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(BASIC STUFF FROM EXAM POINT OF VIEW)
MRUNAL PATEL
QUESTI ONS
1. Current account & capital account.
2. Current & capital account convertibility.
3. Which account is permanent & which is reversible & why?
4. Full capital account convertibility : Pros and cons
5. On which account government needs to keep close eye?
WHAT IS CURRENT AND CAPITAL ACCOUNT?
In an open economy, we buy stuff from abroad (Export), we sell stuff to abroad.(export)
Similarly Indian companies invest abroad, foreign companies invest in India.
So lot of money incoming and outgoing.
Current and Capital accounts are nothing but method of classifying that incoming and
outgoing money.
As you know, Balance of Payment (bop) = Import Export.
This BoP is calculated under two heads: Current Account and Capital Account.


Means money
(Rupees/Dollars/any
currency) sent and
received during





Money sent & received in Export/Import
in goods and services goes here.
Since the money we spend importing
crude oil, is quite larger than the money
we make while exporting stuff.
So for India, Import >> Export
So money going out >> Money coming
in So weve DEFICIT in Current account.
In short Money inflow and outflow via
import-export is classified in Current
Account.
NRIs sending $$ from Dubai and America
(Remittance from abroad)
Loans taken from IMF, World Bank
Tata buys British company; some Japanese
company buys Indian companythat kind
of money is also counted in here.
ONGC buys some Oil reserve in Russia,
Some French co. Buys thorium mine in
India, the kind of money also counted here
(rights over natural resources)
In short Investment and borrowing goes
here In Capital account



NOW WHAT THE HELL IS CURRENT AND CAPITAL ACCOUNT CONVERTIBILITY ???
Convertibility = converting one currency into another. Like rupee to dollar, yen to
poundanything.
Since money is incoming and outgoing. People will need to convert the money into different
currencies based on their requirements.
We classified the incoming and outgoing money into Current and Capital account.
Similarly we classify the procedure involved in converting that money. In brief..

CONVERTABILITY: CURRENT ACCOUNT VS. CAPITAL ACCOUNT
Youve a big mobile store, import 5000 i-
phones a month from America, but the
American supplier accepts payment only in
$$. So you get your rupee converted into $
at forex market at anytime, nobody
prevents you from this.
Again, some of those iphones, you sell to
Bangladesh and Nepal, and get their
currency, and you convert it into Rupees.
Again nobody prevents you from this.
Nobody prevents you from doing it.
A Japanese businessman buys some
building in India, after 5 years, price of that
building is increase 5x times. So he sells It
and wants to convert those Rupees into
Yen so that he can use those Yen back
home in Japan.
He cannot do this easily; he has to stick to
RBI guidelines. Eg. He can only transfer this
money after 5 years lock-in period.
Because this money is classified under
CAPITAL account.So, Money under Capital
Money classified under
Current account can be
easily converted into
dollar,yen, pound, rupee
anything.
Money classified under
Capital account CANNOT be
easily converted into
different currency. RBI has
strict guidelines.
= we donot have
full capital account
convertability !

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Because the money is classified in
CURRENT ACCOUNT
This is Current account convertibility. I.e. It
allows residents to make and receive
trade-related payments receives dollars
(or any other foreign currency) for export
of goods and services and pay dollars for
import of goods and services, make sundry
remittances, access foreign currency for
travel, studies abroad, medical treatment
and gifts etc.
In India, current account convertibility was
established with the acceptance of the
obligations under IMF Agreement in 1994
account is harder to get converted (into
different currency)
It means we dont have Full CAPITAL
account convertibility.
WHICH ACCOUNT IS PERMANENT AND WHICH ACCOUNT IS REVERSIBLE? AND WHY?
Current account Capital account
Permanent Not Permanent
Irreversible Reversible
WHY?
Current account =Money sent and received during import and export
You sold something (exported) and received the money, so that money is yours forever (until
you spend it on something else!) So Current account is permanent and irreversible.
Capital account = Money sent and received during investment and borrowing.
Suppose Japanese guy buys factory in India (capital account), sells it after 5 years and takes
back the money. So Capital account inflow is NOT PERMANENT and hence reversible (because
he took back the money he invested in India).
FULL CAPITAL ACCOUNT CONVERTIBILITY PRO AND CONS
As we saw above, we dont have full capital account convertibility in India.
ARGUMENT IN FAVOR OF FULL CAPITAL ACCOUNT CONVERTIBILITY
It facilitates foreign investments and borrowing. So competition is increased = more factories =
more jobs = more product choices for consumers = good for economy. :)
ARGUMENTS AGAINST OF FULL CAPITAL ACCOUNT CONVERTIBILITY
Local producers have to compete with International giants. So they lose market. :(


o (Counter-argument: Ultimately business is about survival of the fittest, so perform or
perish, aint no need to get sentimental about swadeshi. Why should consumer pay for
not-so-good quality yet expensive product from a local man, if a foreigner is offering
better stuff at cheaper quality?)
What if foreigners buy lot of factories in India and suddenly they find that investing money in
France is better than in India. So they immediately sell all those factories, get their Rupees
converted into Euro and run away! Thatll lead to huge job loss and collapse in Indian market!
o (Counter argument: Its a two way street if Foreigners can do that, Indians can also do it
while investing abroad.)
o Sudden outflow of money happens only when governing institutions have weak
foundations and policies. [For example, when Government is busy firefighting
Sugar,onion prices without any long-term vision, it makes cronies get involved in
speculative business] If every country has sound economic policies, then itll be
attractive to invest in every country. Then there would be no sudden outflow or
inflow of money.
ON WHICH ACCOUNT GOVERNMENT NEEDS TO KEEP CLOSE EYE?
Sorry I dont know that exact answer. Government needs to keep an eye on both accounts to make
changes in trade policies, tax rates etc. But since Capital account inflows come with a risk (of sudden
outflow collapsing the economy), so Government should keep a close eye on Capital account.


