Q. Which of the following constitute Capital Account?

1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment

Select the correct answer using the codes given below.

• 1, 2 and 3
• 1, 2 and 4
• 2, 3 and 4
• 1, 3 and 4

Answer: (b) 1, 2 and 4

Capital Account:

• The capital account keeps track of capital inflows and outflows that have a direct impact on a country’s international assets and liabilities.
• All international trade transactions involving citizens of one country and citizens of other countries are covered.
• The capital account demonstrates how the ownership of a country’s assets and liabilities has changed over time.
• Foreign investment, such as FDI and FPI, immovable properties, intangible assets, trade credits, borrowings from other nations, banking capital, and changes in the foreign exchange reserve are all components of the capital account.
• The capital account also includes NRI deposits, SDRs, and funds held in foreign nations, among other things.
• The capital account is used to finance current account deficits and to absorb current account surpluses.
• Because the capital account deals with financial transfers, it has no direct impact on the nation’s output, revenue, or employment.
• A surplus in the capital account shows that money is flowing into the country, whereas a deficit suggests that money is flowing out.

Balance on the Capital Account

• The net value of all the credits and debits gives the balance on the capital account.
• When the credit items are more than the debit items, it leads to a capital account surplus and indicates the net inflow of capital in the country.
• When the debit items are more than the credit items then it leads to a deficit in the capital account which indicates the net outflow of capital from the country.
• India generally is on a Capital Account Surplus as it attracts a huge share of foreign investments into the country.

Components of Capital Account

• Foreign direct investment (FDI)
  • When foreign citizens purchase Indian capital assets such as firms, industrial complexes, machines, and so on, the capital account is credited. The capital account shows a debit for FDI investments made by Indians in foreign nations.
• Foreign portfolio investment (FPI)
  • When foreign residents buy stocks, government bonds, corporate bonds, and other securities, these purchases are recorded as a credit to the capital account. The purchase of securities and bonds by Indian residents in foreign nations is recorded as a debit in the capital account.
• External Commercial Borrowings
  • It involves financial transactions involving private sector organizations or individuals, as well as the government, borrowing money from foreign countries.
  • The receipts from outside the country, such as loan repayments from foreign citizens, are recorded as a credit in the capital account.
  • The capital account shows a debit for financial transactions involving lending to foreign countries by private sector companies, people, and the government, as well as the repayment of loans acquired from foreign countries.
• Foreign Investments
  • Foreign investments in Indian firms, government bonds, real estate, and other assets are recorded as a credit in the capital account since they result in a foreign exchange inflow.
  • Investments made by Indian citizens in foreign stocks and shares, government bonds, and real estate, among other things, are recorded as a debit in the capital account since they result in a foreign exchange outflow.
• Foreign Exchange Reserves
  • The foreign exchange reserves of a country are the financial assets held by the central bank (in India, the Reserve Bank of India).
  • In the Balance of Payments, these reserves act as a financing component.
  • Any withdrawal from the foreign exchange reserves is represented as a credit in the capital account, while any addition to the reserves is shown as a debit.
  • The BOP account shows the fluctuations in foreign exchange reserves, not the actual foreign exchange reserves.
• External Assistance
  • Borrowings as External Assistance refers to borrowing by a country for the purpose of assisting another country. It has a lower interest rate than what is available on the open market.
  • India receives external assistance from various multilateral agencies such as the World Bank Group, Asian Development Bank, European Investment Bank, New Development Bank, etc.