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

Detail

1. What the capital account records

• The capital account records a country's trade with the rest of the world in assets: money, stocks (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.
• Capital flows are movements of capital (money for investment or lending) into or out of the domestic economy.
• Rule for signs: follow the foreign exchange.
• Debit (−): foreign exchange leaves India. Example: an Indian firm buys a UK car company, so India pays dollars or pounds out.

• Credit (+): foreign exchange comes in. Example: shares of an Indian firm are sold to a Chinese buyer, so dollars come in.

• Capital account surplus: inflows are greater than outflows.

• 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.

• Trap: a capital account surplus is not "good" in itself. It often means India is borrowing, or selling assets to foreigners, to pay for a current account deficit.

2. The BoP identity: how the two accounts fit together

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

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

• If a country runs a current account deficit (CAD), it must pay for it with a capital account surplus, by using up reserves, or both.

• Worked example (real data, derived):
• In 2021-22, India's CAD was US$ 38.7 bn and its reserves rose by US$ 47.5 bn [3].
• So capital account + errors ≈ 47.5 − (−38.7) = US$ 86.2 bn net inflow.

• Net FDI of US$ 38.6 bn was a big part of this, even though net FPI was negative at −US$ 16.8 bn [3].

• Link to 1991: the capital account can dry up quickly. In 1990-91, foreign lenders and NRIs pulled money out. India's reserves fell to a level that could pay for only about two weeks of imports. This forced the 1991 reforms (NCERT Class 11).

3. Table 6.1: a worked capital account (US$ million, illustrative NCERT data)

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

• Check the 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.
• Reading the table: foreign investment (19) is the largest item. Within it, FDI (13) is larger than portfolio (6). FDI is more stable than portfolio money, so this is a healthier mix.

4. The items, one by one

• External assistance: aid and concessional loans from abroad. Concessional loans come 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. They include bank loans, bonds and supplier credit, under RBI rules.
• ECBs can be raised through the automatic route, where the borrower's bank (an AD Category-I bank, meaning a bank authorised to deal in foreign exchange) examines the case, or through the approval route, where the request goes to the RBI [6].
• All-in-cost is the total cost of the loan. It covers interest, fees, expenses, guarantee fees and Export Credit Agency charges. It excludes commitment fees and withholding tax paid in INR [6].
• The 2019 framework made ECB rules instrument-neutral, meaning the same rules apply to loans and bonds. It set a minimum average maturity of 3 years and required lenders to be residents of FATF-compliant countries (countries that follow global anti-money-laundering standards) [5].
• Limits under the older rules (NCERT scaffold): an automatic-route limit of US$ 750 mn per year for many years, and an all-in-cost ceiling of benchmark + 500 bps (500 basis points = 5 percentage points).

• Revision: on 3 October 2025, the RBI released draft rules to rationalise ECB rules under FEMA. Under the draft:

  • borrowing limits would be linked to the borrower's financial strength;
  • ECBs would be raised at market-determined interest rates;
  • the eligible borrower and lender base would be expanded;
  • maturity and end-use rules would be simplified [7].
  • (NCERT/older rule: US$ 750 mn per year; benchmark + 500 bps.) Check the final notified rules.

• Short-term debt: foreign borrowing of up to 1 year maturity. It is mostly trade credit, meaning credit that suppliers or banks give to importers.

• It is risky because it must be rolled over (renewed) again and again. In 1991, lenders refused to roll it over.

• Non-resident deposits: deposits that non-residents keep in Indian banks. They are part of banking capital.

• FCNR(B): held in foreign currency, so the bank bears the exchange-rate risk.
• NRE: held in rupees; can be sent back abroad in full (repatriable).
• NRO: held in rupees for income earned in India; repatriation is limited.

5. 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 how countries record 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;
  • buying and selling non-produced, non-financial assets, such as land for embassies, patents, spectrum licences and brands.

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

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

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

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

• Trap: in the BPM6 layout, FDI and FPI sit in the financial account, not the capital account. The narrow BPM6 capital account is tiny for India.

6. FDI vs FPI

• Foreign direct investment (FDI): foreigners invest in productive enterprises with a lasting interest, meaning they want long-term control or influence over management.

• In India, holding 10% or more of a listed company's equity counts as FDI.

• Foreign portfolio investment (FPI): foreigners invest in shares and bonds without a controlling stake, holding below 10% of equity.

• FIIs (foreign institutional investors) is the older name for FPIs.

• SEBI regulates FPIs.

• Crossing the line: if an FPI's holding goes above 10%, it must either sell down below 10% or have the holding reclassified as FDI under the RBI/SEBI framework.

• Why the difference matters:
• FDI brings factories, technology and jobs, and is hard to pull out quickly.
• FPI is "hot money", meaning it can leave in days.
• Real example: in 2021-22, net FDI was +US$ 38.6 bn, while net FPI was −US$ 16.8 bn [3].
• Another example: in April–September 2023, net FPI was US$ 20.7 bn, but net FDI was only US$ 4.8 bn [4]. Portfolio money can swing much more than FDI.

