sectors, environment, governance.
- Can be tied or untied: Some aid requires procurement from donor country.
6.2 Pros & Concerns
| Aspect | Benefits | Concerns |
|---|---|---|
| Financing | Low-cost funds for development projects. | Dependence if relied on excessively. |
| Policy Space | Can support reforms and institution building. | Conditionalities may affect policy autonomy. |
| External Position | Less pressure than commercial debt. | Still contributes to external liabilities if mostly loan-based. |
flowchart TB WM[IASNOVA.COM]:::wm A["ODA / Foreign Aid"]:::root --> B["Concessional Loans"]:::n1 A --> C["Grants"]:::n2 A --> D["Technical Assistance"]:::n3 B --> B1["Low interest, long tenor"]:::note1 C --> C1["No repayment, conditional use"]:::note2 classDef root fill:#F4ECF7,stroke:#7D3C98,color:#512E5F; classDef n1 fill:#E8F8F5,stroke:#148F77,color:#0E6251; classDef n2 fill:#EBF5FB,stroke:#2874A6,color:#1B4F72; classDef n3 fill:#FEF9E7,stroke:#D68910,color:#7E5109; classDef note1 fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef note2 fill:#D6EAF8,stroke:#1F618D,color:#1B2631; classDef wm fill:#FFFFFF,stroke:#FFFFFF,color:#FF0000,font-weight:900,font-size:11px;
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7. International Capital Flows – Benefits & Risks
International capital flows—FDI, FPI, loans, deposits, aid—can accelerate growth but also create vulnerabilities. The net effect depends on composition, regulation and macroeconomic management.
7.1 Benefits of Capital Flows
- Bridge savings–investment gap: Allow higher investment than domestic savings alone.
- Technology & know-how transfer: Especially through FDI.
- Market development: Deepen financial markets and improve price discovery.
- Risk diversification: Spread risk across investors and countries.
7.2 Risks & Vulnerabilities
- Volatility: Sudden reversals of FPI can trigger crises.
- Currency mismatch: Foreign currency borrowing with domestic-currency revenues.
- External debt overhang: Excessive borrowing can drag growth.
- Asset price bubbles: Surges in inflows can inflate equity and real estate prices.
| Type of Flow | Main Benefit | Key Risk |
|---|---|---|
| FDI | Technology, jobs, stable capital. | Profit repatriation; sectoral dominance. |
| FPI / QFI | Capital market depth, liquidity. | Sudden exits, financial volatility. |
| ECBs & Loans | Large funding for infrastructure & corporates. | Debt and currency risk. |
| NRI Deposits | Flexible bank funding, foreign currency resources. | Interest-sensitive outflows. |
| ODA | Concessional funds for development. | Conditionalities; long-term dependence. |
flowchart TB WM[IASNOVA.COM]:::wm A["International Capital Flows"]:::root --> B["Benefits"]:::n1 A --> C["Risks"]:::n2 A --> D["Policy Response"]:::n3 B --> B1["Higher investment, technology, markets"]:::note1 C --> C1["Volatility, debt, currency stress"]:::note2 D --> D1["Prudential norms, reserves, macro policy"]:::note3 classDef root fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef n1 fill:#E8F8F5,stroke:#148F77,color:#0E6251; classDef n2 fill:#FDEDEC,stroke:#C0392B,color:#7B241C; classDef n3 fill:#EBF5FB,stroke:#2874A6,color:#1B4F72; classDef note1 fill:#D5F5E3,stroke:#1E8449,color:#145A32; classDef note2 fill:#FADBD8,stroke:#922B21,color:#641E16; classDef note3 fill:#D6EAF8,stroke:#1F618D,color:#1B2631; classDef wm fill:#FFFFFF,stroke:#FFFFFF,color:#FF0000,font-weight:900,font-size:11px;
Final takeaway:
Healthy external sector management is not about blocking capital flows, but about getting the mix right
— more stable FDI and long-term flows, prudent use of debt and volatile portfolio flows,
backed by strong reserves and sound macro policies.
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