Definition
When rumors spread that a bank is in trouble, people line up at the counter to pull out their deposits first. Capital outflow is something similar happening at the level of a whole country. It's the flow of investment money and deposits that had come into a country, leaving across its borders in search of somewhere safer or with better terms.
Why Does Money Cross Borders?
Just as water flows downhill, money flows to where conditions are better. When a country's interest rates are high or its companies look likely to earn well, investment money from around the world gathers there. When conditions turn worse, the money that came in changes direction and flows out.
There are three main triggers for that change. The first is when another country raises its interest rates and becomes more attractive than home. The second is when the exchange rate wobbles and the money in your hand looks set to lose value. The third is when politics or institutions feel unstable and property seems hard to protect.
On top of that comes the urge to copy one another. When one investor sells and leaves, the others try to leave before it's too late. That's why capital outflow tends to pile up in one direction and speed up.
Money that came in fairly evenly can leave all at once within a few days. This difference in speed is what makes capital outflow so hard to handle.
Why Is Leaving Money So Scary?
When money leaves, the first thing to shake is the exchange rate. Investors sell the local currency and buy dollars on their way out, so more people are looking for dollars. When the dollar gets more expensive, import prices rise with it, and so does the cost of buying oil and raw materials from abroad.
To hold the dollar's price down, the government and central bank release foreign currency they've saved up, or raise interest rates. Higher rates give money a reason to stay at home, but they weigh heavily on households and companies with loans.
A vicious circle can start here. When the economy cools under the burden of interest, the country looks even worse, and investors who see that pull out more money. You get a loop where the speed of leaving becomes a new reason to leave.
That's why many countries stockpile foreign currency in normal times and agree in advance to lend money to each other in emergencies.
To Be More Precise
To be more precise, "capital outflow" is not a word that means a disaster in itself. Money is always coming in and going out, and statistics compare the money that came in with the money that went out to see which is bigger. A domestic company sending money abroad to build a factory is also counted as an outflow.
What matters is less the size than the speed and the type of money. Factory investment spread over several years moves slowly, but money that only stops briefly in stocks and bonds can change direction overnight. The bigger the share of short-stay money, the bigger the shaking.
Moving property secretly to avoid taxes or escape oversight is called capital flight in its own right. It leaves few records, which makes it hard to see the true state of a country's finances. In English, "capital flight" is sometimes used loosely for all money leaving, but in the narrow sense it refers to this secret kind.
So even among "money going out," you need to look separately at what is leaving and how fast.
Common misconceptions
The moment a foreigner sells domestic stocks, it becomes a capital outflow.
In the statistics, portfolio investment funds are recorded as having left at the time of the sale. But if the seller keeps the proceeds in a local-currency deposit at home, that amount is recorded as coming back in under a different item. So for the country as a whole, money really leaves only when the local currency is exchanged for foreign currency and sent abroad.
Capital outflow is always a sign that a country's economy is falling apart.
A domestic company sending money abroad to buy a foreign factory or company is also counted as an outflow. The worrying case is when money rushes out all at once in a short time.
Where you meet it
Foreign investment money sells domestic bonds and moves to another country after that country's central bank sharply raises interest rates.
A domestic company sending funds from its head office to a local subsidiary to build a factory abroad is also counted as an outflow in the statistics.
In one sentence
It's the flow of money that was in a country leaving across its borders for somewhere safer or with better terms, and when it rushes out all at once, it shakes the exchange rate and the economy.