Capital account

Topic: Balance of Payments and Exchange Rates · NCERT: Class 12, Ch 6 "Open Economy Macroeconomics"

Meaning

The capital account is the part of the balance of payments (BoP) that records a country's trade with the rest of the world in assets: money, shares, bonds, government debt and loans. The current account records goods, services, income and transfers. The capital account records who owns what, and who owes whom.

It matters because it shows how a country pays for its current account deficit (CAD). It also shows whether the money coming in is stable or can run away quickly.

BoP identity: Current account balance + Capital account balance + Errors and omissions = Change in foreign exchange reserves.

• Errors and omissions are a balancing figure for flows that were not recorded properly.

Explanation

How it works: the sign rule

• Capital flows are movements of money for investment or lending into or out of the country.
• Follow the foreign exchange to get the sign:
• Credit (+): foreign exchange comes in. Example: shares of an Indian firm are sold to a Chinese buyer, so dollars come in.

• Debit (−): foreign exchange leaves India. Example: an Indian firm buys a UK car company, so India pays out dollars or pounds.

• Inflows (credits): loans received from abroad, and sales of Indian assets to foreigners.

• Outflows (debits): repayment of foreign loans, and purchases of foreign assets by Indians.
• Capital account surplus: inflows are greater than outflows.
• A surplus is not "good" in itself:
• it often means India is borrowing from abroad,
• or selling its assets to foreigners,
• to pay for a current account deficit.

Components (NCERT "major items" layout)

• External assistance: aid and concessional loans (loans at below-market interest or with long repayment periods). Lenders include the World Bank's IDA, the ADB and friendly governments.
• External commercial borrowings (ECBs): commercial loans that eligible Indian residents raise from non-residents, such as bank loans, bonds and supplier credit, under RBI rules.
• Short-term debt: foreign borrowing of up to 1 year. It is mostly trade credit (credit that suppliers or banks give to importers).

• It is risky because it must be rolled over (renewed) again and again.

• Banking capital: includes non-resident deposits that NRIs keep in Indian banks.

• Foreign investment: FDI plus portfolio investment (FPI).
• FDI (foreign direct investment): foreign investment with a lasting interest, meaning long-term control or influence over the firm. In India, this means 10% or more of a listed company's equity.
• FPI (foreign portfolio investment): holdings of shares and bonds below 10% of equity, with no controlling stake. FPI is "hot money" that can leave in days.

Worked example: NCERT Table 6.1 (US$ million, illustrative)

Item	Value
External assistance (net)	0.15
ECBs (net)	2
Short-term debt	10
Banking capital (net), of which NRI deposits 9	15
Foreign investment (net): FDI 13 + portfolio 6	19
Other flows (net)	−5
Capital account balance	41.15

• Sum: 0.15 + 2 + 10 + 15 + 19 − 5 = 41.15.
• "Net" means inflows minus outflows. For example, net ECB = new ECB loans received − ECB repayments.
• "Of which" trap: the NRI deposits of 9 are inside banking capital of 15. Do not add them again.
• FDI (13) is larger than portfolio (6). Since FDI is more stable, this is a healthier mix.

BPM6: the IMF's new layout

• BPM6 is the IMF's Balance of Payments and International Investment Position Manual, 6th edition (2009). It sets global rules for recording BoP data.
• It splits the old, broad capital account into two parts:
• Capital account (narrow): capital transfers (such as debt forgiveness or migrants' transfers of assets), and the buying and selling of non-produced, non-financial assets (land for embassies, patents, spectrum licences, brands).

• Financial account: almost all trade in financial assets, meaning FDI, portfolio investment, loans, other investment and reserve assets.

• In BPM6, the old "capital account" was renamed the "capital and financial account" [2].

• So under BPM6, FDI and FPI sit in the financial account. The narrow capital account is tiny for India.

What makes it rise or fall

• Rises (bigger surplus): more FDI and FPI inflows, more foreign loans and ECBs, and higher NRI deposits.
• Falls: foreign investors taking money back (repatriation or disinvestment), repayment of loans, and more overseas direct investment (ODI) by Indians. ODI is Indian residents investing in foreign firms, which is a debit.
• Sudden stops: lenders can refuse to roll over short-term debt, and FPI can leave within days. This is how the capital account can dry up quickly.

In India

• Who publishes the data: the RBI publishes quarterly BoP data in two formats [3][4]:
• Statement I: the BPM6 format;

• Statement II: the old "major items" format, which NCERT Table 6.1 follows.

• 1991 crisis: in 1990-91, foreign lenders and NRIs pulled money out, and lenders refused to roll over short-term debt. Reserves fell to a level that could pay for only about two weeks of imports. This forced the 1991 reforms.

