The capital Account & Other Accounts

The capital Account 

The account records the changes in the levels of international financial assets and liabilities. The various classifications within the capital account are private, banking and official. Distinction is also made between short term and long term capital flaws, loans with original maturity of more than one year are classified as long term flows. Long term foreign investment measures all capital investments made between countries, including both direct foreign investment and purchases of securities with maturities exceeding one year. Short term foreign investment measures flows of funds invested in securities with maturities of less than one year. Because of the short maturity, investors of such securities will often maintain their funds in a given country for only a short time, causing short term investment flows to be quite volatile over time.

 Private-capital Flows:

These flows consist of several types of transactions. Among them are: long term loans received by individuals and companies (other than banking institutions), investment by foreigners in the joint stock companies in India, repayment of long term loans by non- resident, obtained from residents, repatriation of Indian investments abroad, deposits in non-resident (external) rupee accounts and in foreign currency non-resident accounts. Capital outflows (debit entries) comprise investments by residents in shares and other financial assets abroad, repayment of foreign loans by residents, repatriation of foreign investments in India, long term loans made to non-residents and so forth. 

Short term capital flows on private account consists of short term borrowings and investments.

Banking Capital Flows:

Capital movements in banking sector covers changes in foreign assets and liabilities of commercial banks, whether privately owned or government owned and cooperative banks. Assets consist of balances held by banks with their foreign branches or correspondent banks abroad, and rupee assets representing loans granted by Indian banks to branches of foreign banks in India and correspondent banks. Liabilities consist of Indian banks' debit balances in their foreign accounts and credit balances held by nonresident banks and few other institutions with banks in India. Any increase in assets (or decrease in liabilities) will be a debit entry while a decrease in assets (or increase in liability) a credit. 

Official Capital flows: 

This category covers transactions affecting foreign financial assets and liabilities of the government of India and the Reserve Bank of India, excluding transactions relating to official reserve assets. Government of India's purchase and repurchase from the IMF are shown in a separate account. Loans received by the Government of India from foreign governments and international institutions are treated as credit entries and amortization or repayment of such loans as debit. 

Look at Table 3.2 which shows India’s balance of payments on Current Account and capital Account in recent years.

The Other Accounts
The remaining accounts in India’s BOP are set out in table 3.4.

The IMF account contains, as mentioned above, purchases (credits) and repurchases from the IMF. SDRs (Special Drawing Rights) are a reserve asset created by the JMF and allocated to member countries from time to time. Subject to IMF regulations, SDRs can be used to settle international payments between monetary authorities of member countries. .An allocation is a credit and the utilization is a debit. The reserves and Monetary Gold account increases (debits) and decreases (credits) in reserve assets. Reserve assets consist of RBI holdings of gold and foreign exchange (in the form of balances with foreign central banks and investments in foreign government’s securities) and Government’s holdings of SDRs.

The Current Account (BOP)

Look at Table below where the structure of the current account in India’s BOP statement has been shown. Let us briefly discuss each of the above heads and subheads. 

1. Merchandise: Merchandise exports valued on F.O.B... (Free on board) basis, on private and government account are the credit entries data for these items. They are calculated from the various documents exporters fill and submit to designated authorities. Imports valued at C.I.F. (Cost, Insurance and Freight) are the debit entries. The difference between the totals of credits and debits appears in the 'Net' column. This is the balance on Merchandise Trade Account, a deficit, if negative and a surplus if positive. 

2. Non-Monetary Gold Movements: Gold is both a commodity and a financial asset. It is treated as financial assets when it is held by the monetary authority. "Monetization" of gold refers to the transaction when the monetary authority acquires gold, from residents and non residents to add to reserves. This gets recorded as a debit entry in reserve account and the offsetting credit entry is made in the non monetary gold account. Conversely, when the monetary authority acquires gold demonetization, reserve account shows a credit and the non monetary gold movement account shows a debit. Gold imported (or exported) by other agencies form a part of the merchandise trade account. 

Table: Structure of Current Account in India's Balance of Payments Statement.

