Capital Account: Tracking International Wealth Transactions

The Capital Account is a record of all international transactions of assets, where assets are various forms of wealth such as money, stocks, bonds, and government debt.

Key Components of Capital Account Transactions 

• The transactions encompass various items, including, Foreign direct Investments,(FDIs), Foreign Institutional Investments (FIIs), External borrowings and assistance etc.

Understanding Financial Health:

• The transactions recorded in the capital account provide insight into a country’s financial interactions on an international scale, showcasing the flow of assets across borders.
• The balance between debit and credit items reflects the financial health and global economic position of a country.

Balance on Capital Account

• The capital account: It is in balance when capital inflows (like receipt of loans from abroad, sale of assets or shares in foreign companies) are equal to capital outflows (like repayment of loans, purchase of assets or shares in foreign countries).
• The surplus is when capital inflows are greater than capital outflows.
• A deficit is when capital inflows are lesser than capital outflows.

How is the Balance of Payments Surplus achieved? 

• The Balance of Payments (BoP): It mirrors the financial dynamics of an individual, spending more than the income necessitates either selling assets or borrowing to bridge the gap.
• Similarly, a country with a current account deficit (spending more than it earns from global sales) must either sell assets or borrow internationally to offset the deficit.

• The equation Current account + Capital account = 0 shows the BoP is in equilibrium where a current account deficit is counterbalanced by a capital account surplus, denoting a net capital inflow.

How is the balancing of payments mechanism executed?

• International Lending: A country can attain a BoP equilibrium by fully financing its current account deficit through international lending, devoid of any reserve movements.
• Foreign Exchange Reserves: Alternatively, a country could utilise its foreign exchange reserves to balance any deficit in its BoP.
• Sale of Foreign Exchange: The Reserve Bank engages in the sale of exchange during a deficit scenario, termed an official reserve sale.
• A decrease in official reserves signifies an overall BoP deficit, while an increase denotes a BoP surplus.
• The Monetary Authorities: It acts as the ultimate financiers of any BoP deficit or the recipients of any surplus.

• Relevance of Official Reserve Transactions: Official reserve transactions hold greater relevance under a fixed exchange rate regime as compared to a floating exchange rate system.

Understanding Errors and Omissions in Balance of Payments:

• It is difficult to record all international transactions accurately. 
• Thus, we have a third element of BoP (apart from the current and capital accounts) called errors and omissions, which reflects this.
  • Following Table  provides a sample of Balance of Payments for India.

DOWNLOAD PDF