Balance of Payments – Current & Capital Account
🟠 Topic 63: Balance of Payments – Current & Capital Account
📌 Introduction
The Balance of Payments (BoP) is a comprehensive record of a country’s economic transactions with the rest of the world over a specific period. It captures the flow of goods, services, capital, and financial assets across borders. A healthy BoP indicates a stable economy, while persistent imbalances may lead to currency depreciation, foreign reserve depletion, and external debt stress.
🔹 What is Balance of Payments?
📖 Definition
BoP is a systematic statement that records all economic transactions between residents of a country and the rest of the world during a given period.
Structure of BoP
| Account | Components | Nature |
|---|---|---|
| Current Account | Trade, services, income, transfers | Short-term |
| Capital Account | Capital transfers, asset transactions | Relatively minor |
| Financial Account | Foreign investment, loans, reserves | Long-term |
🔹 Current Account – Components
1️⃣ Merchandise Trade (Trade Balance)
- Exports and imports of goods.
- Trade deficit = Imports > Exports.
| Example | Items |
|---|---|
| Exports | Textiles, software, pharmaceuticals |
| Imports | Crude oil, electronics, gold |
2️⃣ Services Trade (Invisible Balance)
- Exports and imports of services.
- India enjoys a services trade surplus.
| Example | Items |
|---|---|
| Exports | IT services, tourism, consulting |
| Imports | Shipping, patent fees |
3️⃣ Primary Income (Investment Income)
- Earnings from foreign investments.
- Payments made to foreign investors in India.
| Example | Items |
|---|---|
| Receipts | Interest from foreign bonds |
| Payments | Dividends to FDI investors |
4️⃣ Secondary Income (Transfers)
- Remittances from Indians abroad.
- Grants and donations from international bodies.
| Example | Items |
|---|---|
| Receipts | NRI remittances |
| Payments | Disaster relief donations to other nations |
Current Account Deficit (CAD)
✅ Current Account Deficit (CAD) = Total Current Account Outflows – Total Current Account Inflows
🔔 Persistent CAD leads to rupee depreciation and higher external borrowings.
🔹 Capital Account – Components
1️⃣ Capital Transfers
- Transfers related to migrant property, debt forgiveness, or grants for infrastructure.
- Minor component for India.
2️⃣ Acquisition/Disposal of Non-Produced, Non-Financial Assets
- Transfers involving patents, copyrights, or natural resources rights.
✔️ Capital account is relatively insignificant in India’s BoP.
🔹 Financial Account – Components
1️⃣ Foreign Direct Investment (FDI)
- Long-term investments with controlling interest.
- Example: Investment by Amazon in Indian subsidiaries.
2️⃣ Foreign Portfolio Investment (FPI)
- Short-term investments in stocks and bonds.
- Highly volatile, sensitive to global factors.
| Example | Items |
|---|---|
| Inflow | Foreign institutional investors buying shares |
| Outflow | FPI selling due to Fed rate hikes |
3️⃣ External Commercial Borrowings (ECB)
- Loans raised by Indian corporates from foreign lenders.
- Useful for infrastructure projects but raises debt servicing burden.
4️⃣ Reserve Assets (Foreign Exchange Reserves)
- Managed by RBI.
- Includes: ✔️ Foreign currency assets.
✔️ Gold reserves.
✔️ Special Drawing Rights (SDRs).
Overall Balance
✅ Overall Balance = Current Account + Capital Account + Financial Account
If overall BoP is positive, forex reserves increase.
If overall BoP is negative, forex reserves decrease.
🔹 Trends in India’s BoP (2023)
| Indicator | Value |
|---|---|
| Current Account Deficit | ~1.7% of GDP |
| Merchandise Trade Deficit | ~$260 billion |
| Services Trade Surplus | ~$140 billion |
| Net Remittances | ~$110 billion |
| FDI Inflows | ~$71 billion |
| Forex Reserves | ~$620 billion |
BoP and Rupee Stability
- High CAD can trigger rupee depreciation, as demand for dollars increases.
- RBI intervenes in forex markets using reserves to stabilize the rupee.
Case Study – BoP Crisis 1991
- Current Account Deficit exceeded 3% of GDP.
- Foreign reserves fell to cover just 2 weeks of imports.
- Led to: ✔️ Rupee devaluation.
✔️ IMF bailout with structural reforms.
✔️ Economic liberalization (LPG reforms).
🔹 Causes of Current Account Deficit in India
| Factor | Example |
|---|---|
| High Oil Imports | 85% dependence on imported crude |
| Gold Imports | High consumer demand |
| Electronics Imports | Low domestic manufacturing |
| Weak Export Competitiveness | Labour laws, infrastructure bottlenecks |
🔹 Measures to Manage BoP & CAD
1️⃣ Export Promotion
- Incentives under RoDTEP scheme.
- PLI schemes to boost manufacturing exports.
2️⃣ Import Substitution
- Domestic production under Make in India.
- Focus on renewables to cut oil import dependence.
3️⃣ Boosting Remittances
- Engagement with Indian diaspora.
- Encouraging NRI investments (NRI bonds).
4️⃣ Attracting FDI
- Ease of doing business reforms.
- Liberalized FDI caps in defence, telecom, insurance.
5️⃣ Strengthening Forex Reserves
- Building adequate reserves for external shocks.
- Maintaining debt service ratio below risk thresholds.
🔹 Importance of BoP Management
✔️ Ensures external sector stability.
✔️ Protects rupee from volatility.
✔️ Provides confidence to foreign investors.
✔️ Ensures sustainable external debt levels.
✔️ Facilitates smooth capital flows.
📚 Practice MCQ
1️⃣ Which of the following is part of India’s Current Account?
- FDI inflows
- Remittances from NRIs
- Payment of interest on external loans
- Portfolio investment inflows
✅ Options:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1, 3, and 4 only
(d) 2, 3, and 4 only
2️⃣ A Current Account Surplus means:
✅ Options:
(a) Exports exceed imports
(b) Capital inflows exceed outflows
(c) Foreign reserves are rising
(d) Government is running a fiscal surplus
3️⃣ Which organisation maintains India’s forex reserves?
✅ Options:
(a) Ministry of Finance
(b) RBI
(c) SEBI
(d) EXIM Bank