3. Invisibles: Credits under 'invisibles' consist of services rendered by residents to non residents, income earned by residents on their ownership of foreign financial assets (interest, dividends etc.), income earned from the use, by non residents, of non-financial assets such as patents and copy rights owned by residents and the offset entries to the cash and in kind gifts received by residents from non-resident. Debits consist of same items with the roles of residents and non-residents reversed. A few examples may be cited as follows: 

• Receipts in foreign exchange, reported by authorized dealers in foreign exchange, remitted to them by organizers of foreign tourist parties located, I abroad for meeting hotel and other local expenses of the tourists. This will be a credit under "travel". 
• Freight charges paid to nonresident airlines or shipping companies directly will appear as debits under transportation. 
• Premiums on all kinds of insurance and re-insurance provided by Indian insurance companies to non-resident clients is a credit entry under "insurance", 
• Profits remitted by the foreign branch of an Indian company to the parent company represent a receipt of 'direct investment income', to be recorded as a credit entry under 'investment income', Interest paid by an Indian company on its borrowings abroad will appear as a debit. 
• Funds received from a foreign government for the maintenance of their embassy, consulates etc, in India will constitute a credit entry under 'Government not included elsewhere’.
• Foreign exchange earnings of Indian consultancy firms for professional services rendered to non residents will be recorded as a credit entry under miscellaneous. Similarly, professional services provided to residents by nonresident companies will appear as debit entry. 
• Revenue contributions made by the Government of India to international institutions or nonresident entities abroad will be recorded as a debit entry under ‘official transfer’. Simply, cash remittances for family maintenance received from Indian nationals working abroad will be a credit entry under private transfers. 

Look at Table 3.2 which gives you an idea about India's balance of 'payments:

The net balance between the credit and debit entries under the heads merchandise, non- monetary gold movements taken together is the Current Account Balance. The net balance is taken as deficit, if negative (debits exceed credits), a surplus, if positive (credits exceed debits).

COMPONENTS OF BALANCE OF PAYMENTS

The balance of payments is a collection of accounts conventionally grouped into three main categories with subdivisions in each. Three main categories are: 

a) The Current Account: Under this are included imports and exports of goods and services and unilateral transfers, which reflect government and private gifts and grants. 

b) The Capital Account: Under this are grouped transactions leading to changes in foreign financial assets and liabilities of the country. 

c) The Reserve Account: In principle, this is not different from the capital account it as much as it relates to financial assets and liabilities. However, in this category, only reserve assets are included. These are the assets which the central bank of the country uses to settle the deficits and surpluses that arise in the other two categories.

Balance of Payments

DEFINITION 
Balance of payment is an accounting record of the transactions between the residents of one country and the residents of the rest of the world over a given period of time. Transactions in which domestic residents either purchase assets (goods and services) from abroad or reduce foreign liabilities are considered uses (out flow) of funds because payments abroad must be made. Similarly, transactions in which domestic residents either sell assets to foreign residents or increase their liabilities to foreigners are sources (inflows) of funds because payments from abroad are received. Thus, in a way, it resembles a company's sources and use of funds statement.

UNDERLYING PRINCIPLES AND CONCEPTUAL FRAMEWORK
The balance of payment is part of a larger system of social accounts recording the economic activity of an economy and its various sections. The social accounts relate to economic transactions not only within the domestic economy but also between the domestic economy and the rest of the world. Balance of payment is concerned with economic transactions; five basic types of economic transactions may be distinguished. They are: 

a) Purchases and sales of goods and services against financial items i.e. the interchange of goods and services against claims and monetary gold;

b) Barter, i.e. the interchange of goods and services against other goods and services;

c) The interchange of financial items against other financial items e.g. sale of securities for money, or the repayment of commercial debts in money;

d) The provisions or acquisition of goods and services without requital, e.g. grants in aid;

e) The provision or acquisition of financial items without requital, e.g. In payment of taxes or as a gift.

The social accounts have common rules of credit and debit for recording economic transactions. Credit entries are made for the provision of goods and services or of financial items, whether they are sold, bartered, or furnished without requital. Debit entries are made for acquisition of goods and services or of financial items, whether these items are purchased, obtained by barter, or acquired without requital, for the first three types of transactions, the rules immediately result in equal credit and debit entries. For the remaining types, a credit entry for goods and services or financial items is matched by a debit entry for an unrequited transfer, and vice versa.

