Economics Ch - 12 Class 12th (Balance of Payment) Part - 2

     Ch - 12 (Balance of Payment) Part - 2

Capital Account  :- Capital account records receipts and payment of such transaction which cause an impact on asset - liability status of a country in relation to the rest of the world.

Export and Import of capital goods ( plant and machinery ) is not included in the capital account. Export and import of all types of goods ( consumer goods or capital goods ) is recorded as Merchandise or visible trade in the current account of BOP. Thus export and import of capital goods has nothing to do with capital account of BOP.

   Principal Components of Capital A/c -

1. Borrowing  - Borrowing is split as :

                     a) External commercial borrowing

                     b) External assistance

The principal difference between two is that while external commercial borrowing is available at market rate of interest and external assistance is available at concessional rate of interest.

Borrowing from rest of the world  raises our liability to rest of the world. It is recorded as a credit item in the Capital account of BOP because all receipts of foreign exchange are recorded as credit items in BOP accounts.

Borrowing of rest of the world  would be recorded as debit item in capital account as it causes flow of foreign exchange from of our country to rest of the world.

2. Foreign Investment  - It split as a :

        a) Port folio Investment 

        b) Foreign Direct Investment(F.D.I.)

a) Port folio Investment - basically refers to foreign institutional investment (F.I.I.). It is the investment by the rest of the world in the shares and bonds of the domestic companies.

b) Foreign Direct Investment - It relates to ownership of enterprises in the domestic economy by rest of the world.

  Other Components of Capital Account  :- 

3. N.R.I. deposits  - It is also a significant component of Capital account. Only such N.R.I. deposits are to be considered as a component of capital accounts which are made in the domestic economy. Thus non-residents Indians should make deposits in India.

   Money sent by the N.R.I. to their families in India is to be treated as Current transfer and are to be recorded in current account of BOP.

4. Banking Capital ( other than N.R.I. deposits )  - Banking capital is yet another component of capital account. It refers to Foreign assets held by the commercial banks. Owing to the draw down of foreign assets of the commercial banks ( the commercial banks converting their foreign assets into liquidity ), inflow of foreign exchange into the domestic economy tends to rise.

5. Short-term trade credit  - It arises on account of purchases in the international market without making immediate payment. Repayment of short-term debt to rest of the world leads to outflow of foreign exchange to rest of the world. Accordingly it is recorded in the Capital account with a negative sign. Inward flow of foreign exchange. On the other hand,it is recorded with a positive sign.

Capital Account = Inflow of foreign currency in terms of assets and liabilities ─ Outflow of                                foreign currency in terms of assets and liabilities

                       Official Reserve Account   :-

It is an account indicating the reserve of foreign currency with RBI.

RBI is the custodian of Forex reserve of the country and all the Forex transactions are routed through RBI. If BOP balance is positive, it causes increase in official reserve and if BOP balance is negative, it causes decrease in official reserves.

When Official Reserve Account is shown as a part of Capital A/c  :-

Sometimes, official reserve account is shown as a part of capital A/c,rather than a separate account. If official reserve are shown as a part of the capital account, then BOP always balance because for the purpose of balancing BOP accounts, increase in official reserve is indicated by negative sign while decrease in official reserve is indicated by positive sign. Accordingly, BOP shows a perfect balance.

When Official Reserve Account is not shown as a part of Capital A/c  :- 

Then the official reserves account is separately presented. In such situation, the current and capital account together may show a surplus or deficit BOP.

    BOP Surplus  =  Current A/c Surplus + Capital A/c Surplus.

    BOP Deficit   =  Current A/c Deficit  + Capital A/c Deficit.

 Equilibrium And Disequilibrium in BOP   :-

BOP equilibrium is struck when Current A/c Balance + Capital A/c Balance + Errors and Omission = Zero. And there is no movement (increase or decrease) of official reserves of the Central bank.

 Disequilibrium of BOP  :- A disequilibrium in BOP occurs when the sum total of current account balance and capital account balance is not zero, instead it is either some positive number or some negative number.

    

BOP Surplus = Current A/c balance + Capital A/c balance is some positive number.

BOP Deficit  = Current A/c balance + Capital A/c balance is some negative number.

Causes of Disequilibrium of BOP :- 

1.) Huge development expenditure by the govt. owing to which these are large scale imports.It may cause deficit BOP disequilibrium.

2.) Business cycles in terms of recession, depression, recovery and boom. A period of boom may witness large scale exports of a country. Accordingly a surplus BOP disequilibrium may occur.

3.) High rate of inflation in the domestic market, compelling large scale imports of essential goods. This causes deficit BOP disequilibrium.

4.) Political instability owing to which inflow of direct foreign investment and port folio investment from abroad may shrink. It causes deficit on capital account BOP.

5.) Change in Taste and Preference owing to which pattern of demand may change. A favourable change may encourage exports leading to Current A/c surplus while unfavourable change leads to Current A/c deficit.