1. CAPITAL ACCOUNT

   The capital account measures transfer in assets and liabilities.

The components of the capital account include foreign investment and loans, banking and other forms of capital, as well as monetary movements or changes in the foreign exchange reserve. The capital account flow reflects factors such as commercial borrowings, banking, investments, loans, and capital.

If a country has a current account deficit, then, assuming exchange rates are floating, it will have an equivalent capital account surplus. This is necessary to finance a current account deficit.

Balance of Payment

        It is more elaborate concept than balance of trade. BOP include all parts of transaction happens between countries. The balance of payments (BOP) is a statement of all transactions (including service) made between entities in one country and the rest of the world over a defined period of time, such as a quarter or a year.

        It is a systematic record of a country’s economic and financial transaction with the rest of the world over a period of time. Central Banks of each country prepare their own BOP records based on IMF’s guidelines. All those figures are expressed in dollars for simplification and comparison purposes.

        The sum of all transactions recorded in the balance of payments must be zero, as long as the capital account is defined broadly. The reason is that every credit appearing in the current account has a corresponding debit in the capital account, and vice-versa. If a country exports an item (a current account credit), it effectively imports foreign capital when that item is paid for (a capital account debit). 

BOP = Current Account Balance + Capital Account Balance

At the end of financial year or particular period, BOP is calculated by central Bank If BOP is Surplus Balance Money Added to Foreign Exchange Reserve If BOP is deficit Balance is deduced from Foreign Exchange Reserve

When the export of a country exceeds the import, then BOP is termed as the favourable BOP or surplus BOP. But when import exceeds the export, then BOP is termed as the unfavourable or deficit BOP.

BOP Disequilibrium

        The BOP deficit or surplus indicate imbalance in the BOP. This imbalance is interpreted as BOP Disequilibrium. A country’s balance of payments is said to be in disequilibrium when its autonomous receipts (credits) are not equal to its autonomous payments (debits)

        One country’s credit is other countries. Debit Hence BOP of world is always zero.

        When current account receipts are greater than current account expenditure it is known as current accounts surplus. Similarly, the reversal is known as current account deficit. A Current Account Deficit should always balance by capital account surplus. Since India is labour intensive country, it always have strong capital account surplus. India always has current account deficit because,

1)     More Dependent of imported crude oil.

2)     High level of gold consumption which is imported

3)     Unavailability of certain resources

BOP CRISIS – India 1991

        India faced its worst financial crisis in 1991 when it was close to default. Foreign exchange reserves had been reduced to such a point that India could barely finance three weeks’ worth of imports. To manage the crisis Indian government kept national gold reserves as a pledge to the IMF in exchange for a loan to cover BOP debts.