<<–2/”>a href=”https://exam.pscnotes.com/5653-2/”>p>Let’s break down the differences between current and capital accounts in detail.
Introduction
The Current Account and Capital Account are two components of a nation’s Balance of Payments (BOP). The BOP is a systematic record of all economic transactions between residents of a country and the rest of the world over a specific period. These accounts provide crucial insights into a country’s economic Health, trade patterns, and financial stability.
Key Differences: Current Account vs. Capital Account
| Feature | Current Account | Capital Account |
|---|---|---|
| Nature of Transactions | Records the flow of goods, Services, income, and unilateral transfers between a country and the rest of the world. | Records the flow of financial assets between a country and the rest of the world. |
| Focus | Primarily reflects a country’s net income from international trade and Investment. | Primarily reflects changes in a country’s foreign assets and liabilities. |
| Time Horizon | Deals with short-term transactions that affect a country’s income and expenditure in the present. | Deals with long-term transactions that affect a country’s net worth and investment position. |
| Components | – Exports and imports of goods and services – Income from investments (dividends, interest, etc.) – Current transfers (Remittances, foreign aid, etc.) | – Foreign Direct Investment (FDI) – Portfolio investment (stocks, Bonds) – Other investments (loans, currency deposits) – Reserve assets |
| Impact on Economy | A Current Account Deficit indicates a country is spending more on imports than it is earning from exports, potentially leading to currency depreciation and increased borrowing. | A capital account surplus indicates a country is attracting more foreign investment than it is investing abroad, potentially leading to currency appreciation. |
Advantages and Disadvantages of Current Account
| Advantages | Disadvantages |
|---|---|
| – Provides information about a country’s competitiveness in international trade. – Helps assess a country’s ability to generate income from abroad. – Indicates the sustainability of a country’s external borrowing. | – A persistent deficit can lead to currency depreciation and higher interest rates. – It may indicate an overreliance on foreign borrowing to finance consumption. – Can limit a country’s policy Options to address economic challenges. |
Advantages and Disadvantages of Capital Account
| Advantages | Disadvantages |
|---|---|
| – Facilitates the flow of capital for investment and development. – Can help finance Infrastructure-2/”>INFRASTRUCTURE projects and promote economic Growth. – Allows countries to diversify their assets and reduce risk. | – Excessive capital inflows can lead to asset bubbles and financial instability. – Can increase a country’s vulnerability to sudden capital outflows and economic shocks. – May limit a country’s ability to control its exchange rate and Monetary Policy. |
Similarities Between Current Account and Capital Account
- Both are components of the balance of payments.
- Both provide valuable information about a country’s economic interactions with the rest of the world.
- Both are interconnected and can influence each other.
FAQs on Current Account and Capital Account
What is the relationship between the current account and capital account?
- The current account and capital account are mirror images of each other. In theory, a current account deficit is financed by a capital account surplus, and vice versa. However, in practice, there may be discrepancies due to measurement errors and unrecorded transactions.
Why is the balance of payments always zero?
- The balance of payments is an accounting identity, meaning that it must always balance. Any deficit in one account must be offset by a surplus in another account.
What are the implications of a persistent current account deficit?
- A persistent current account deficit can lead to increased foreign debt, currency depreciation, higher interest rates, and potential economic instability.
Can a country have a current account surplus and a Capital Account Deficit simultaneously?
- Yes, it’s possible but less common. It might occur when a country uses its current account surplus to invest heavily abroad, resulting in a capital account deficit.
Let me know if you’d like more details on any specific aspect!