Q&A: Current and Capital Account

Q: Please explain the difference between the current and the capital account on the balance of payments

The current account is the

Balance of

Trade in goods
Trade in services
Net investment income from external assets
Net transfers

Capital account captures inflows and outflows of different forms of capital

Portfolio investment e.g. money flowing into / out of stock markets, pension funds, hedge funds etc
Direct capital investment e.g. fixed investment in factories
Short term banking flows ... also known as hot money

In principle a country running a current account deficit can ‘balance’ things up by running a surplus on the capital account - the UK is a good example, because the economy has been a favoured location for FDI and there is a strong appetite among foreign investors for UK government bonds

A country running a current account surplus can run capital account deficits i.e. invest heavily overseas or just accumulate foreign exxchange reserves e.g. China, Norway, Oil exporting nations .... some of whom have created their own sovereign wealth funds

In principle the BoP must balance .... it does so because of adjustments that countries make to their foreign exchange reserves using IMF agreed accounting measures and also because of the balancing item which reflects errors and ommissions!