Capital/Financial Vs Current Account, Official Reserve Sale, BOP & Capital account

 

           

Understanding Capital/Financial  and Current Account : 

Capital account deals with the change in ownership of a country’s assets,

                                                              while

  Current Account reflects the change in a country’s net income.

Ex. In case of a factory acquisition by an MNC in India, payment of dollars by MNC will result in Inflows of dollars alongwith lose of ownership by Indian on  the factory.

Income by that MNC will be a part of Current account while acquisition of factory is part of Capital Account.

 Capital and financial  Account:

• Those transactions, which cause a change in the ownership of assets or liabilities of a country.
• Capital and financial account has two categories of the capital and financial account. 
• Many a times ,this account is commonly referred to as Capital Account but its a misnomer as the so-called capital account portion is in fact small or even negligible for many countries. 

Capital account:

• It includes acquisition or disposal of “intangible nonfinancial assets and proprietary rights” such as trademarks, patents, copyrights, leasing agreements, and mineral rights. 
• Debt forgiveness is included in this subaccount, as part of capital transfers

 Because the capital account is typically small, the name for this part of the BOP is often abbreviated as “financial account.” 

Financial account :

• Direct investment, which is further divided into equity capital and reinvested earnings;
• Portfolio investment, which includes long-term debt and equity securities, money market instruments, and tradable financial derivatives, including dollarnd interest rate swaps;
• Other investment, such as trade credits and general borrowing, and IMF credit; and
• Change in Foreign Exchange Reserves 

Change in Foreign Exchange Reserves:

When BOP is not Zero despite exhaustion of all tools, then country could use its forex reserves to neutralise it.

Official Reserve Sale: 

When all tools of Capital and financial Accounts are exhausted and Current Account Deficit still remains, then RBI sells Foreign Reserves to ensure the Zero BOP.

Correlation between Balance of Payment and Capital Account:

• Balance of Payments of a country should be balanced .
• If a country has current account Deficit, it must be financed either  by selling assets or by borrowing abroad. 
• Thus, any current account deficit must be financed by a capital account surplus, that is, a net capital inflow or selling of the assets :

Current account + Capital account =0