As stated earlier, balance of payments is concerned with economic transactions between the residents of the reporting country and the residents of the rest of the world. To acquire an in depth understanding, it is necessary to clarify the concept of residents. This term is certainly not identical with the term “citizen” though there is normally a substantial overlap. As regards individuals, ‘residents’ means those individuals whose general centre of interest can be said to rest in the given economy. They consume goods and services, participate in the productive process or otherwise carry out economic activity within the territory of the country on other than a temporary basis. Members of diplomatic and consular staffs and official missions, members of armed forces stationed abroad, and citizens undergoing medical treatment or studying abroad are considered residents of their own rather than of the country where they are staying. The extent to which other citizens living abroad are treated as residents (travelers) or foreigners (emigrants) depends upon a number of factors such as permanence of their living and the extent to which they shift their general "centre of interest". As regards non-individuals a set of conventions have been evolved. For example, governments and nonprofit bodies servicing resident individuals are residents of the respective countries. For enterprises, rules are somewhat complex particularly those concerning unit of corporate branches of foreign multinationals, According to IMF rules, these are considered to be residents of countries where they operate, though they are not a separate legal entity from the parent located abroad, international organizations like the UN, the World Bank, the IMF are not considered to be residents of any national economy even though their offices may be located within the territories of any number of countries.

BALANCE OF PAYMENT ACCOUNTING
The balance of payment is a standard double entry accounting record and as such subject to all the rules of double entry book-keeping viz. For every transaction two entries must be made. One credit (+) and one debit (-) and leaving aside errors and omissions, the total of credits must exactly match the total of debits i.e. the balance of payments must always balance.

Simple accounting rules followed in BOP is the following:

1. All transactions which lead to an immediate or prospective payment from the rest of the world to the country should be recorded as credit. Hence, all payments received for export of goods and services as also loans received abroad or inward foreign investment-whether direct or portfolio would be credit items,

2. Conversely, all transactions which result in an actual or prospective payment from the country to the rest of the world should be recorded as debits.

3. A transaction which results in an increase in demand for foreign exchange is to be recorded as debit entry while a transaction which results in an increase in the supply of foreign exchange is a credit entry.

Modern Theory of Trade

The contemporary theories of trade deviate from the assumptions of perfect competition and constant returns to scale made both in the classical and the neoclassical models. In the modern theories the market structure is either monopolistic or oligopolistic. In the former case a large number of producers produce goods that are not identical but differentiated in quality or design. In the latter case only a few producers serve the market with either identical products or differentiated products. The products which are just differentiated horizontally are similar in quality but different in design, like a red pen and a blue pen, white wine and red wine or wooden furniture and steel furniture. Vertical product differentiation involves quality differences as in small cars and large cars, lf the products are horizontally differentiated they are produced by more or less the same technology. Vertical product differentiation would. Invariably mean that the technology varies with quality or type of the product.

The modem theories assume economy of scale in production. An example of economy of scale is shown in the following Table:

One may easily check that the technology described above is a departure from the constant returns to scale we have been using so far. For example the output is doubled from 1 to 2 as labour is less than doubled from 3 to 5. Suppose that there are two similar goods, A and B being produced by the above technology, the economy has 10 units of labour. The consumers will consume the two goods in 1:1 proportion. Therefore the labour force will have to be equally divided in the production of the two goods and 2 units each of A and B will be produced and consumed in the economy. Now suppose there is another economy with the same technology to produce A and B having 10 units of labour. Then it is quite easy to see that one economy produces only A and the other produces only B and then trade with each other then the consumers in each country will be able to consume 3.5 units each of A and B and be better off than autarky. This is an example of trade taking place between two countries having the same technology and factor endowments simply due to economy of scale. But there is difference in the nature of trade. In the earlier models the products were different and produced by different technologies and the trade was between two industries, such as one country exporting cloth and importing wheat. This kind of trade is called inter-industry trade. But in the contemporary models trade is intra-industry, i.e., in the same industry located in two different countries. It is like one country exporting white wine and importing red wine - both goods requiring the same technology as in the above example. It turns out that a very substantial part of world trade is intra-industry in nature which shows the importance of modern theories in the contemporary world.