Question

What do you understand by Current Account and Capital Account of Balance of Payments?

Hint:

A simple way to differentiate: Current Account transactions are like a household's regular income and expenditure. Capital Account transactions are like a household taking a loan or buying property—they affect its assets and debts.

Answer 1

Step 1: Understanding the Concept:
The Balance of Payments (BOP) is a systematic statement of all economic transactions between the residents of a country and the rest of the world over a specific period, usually a year. It is broadly divided into two main accounts: the Current Account and the Capital Account.

Step 2: Current Account of BOP:
The Current Account records all transactions of a 'current' nature. These are transactions that do not cause a future claim or change the asset/liability status of the country. It shows the net income generated by a country in the international market.
The main components of the Current Account are: \begin{enumerate} \item Trade in Goods (Visible Trade): This includes the export and import of physical goods. The balance of exports and imports of goods is called the Balance of Trade. \item Trade in Services (Invisible Trade): This includes the export and import of non-tangible items like services. It is further divided into: \begin{itemize} \item Factor Services: Income from investment (profit, interest, dividends). \item Non-Factor Services: Services like shipping, banking, insurance, and tourism. \end{itemize} \item Current Transfers (Unilateral Transfers): These are one-way payments for which nothing is received in return, such as gifts, grants, donations, and personal remittances. \end{enumerate}

Step 3: Capital Account of BOP:
The Capital Account records all transactions that do cause a change in the assets or liabilities of the residents of a country or its government. It reflects the net change in national ownership of assets.
The main components of the Capital Account are: \begin{enumerate} \item Investments: These are international investments made by residents. \begin{itemize} \item Foreign Direct Investment (FDI): Purchase of an asset (e.g., a factory) that gives direct control to the purchaser. \item Portfolio Investment (FII/FPI): Purchase of financial assets like stocks and bonds, which does not give direct control. \end{itemize} \item Loans and Borrowings: This includes all types of borrowings and lendings from/to the rest of the world, such as External Commercial Borrowings (ECBs) and external assistance. \item Changes in Foreign Exchange Reserves: The foreign currency assets held by a country's central bank (e.g., the RBI) are its reserves. Any withdrawal from or addition to these reserves is recorded in the capital account. \end{enumerate}

Step 4: Final Answer:
The Current Account of the BOP records the flow of goods, services, income, and transfer payments that do not affect a country's assets or liabilities. The Capital Account records the flow of capital through investments and loans that do affect a country's asset or liability position.