Current Account vs Capital Account

Notes

Basis	Current account	Capital (and financial) account
Records	Transactions in goods, services, income and transfers	Transactions in assets and liabilities: investment, loans, reserves
Nature	Affects national income (flows)	Affects assets and liabilities (stocks)
Components	Merchandise trade, services, primary income, secondary income (remittances)	FDI, FPI, ECBs, NRI deposits, external assistance, trade credit, reserve changes
Balance	Current account deficit (CAD) when payments exceed receipts	Net capital inflow that finances the CAD
Identity	CA + KA (including reserves) = 0

India's current account

Merchandise trade deficit (oil, gold, electronics, coal) of roughly US$240-280 billion a year, partly offset by a services surplus (IT, business services, travel) and remittances (India is the world's top recipient, over US$100 billion). The CAD is therefore small.
CAD financing: FDI is stable; FPI is volatile; ECBs and NRI deposits (NRE, NRO, FCNR(B)) also help. A large CAD with volatile flows raises vulnerability to a sudden stop.

Convertibility

Current account convertibility: achieved in August 1994 (India accepted Article VIII of the IMF). Capital account convertibility: only partial; the Tarapore Committee (1997, 2006) set conditions: lower fiscal deficit, inflation of 3-5%, lower NPAs and adequate reserves.
FEMA, 1999 replaced FERA, 1973: current account transactions are free; capital account transactions are regulated by the RBI.

Key Points

Current account: goods, services, income, transfers; capital account: investment and loans.
CAD is financed by net capital inflows.
India has a goods deficit but a services surplus and large remittances.
Current account convertibility: 1994; capital account: partial (Tarapore Committee).
FEMA (1999) replaced FERA (1973).

MCQs

Q1. Which of the following is a capital account item? (a) Software exports (b) FPI (c) Remittances (d) Merchandise imports Ans: (b).

Q3. The Committee on capital account convertibility was headed by: (a) S.S. Tarapore (b) C. Rangarajan (c) Raghuram Rajan (d) Vijay Kelkar Ans: (a).