FOR THE CURIOUS SOULS: EXAMPLE OF CURRENT AND CAPITAL ACCOUNT FOR 2009
APPENDIX TABLE 51 : INDIAS OVERALL BALANCE OF PAYMENTS
Item Rupees crore US $ million
2006-
07
2007-08
PR
2008-09
P
2006-
07
2007-
08 PR
2008-
09 P
1 2 3 4 5 6 7
A. CURRENT ACCOUNT
1 Exports, f.o.b. 5,82,871 6,67,757 7,98,956 1,28,888 1,66,163 1,75,184
2 Imports, c.i.f. 8,62,833 10,36,289 13,41,069 1,90,670 2,57,789 2,94,587
3 Trade Balance -
2,79,962
-3,68,532 -5,42,113 -61,782 -91,626 -
1,19,403
4 Invisibles, Net 2,35,579 2,99,618 4,09,842 52,217 74,592 89,586
A) Non-Factor
Services
1,33,064 1,51,059 2,28,778 29,469 37,565 49,818
Of which:

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Software
Services
1,41,356 1,62,020 2,15,588 31,300 40,300 47,000
B) Income -33,234 -19,888 -21,116 -7,331 -4,917 -4,511
C) Private
Transfers
1,34,608 1,67,495 2,01,050 29,825 41,705 44,047
D) Official
Transfers
1,141 952 1,130 254 239 232
5 Current Account
Balance
-44,383 -68,914 -1,32,271 -9,565 -17,034 -29,817
B. CAPITAL ACCOUNT
1 Foreign
Investment, Net
(a+b)
66,791 1,80,788 11,760 14,753 44,957 3,462
A) Direct
Investment

Of which: 34,910 61,793 76,822 7,693 15,401 17,496
I) In India 1,02,652 1,37,434 1,58,579 22,739 34,236 34,982
Equity 73,969 1,07,320 1,25,362 16,394 26,758 27,809
Re-invested
Earnings
26,371 28,859 29,705 5,828 7,168 6,426
Other
Capital
2,312 1,255 3,512 517 310 747
Ii) Abroad -67,742 -75,641 -81,757 -15,046 -18,835 -17,486
Equity -56,711 -57,936 -63,478 -12,604 -14,421 -13,558
Re-invested
Earnings
-4,868 -4,363 -4,985 -1,076 -1,084 -1,084
Other
Capital
-6,163 -13,342 -13,294 -1,366 -3,330 -2,844
B) Portfolio
Investment
31,881 1,18,995 -65,062 7,060 29,556 -14,034
In India 31,630 1,18,348 -64,206 7,004 29,394 -13,855
Abroad 251 647 -856 56 162 -179
2 External
Assistance, Net
7,973 8,465 12,435 1,775 2,114 2,638
Disbursements 16,978 17,022 23,535 3,767 4,241 5,042
Amortisation -9,005 -8,557 -11,100 -1,992 -2,127 -2,404
3 Commercial
Borrowings, Net
72,365 91,180 38,009 16,103 22,633 8,158
Disbursements 93,932 1,22,270 71,626 20,883 30,376 15,382
Amortisation -21,567 -31,090 -33,617 -4,780 -7,743 -7,224
4 Short Term Credit,
Net
30,096 68,878 -31,160 6,612 17,183 -5,795
5 Banking Capital


Of which: 8,477 47,148 -19,868 1,913 11,757 -3,397
NRI Deposits, Net 19,574 706 20,431 4,321 179 4,290
6 Rupee Debt
Service
-725 -488 -476 -162 -121 -101
7 Other Capital, Net
@
18,696 37,802 21,681 4,209 9,470 4,181
8 Total Capital
Account
2,03,673 4,33,773 32,381 45,203 1,07,993 9,146
C. Errors & Omissions 4,344 4,830 2,775 968 1,205 591
D. Overall Balance
[A(5)+B(8)+C]
1,63,634 3,69,689 -97,115 36,606 92,164 -20,080
E. Monetary
Movements (F+G)
-
1,63,634
-3,69,689 97,115 -36,606 -92,164 20,080
F. IMF, Net 0 0 0 0 0 0
G. Reserves and
Monetary Gold
(Increase -, Decrease
+)
-
1,63,634
-3,69,689 97,115 -36,606 -92,164 20,080
P : Provisional. PR : Partially Revised.
@ : Includes delayed export receipts, advance payments against imports, net funds
held abroad and advances received pending issue of shares under FDI.
Note : 1. Gold and silver brought by returning Indians have been included under imports,
with a contra entry in private transfer receipts.
2. Data on exports and imports differ from those given by DGCI&S on account of
differences in coverage, valuation and timing.