What Is Capital Account?
The capital account is the section of a country's balance of payments that records all international transactions involving capital flows, such as investments, loans, and acquisitions of assets such as property or equipment.
Renowned economist Jagdish Bhagwati describes the capital account as "the transactions that involve ownership of assets and liabilities across borders" (Bhagwati, 1998).
More Thorough Understanding of the Term
The capital account is one of two primary components of a country's balance of payments, along with the current account. The capital account tracks foreign financial movements, whereas the current account records transactions connected to the trade of goods and services.
A capital account is a section of the balance of payments. Under the revised format of the International Monetary Fund, the capital account measures capital transfers and the acquisition and disposal of non-produced non-financial assets.
Under traditional definitions, still used by many countries, the capital account measures public and private international lending and investment. Most of the conventional definition of the capital account is now incorporated in IMF statements as the "financial account."
The capital account essentially tracks financial assets and liabilities transferred between governments. These transactions are classed as either inbound or outward capital flows. Foreign entities investing in the home economy are called inward flows, while domestic entities investing in other economies are called outward flows.
How Does This Work?
The capital account is an essential factor in measuring a country's economic health since it shows its foreign investment and ability to invest abroad.
A country having a capital account surplus is more appealing to foreign investors and may have a better economy. A country with a deficit, on the other hand, may encounter difficulties attracting foreign investment, leading to economic instability.
Capital account transactions might be inward or outward in nature. Foreign entities invest in their home nation through inward transactions, while local firms invest overseas through outward transactions.
Foreign direct investment (FDI) in domestic enterprises, foreign portfolio investment (FPI) in domestic securities, and loans from foreign corporations are examples of inward transactions.
Domestic direct investment in overseas enterprises, domestic portfolio investment in international assets, and loans to foreign entities are examples of outward transactions.
Example
Consider the case of a developing country seeking foreign investment to demonstrate the significance of the capital account. Assume the country has a high trade imbalance, which means it imports more than it exports. The country must recruit foreign investment to finance its deficit to balance its accounts. In this instance, the country may push FDI-attractive policies such as tax breaks or reduced regulatory hurdles.
The country can create jobs, raise economic output, and reduce the trade imbalance by attracting foreign investment. Attracting foreign investment, on the other hand, comes with dangers. For example, foreign investors may abruptly withdraw their investments, resulting in an economic catastrophe.
In Sentences
- The capital account indicates a country's ability to attract and invest foreign capital, making it a critical policy factor.
- The capital account is an essential measure of a country's economic health.