• How the capital account paid for a CAD in 2021-22:
• the CAD was US$ 38.7 bn and reserves rose by US$ 47.5 bn [3];
• so capital account + errors ≈ 47.5 − (−38.7) = US$ 86.2 bn net inflow;

• net FDI was +US$ 38.6 bn, while net FPI was −US$ 16.8 bn [3].

• Swings in the flows:

• In April–September 2023, net FPI was US$ 20.7 bn, but net FDI was only US$ 4.8 bn [4].

• Net FDI was −US$ 0.3 bn in July–September 2023 [4].

• Latest FDI:

• Gross FDI inflows were US$ 81.04 bn (provisional) in FY 2024-25, up 14% from US$ 71.28 bn in FY 2023-24 [7].

• Cumulative FDI inflows crossed US$ 1 trillion between April 2000 and September 2024 [7].

• Gross FDI rose but net FDI fell:

• Gross FDI rose from US$ 47.2 bn (April–November 2023) to US$ 55.6 bn (April–November 2024), a rise of 17.9% [8].

• But net FDI fell, because foreign investors took more money home by selling shares through secondary sales and IPOs [8].

• Rules behind the flows:

• Non-resident deposits: FCNR(B) is held in foreign currency, so the bank bears the exchange-rate risk. NRE is a rupee account and fully repatriable (can be sent back abroad in full). NRO is a rupee account for income earned in India, with limited repatriation.
• FPIs are regulated by SEBI.
• ECBs: the 2019 framework made the rules instrument-neutral (the same rules for loans and bonds). It set a minimum average maturity of 3 years and required lenders to be from FATF-compliant countries [5]. On 3 October 2025, the RBI released draft rules that link borrowing limits to the borrower's financial strength and allow market-determined interest rates [6].
• ODI is governed by the FEMA (Overseas Investment) Rules, 2022.
• Press Note 3 (2020): all FDI from countries that share a land border with India must use the government route (prior approval).

Don't confuse with

• Current account: it records goods, services, income and transfers. The capital account records trade in assets and liabilities (loans, shares, bonds).
• Financial account (BPM6): under BPM6, FDI, FPI, loans and reserve assets belong here, not in the capital account. The BPM6 capital account is narrow and covers only capital transfers and non-produced, non-financial assets.
• Capital account convertibility: this is the freedom to convert rupees into foreign currency for asset transactions. It is a policy choice. The capital account is only the record of those transactions.
• Gross FDI vs net FDI: net FDI = gross FDI inflows − repatriation/disinvestment by foreigners − ODI by Indians. Gross can rise while net falls, as it did in 2024 [8].

Prelims Hooks

• Sign rule: buying a foreign asset is a debit. Selling an Indian asset to foreigners is a credit.
• BoP identity: CA balance + capital account balance + errors and omissions = change in forex reserves.
• BPM6 (IMF, 2009): FDI, FPI, loans and reserves go in the financial account. The narrow capital account holds capital transfers and non-produced, non-financial assets (patents, spectrum licences, land for embassies).
• The RBI publishes BoP data in both the BPM6 format (Statement I) and the old format (Statement II) [3].
• FDI is 10% or more of a listed company's equity, and FPI is below 10%. FCNR(B): the bank bears the currency risk.
• Trap: "A capital account surplus always shows a strong economy" is false. It may mean the country is borrowing to fund a CAD.

Mains Points

• The quality of capital flows matters more than their size.
• FDI is sticky and brings factories, technology and jobs.
• FPI and short-term debt can reverse fast. Examples are the 1991 crisis and net FPI of −US$ 16.8 bn in 2021-22 [3].

• So Indian policy prefers equity over debt and long-term over short-term flows. It does this through ECB maturity floors [5] and a gradual path to capital account convertibility.

• Falling net FDI is a mixed signal.

• The good side: foreign investors are exiting with profits through IPOs, which shows that India's stock market is deep [8].
• The worry: the CAD then depends more on volatile FPI.

• The policy answer is ease of doing business, stable tax rules and PLI-type incentives.

• Openness vs security and stability.

• Press Note 3 (2020), checks on round-tripping (DTAA changes, GAAR, SEBI disclosure rules) and the FATF-compliant lender rule [5] give up some inflows for security and tax fairness.
• The draft 2025 ECB changes [6] widen access to foreign funds. But unhedged dollar loans carry a currency-mismatch risk (the loan is in dollars but earnings are in rupees) when the rupee falls.

Related concepts

• BPM6
• Capital flows
• Foreign Direct Investment
• Foreign portfolio investment
• Greenfield and brownfield investment
• Automatic route and government route
• Overseas direct investment
• Round-tripping
• External commercial borrowings
• Non-resident deposits

Read more

• Balance of payments II: the capital (financial) account and BPM6