Capital Account
1 Quick Explanation 1–3 min
The capital account records transactions that change assets and liabilities — loans, investments, foreign reserves.
It finances the current account: a CAD must be matched by a capital account surplus.
2 Detailed Notes
Definition
Definition
The capital account records transactions that lead to changes in foreign financial assets and liabilities of residents — foreign investment, loans, banking capital and changes in foreign exchange reserves.
Key points
Components
- Foreign Direct Investment (FDI): long-term investment in companies (factories, equity).
- Foreign Portfolio Investment (FPI): shares, bonds, mutual funds (short-term, footloose).
- External commercial borrowings & loans.
- Banking capital (NRI deposits).
- Change in foreign exchange reserves.
Comparison
FDI vs FPI
| Basis | FDI | FPI |
|---|---|---|
| Nature | Long-term, management control | Short-term, financial returns |
| Form | Factories, equity with control | Shares, bonds, MF units |
| Stability | Stable, helps growth | Volatile ('hot money') |
| Example | Company setting up plant in India | Foreign fund buying Indian shares |
Formula
The accounting link
Current Account Balance + Capital Account Balance + Change in Reserves = 0A current account deficit is financed by a capital account surplus (inflows) or by drawing down foreign exchange reserves.
Important
Exam angle
When asked 'how is a BOP deficit financed?': through capital inflows (FDI/FPI/loans/NRI deposits) or by dipping into forex reserves.
In One Minute
Capital account = FDI + FPI + loans + banking capital + reserve changes. It finances the current account: surplus capital inflows offset a current account deficit.
Important for Exam
- ⭐ 1-mark: FDI vs FPI.
- ⭐ 3-marks: components of capital account.
- ⭐ How a current account deficit is financed.
- ⭐ FDI vs FPI difference table.
Watch & Learn
Watch on YouTubeFundamentals - Interest On Capital - Accountancy - Class 12 - Part 3
by Rajat Arora
Why watch? FDI/FPI and components in detail.
Open on YouTube Watch on YouTubeFundamentals - Interest On Capital - Accountancy - Class 12 - Part 3
by Rajat Arora
Why watch? Simple comparison for 3-mark questions.
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