What’s it: A capital account is a part of the balance of payments in addition to the current account and financial account. It records the net proceeds from capital expenditure and income transactions. It has two main components, namely the capital transfer and non-production non-financial assets.
The capital account is a less critical part of the balance of payments because its contribution is less significant than the other two sections.
The difference between the capital account and the financial account
A financial account shows you the net ownership of assets by and in a country. It encapsulates the sale and purchase of assets through portfolio, direct, and derivatives investments. For example, foreign investors buy shares of domestic companies. The transaction will fall into the financial account. Likewise, domestic investors’ purchase of shares on the international market is also included in the calculation.
Meanwhile, capital accounts include transactions related to capital expenditures and income between a country and the rest of the world. The two main components are:
- Capital transfer
- Non-produced non-financial assets.
In some literature, the authors may combine capital accounts with financial accounts and come under the “capital account.” While in other literature, the authors separate the two.
Then, if you add up to the current account, it must equal zero. A positive “capital account” must be balanced by a negative current account at an equivalent amount. That shows you, a country has to borrow from around the world to finance current account deficits, usually due to trade deficits.
Likewise, when the “capital account” is negative, the current account must be positive, which occurs when the trade balance is a surplus. The trade surplus leaves the country with more money than it needs to finance imports and investment. Thus, the country can use it to buy assets abroad (for example, buying US government bonds).
Calculating the capital account
In this discussion, assume capital accounts with financial accounts are two separate accounts. The two main sub-accounts for capital account are transfers of capital and non-produced non-financial assets.
Capital transfers include items such as:
- Debt forgiveness
- Debt assumption
- Extraordinary claims related to non-life insurance
- Investment grants
- Transfers by migrants entering or leaving a country, both for goods or financial assets.
- Transfer of funds from sale or acquisition of fixed assets
Meanwhile, non-produced non-financial assets include intangible assets such as:
- Rights to natural resources, such as the right to mine minerals or to drill for oil offshore
- Marketing assets
The capital account adds up the net value of the sub-accounts for non-produced non-financial assets and capital transfers. Capital inflow transactions represent the credit side, while capital outflow transactions represent the debit side.