Hello everyone.
I am posting this article after a very long break.
Hope this will enrich you.
The topic for today is
Current Account and Capital Account. This is in continuation of my earlier post on Balance of Payments
Current Account - It is defined as the sum of net revenue on exports minus payments for imports, factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers.
It shows us the picture of the nature of foreign trade.
A surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse.
As exports generate positive net sales, and the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports.
If an economy is running current account deficit, it is absorbing (absorption = domestic consumption + investment + government spending) more than that it is producing. This can only happen if some other economies are lending their savings to it (in the form of debt to or direct/ portfolio investment in the economy) or the economy is running down its foreign assets such as official foreign currency reserve.
On the other hand, if an economy is running a current account surplus it is absorbing less than that it is producing. This means it is saving. As the economy is open, this saving is being invested abroad and thus foreign assets are being created.
Capital Account - It reflects net change in national ownership of assets.
It is calculated as:
Capital Account - FDI + portfolio investment + other investment + reserve account
Foreign direct investment (FDI), refers to long term capital investment such as the purchase or construction of machinery, buildings or even whole manufacturing plants. If foreigners are investing in a country, that is an inbound flow and counts as a surplus item on the capital account. If a nation's citizens are investing in foreign countries, that's an outbound flow that will count as a deficit. After the initial investment, any yearly profits not re-invested will flow in the opposite direction, but will be recorded in the current account rather than as capital.
Portfolio investment refers to the purchase of shares and bonds. It's sometimes grouped together with "other" as short term investment. As with FDI, the income derived from these assets is recorded in the current account; the capital account entry will just be for any international buying or selling of the portfolio assets.
Other investment includes capital flows into bank accounts or provided as loans. Large short term flows between accounts in different nations are commonly seen when the market is able to take advantage of fluctuations in interest rates and / or the exchange rate between currencies. Sometimes this category can include the reserve account.
Reserve account is operated by a nation's central bank to buy and sell foreign currencies; it can be a source of large capital flows to counteract those originating from the market. Inbound capital flows (from sales of the account's foreign currency), especially when combined with a current account surplus, can cause a rise in value (appreciation) of a nation's currency, while outbound flows can cause a fall in value (depreciation). If a government (or, if authorized to operate independently in this area, the central bank itself) doesn't consider the market-driven change to its currency value to be in the nation's best interests, it can intervene.
A surplus in the capital account means money is flowing into the country, but unlike a surplus in the current account, the inbound flows will effectively be borrowings or sales of assets rather than earnings. A deficit in the capital account means money is flowing out the country, but it also suggests the nation is increasing its claims on foreign assets.
I will be posting more such informative articles. If you wish information on specific topics, then do let me know ( in the comments section )
I am posting this article after a very long break.
Hope this will enrich you.
The topic for today is
Current Account and Capital Account. This is in continuation of my earlier post on Balance of Payments
Current Account - It is defined as the sum of net revenue on exports minus payments for imports, factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers.
It shows us the picture of the nature of foreign trade.
A surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse.
As exports generate positive net sales, and the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports.
If an economy is running current account deficit, it is absorbing (absorption = domestic consumption + investment + government spending) more than that it is producing. This can only happen if some other economies are lending their savings to it (in the form of debt to or direct/ portfolio investment in the economy) or the economy is running down its foreign assets such as official foreign currency reserve.
On the other hand, if an economy is running a current account surplus it is absorbing less than that it is producing. This means it is saving. As the economy is open, this saving is being invested abroad and thus foreign assets are being created.
Capital Account - It reflects net change in national ownership of assets.
It is calculated as:
Capital Account - FDI + portfolio investment + other investment + reserve account
Foreign direct investment (FDI), refers to long term capital investment such as the purchase or construction of machinery, buildings or even whole manufacturing plants. If foreigners are investing in a country, that is an inbound flow and counts as a surplus item on the capital account. If a nation's citizens are investing in foreign countries, that's an outbound flow that will count as a deficit. After the initial investment, any yearly profits not re-invested will flow in the opposite direction, but will be recorded in the current account rather than as capital.
Portfolio investment refers to the purchase of shares and bonds. It's sometimes grouped together with "other" as short term investment. As with FDI, the income derived from these assets is recorded in the current account; the capital account entry will just be for any international buying or selling of the portfolio assets.
Other investment includes capital flows into bank accounts or provided as loans. Large short term flows between accounts in different nations are commonly seen when the market is able to take advantage of fluctuations in interest rates and / or the exchange rate between currencies. Sometimes this category can include the reserve account.
Reserve account is operated by a nation's central bank to buy and sell foreign currencies; it can be a source of large capital flows to counteract those originating from the market. Inbound capital flows (from sales of the account's foreign currency), especially when combined with a current account surplus, can cause a rise in value (appreciation) of a nation's currency, while outbound flows can cause a fall in value (depreciation). If a government (or, if authorized to operate independently in this area, the central bank itself) doesn't consider the market-driven change to its currency value to be in the nation's best interests, it can intervene.
A surplus in the capital account means money is flowing into the country, but unlike a surplus in the current account, the inbound flows will effectively be borrowings or sales of assets rather than earnings. A deficit in the capital account means money is flowing out the country, but it also suggests the nation is increasing its claims on foreign assets.
I will be posting more such informative articles. If you wish information on specific topics, then do let me know ( in the comments section )
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