7. Types and routes of FDI

• Greenfield investment: a foreign firm builds a new facility from scratch. It creates new capacity and jobs.
• Brownfield investment: a foreign firm buys or expands an existing facility or company. Example: Cargill buying Parakh Foods.
• Automatic route: no prior government approval is needed. The investor only reports to the RBI afterwards.
• Government route: prior approval is needed from the ministry concerned.
• Press Note 3 (2020): all FDI from countries sharing a land border with India must use the government route. China is the key target. This is also a trap: it covers all sectors.
• FIPB (Foreign Investment Promotion Board) was abolished in 2017. Its work passed to the administrative ministries, with DPIIT coordinating.

8. Overseas direct investment (ODI)

• Overseas direct investment (ODI): investment by Indian residents in foreign entities. In the BoP, it is an outflow (debit).
• It is governed by the FEMA (Overseas Investment) Rules, 2022.
• Examples: Tata–Corus (2007) (steel, UK/Netherlands) and Tata–JLR (2008) (cars, UK).
• Net FDI = gross FDI inflows − repatriation/disinvestment by foreigners − ODI by Indians.

9. Round-tripping

• Round-tripping: Indian money is sent abroad, often through Mauritius or Singapore, and brought back as "foreign" investment. The aim is to save tax or gain other benefits.
• Fixes:
• DTAA amendments: DTAA means Double Taxation Avoidance Agreement. They were amended with Mauritius in 2016 and Singapore in 2017, so capital gains are now taxed in India.
• GAAR (General Anti-Avoidance Rules), from April 2017: tax officers can deny tax benefits to deals that exist mainly to avoid tax.
• SEBI beneficial-ownership disclosure rules (2023): FPIs with concentrated holdings must disclose who really owns them.

10. Trends

• Class 11 data: foreign investment (FDI + FII) rose from about US$ 100 mn in 1990-91 to US$ 23 bn in 2022-23.
• Latest gross FDI: total FDI inflows were US$ 81.04 bn (provisional) in FY 2024-25, up 14% from US$ 71.28 bn in FY 2023-24 [8].
• The services sector got the most FDI equity at 19%, then computer software and hardware (16%) and trading (8%) (FY 2024-25) [8].

• Cumulative FDI inflows crossed US$ 1 trillion between April 2000 and September 2024 [8].

• Gross vs net:

• Gross FDI inflows rose from US$ 47.2 bn (April–November 2023) to US$ 55.6 bn (April–November 2024), a rise of 17.9% [9].
• Over the same months, net FDI fell because repatriation/disinvestment rose [9].
• Foreign investors were cashing out through secondary sales and IPOs in a strong stock market [9].

• Indian firms' rising ODI also lowers net FDI (NCERT scaffold; check the current figures).

• Recent quarterly swing: net FDI was −US$ 0.3 bn in July–September 2023 [4].

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 reserves.
• BPM6 (IMF, 2009) splits the old capital account into a narrow capital account (capital transfers and non-produced, non-financial assets) and a financial account (FDI, FPI, loans, reserves).
• RBI publishes BoP data in both BPM6 format (Statement I) and the old format (Statement II) [3].
• FDI: 10% or more of a listed company's equity. FPI: below 10%. FII is the old name for FPI.
• FCNR(B): the bank bears the currency risk. NRE: rupee account, fully repatriable. NRO: limited repatriation.
• ECB all-in-cost excludes commitment fees and withholding tax paid in INR [6]. Minimum average maturity: 3 years under the 2019 framework [5].
• Press Note 3 (2020): land-border countries go on the government route. FIPB was abolished in 2017.
• ODI is governed by the FEMA (Overseas Investment) Rules, 2022. GAAR has applied since April 2017.
• 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

• Quality of capital flows matters more than quantity.
• FDI is sticky and brings technology.
• FPI and short-term debt can reverse fast (1991; FPI of −US$ 16.8 bn in 2021-22 [3]).

• So India's policy favours equity over debt, and long-term over short-term flows: ECB maturity floors and a gradual approach to capital account convertibility.

• Falling net FDI is a mixed signal.

• The good side: foreign investors are exiting profitably through IPOs, which shows the market is deep [9].
• The worry: the CAD then leans more on volatile FPI.

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

• Openness vs security.

• Press Note 3 (2020), round-tripping checks (DTAA changes, GAAR, SEBI disclosure) and the FATF-compliant-lender rule for ECBs [5] trade some capital inflow for national security and tax fairness.

• ECB liberalisation.

• Market-determined pricing and limits linked to the borrower's financial strength (draft, October 2025) [7] widen access to funds.
• But unhedged foreign-currency debt carries currency-mismatch risk (a loan in dollars, earnings in rupees) when the rupee depreciates.