Capital account

Definition

The capital account is a component of a country's balance of payments that records all transactions related to the purchase and sale of assets, such as investments and loans, between residents and non-residents. It provides insight into how much capital is flowing into or out of a country, which can affect its exchange rate and overall economic health.

5 Must Know Facts For Your Next Test

1. The capital account includes both foreign direct investment (FDI) and portfolio investment, showing how investors are interacting with different countries.
2. A surplus in the capital account indicates that more money is entering a country than leaving it, often signaling economic strength and attractiveness to foreign investors.
3. Conversely, a deficit in the capital account suggests that more money is leaving the country than coming in, which can raise concerns about economic stability and currency value.
4. Changes in the capital account can influence exchange rates; for example, an inflow of foreign capital can lead to an appreciation of the local currency.
5. The capital account works alongside the current account to form the overall balance of payments, helping to provide a complete picture of a nation's economic interactions with the world.

Review Questions

• How does the capital account interact with a country's balance of payments, and what implications does this have for its economy?
  • The capital account is part of the broader balance of payments, which includes both the current account and the capital account. This interaction helps to illustrate the financial health of a country by showing whether it is investing more abroad or attracting foreign investment. A positive capital account indicates net inflows, which can lead to stronger economic growth, while negative flows might suggest potential economic challenges.
• Discuss how changes in foreign direct investment (FDI) impact the capital account and what this means for currency exchange rates.
  • When there is an increase in foreign direct investment (FDI), it typically leads to a surplus in the capital account due to greater inflows of foreign capital. This influx can strengthen the local currency as demand increases from investors wanting to convert their currency to invest in domestic assets. On the flip side, if FDI decreases, it can result in a deficit in the capital account, potentially leading to depreciation of the currency as outflows exceed inflows.
• Evaluate how fluctuations in the capital account can reflect broader economic conditions and affect international monetary relations.
  • Fluctuations in the capital account can serve as indicators of broader economic conditions such as investor confidence and overall economic stability. For instance, significant inflows may indicate a robust economy attracting investments, while outflows could suggest instability or lack of confidence in future growth. These changes not only affect domestic economic policies but also impact international monetary relations, influencing how countries engage in trade and manage their currencies amidst changing global dynamics.

Related terms

balance of payments: A comprehensive record of a country's economic transactions with the rest of the world over a specific period, including trade, services, income, and capital movements.

foreign direct investment (FDI): An investment made by a company or individual in one country in business interests in another country, often through establishing business operations or acquiring assets.

portfolio investment:

Investments in financial assets such as stocks and bonds in another country, where the investor does not have direct control over the assets.