You’ve heard of the current account deficit and all that. But what, really, is the concept?
Here’s a primer.
Every country has to deal with other countries.
All of this, you might see, is money that typically comes into a country (or goes out) but has no “obligation” to return. It’s like if you go pay a barber for a haircut, you don’t consider that the barber owes you something because you paid him or left your hair behind. The money is the barber’s, to use as he chooses, and you needn’t figure in his future plans.
Think of this as a “current” account. If what a country gets from abroad (credit) is less than what it pays out (debit), then you have what is called a Current Account Deficit. Otherwise, you have a Current Account Surplus.
A capital transaction is when you use your money to buy an asset abroad, or when someone abroad transfers money to buy an asset in your country. This is what comes under a Capital Account.
Together the Capital and Current Accounts make the Balance of Payments.
We’ll divide the current account into a financial capital transaction (where you buy financial assets like fixed deposits, or shares, or bonds) and non-financial capital transaction (where you buy stuff that’s not financial, like a house or such).
The latter, the non-capital-financial-transaction, is what the IMF calls the Capital Account.
The former, or the Financial Account consists of:
The concept of a Balance of Payments is that the Current Account, the Capital Account and the Financial Account will cancel out each other. The Current Account is, by definition, financed by the Capital/FInancial Accounts.
In India the RBI releases this information on a regular basis, every quarter. The Current Account Deficit is a particular source of worry, because it had been widening and can result in a serious correction in the dollar-rupee equation – which it did, in 2013.
We’ve created a “waterfall’ model for you to understand this concept better:
And then, here’s how the Balance of Payments works (the big pieces)
As you can see, the Green elements add to the balance, while the red elements subtract from it.
We hope this helps you understand the Current and Capital Account, and the Concept called the Balance of Payments.
Here are three videos you may like, that are by Khan Academy, on the concept. This is marginally different for India, but we hope it will help you understand things better.