Definition of The Capital Account

The Capital Account

Capital account records public and private investment, and lending activities. It is the net change in foreign ownership of domestic assets. If foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets in a given year, then the domestic country has a capital account surplus. On the other hand, if domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets in a given year, then the domestic country has a capital account deficit. It is known as “financial account”. IMF manual lists out a large number of items under the capital account. But India, and many other countries, has merged the accounting classification to fit into its own institutional structure and analytical needs. Until the end of the 1980s, key sectors listed out under the capital account were:

i): Private capital,

ii): Banking capital, and

iii): Official capital.

Private capital was sub-divided into (i) long-term and (ii) short-term, with loans of original maturity of one year or less constituting the relevant dividing line. Long-term private capital, as published in the regular BOP data, covered foreign investments (both direct and portfolio), long-term loans, foreign currency deposits (FCNR and NRE) and an estimated portion of the unclassified receipts allocated to capital account. Banking capital essentially covered movements in the external financial assets and liabilities of commercial and co-operative banks authorized to deal in foreign exchange. Official capital transactions, other than those with the IMF and movements in RBI’s holdings of foreign currency assets and monetary gold (SDRs are held by the government), were classified into loans, (ii) amortization, and (iii) miscellaneous receipts and payments. The structure of capital account in India’s balance of payments is shown in Table.

Components of Capital Account

From 1990-91 onwards, the classification adopted is as follows:

Foreign Investment – Foreign investment is bifurcated into Foreign Direct Investment (FDI) and portfolio investment. Direct investment is the act of purchasing an asset and at the same time acquiring control on it. The FDI in India could be in the form of inflow of investment (credit) and outflow in the form of disinvestments (debit) or abroad in the reverse manner. Portfolio investment is the acquisition of an asset, without control over it. Portfolio investment comes in the form of Foreign Institutional Investors (FIIs), offshore funds and Global Depository Receipts (GDRs) and American Depository Receipts (ADRs). Acquisition of shares (acquisition of shares of Indian companies by non-residents under section 5 of FEMA, 1999) has been included as part of foreign direct investment since January 1996.

Loans – Loans are further classified into external assistance, medium and long-term commercial borrowings and short-term borrowings, with loans of original maturity of one-year or less constituting the relevant dividing line. The principal repayment of the defense debt to the General Currency Area (GCA) is shown under the debit to loans (external commercial borrowing to India) for the general currency area since 1990-91.

Banking Capital – Banking capital comprises external assets and liabilities of commercial and government banks authorized to deal in foreign exchange, and movement in balance of foreign central banks and international institutions like, World Bank, IDA, ADB and IFC maintained with RBI. Non-resident (NRI) deposits are an important component of banking capital.

Rupee Debt Service – Rupee debt service contains interest payment on, and principal re-payment of debt for the erstwhile rupee payments area (RPA). This is done based on the recommendation of high-level committee on balance of payments.

Other Capital – Other capital is a residual item and broadly includes delayed exports receipts, funds raised and held abroad by Indian corporate, India’s subscriptions to international institutions and quota payments to IMF. A delayed export receipt essentially arises from the leads and lags between the physical shipment of goods recorded by the customs and receipt of funds through banking channel. It also includes rupee value of gold acquisition by the RBI (monetization of gold).

Movement in Reserves – Movement in reserves comprises changes in the foreign currency assets held by the RBI and SDR balances held by the government of India. These are recorded after excluding changes on account of valuation. Valuation changes arise because foreign currency assets are expressed in terms US dollar and they include the effect of appreciation/depreciation of non-US currencies (such as Euro, Sterling, Yen and others) held in reserves. Furthermore, this item does not include reserve position with IMF.

The above discussion details that capital account transactions of financial assets and liabilities between residents and nonresidents, and comprises the sub-components: direct investment, portfolio investment, financial derivatives, and other investment.

As per the earlier classification, institutional character of the Indian creditor/debtor formed the dividing line for capital account transaction, whereas now it is the functional nature of the capital transaction that dominates the classification.