Question

7. Explain the following terminologies: capital account, current account, and balance of payment.

Answer 1

During a given period, exports and imports of all goods and services and unilateral transfers are recorded in current account. The inflow and outflow of money in an economy related to the visible trade, invisible trade and unilateral tranfers is recorded in current account. Current account consists of the following:

1. Visible trade which is the imports and exports of goods

2. Invisible trade which is the imports and exports of services

3.Unilateral transfers (one sided transactions)

4. Income received from abroad for paid to a foreign country

When the amount on credit side is greater than the amount on the debit side, it is known as surplus in current account. This means there is a net inflow of foreign exchange in the economy.

When the amount on debit side is greater than the amount on the credit side, it is known as deficit in current account. This means there is a net outflow of foreign exchange in the economy.

Capital account:

The financial transactions between a home country and the rest of world that lead to a change in the assets or liabilities of that home country are recorded in capital account. Capital account includes the following:

1.It includes the amount home country borrows from abroad and the amount that home country lends to other countries.

2.It includes investments made by the foreign countries in home country and the investments made by the home country abroad.

3.Any changes that occur in the foreign echange reserves are included in the capital account.

When the amount on credit side is greater than the amount on the debit side, it is known as surplus in capital account. This means there is a net inflow of foreign exchange in the economy.

When the amount on debit side is greater than the amount on the credit side, it is known as deficit in capital account. This means there is a net outflow of foreign exchange in the economy.

Balance of Payments:

Balance of payments is a record of all the financial transactions that take place between the residents of a country and the rest of the world during a particular period of time. Balance of payment divides the international transactions into current account and capital account. The balance of payment is reported either quarterly or yearly. It indicates the financial position and net international investment position of an economy. It tells if a country has enough savings for imports and has enough output for growth.