Current vs. Capital Account: An Overview

The current and capital accounts represent two halves of a nation's balance of payments. The current account represents a country's net income over a period of time, while the capital account records the net change of assets and liabilities during a particular year.

In economic terms, the current account deals with the receipt and payment in cash as well as non-capital items, while the capital account reflects sources and utilization of capital. The sum of the current account and capital account reflected in the balance of payments will always be zero. Any surplus or deficit in the current account is matched and canceled out by an equal surplus or deficit in the capital account.

Current Account

The current account deals with a country's short-term transactions or the difference between its savings and investments. These are also referred to as actual transactions (as they have a real impact on income), output and employment levels through the movement of goods and services in the economy.

The current account consists of visible trade (export and import of goods), invisible trade (export and import of services), unilateral transfers, and investment income (income from factors such as land or foreign shares). The credit and debit of foreign exchange from these transactions is also recorded in the balance of current account. The resulting balance of the current account is approximated as the sum total of balance of trade.

Transactions are recorded in the current account in the following ways:

  • Exports are noted as credits in the balance of payments
  • Imports are recorded as debits in the balance of payments

The current account gives economists and other analysts an idea of how the country is faring economically. The difference between exports and imports, or the trade balance, will determine whether a country's current balance is positive or negative. When it is positive, the current account has a surplus, making the country a "net lender" to the rest of the world. A deficit means the current account balance is negative. In this case, that country is considered a net borrower.

If imports decline and exports increase to stronger economies during a recession, the country's current account deficit drops. But if exports stagnate as imports grow when the economy grows, the current account deficit grows.

Capital Account

The capital account is a record of the inflows and outflows of capital that directly affect a nation’s foreign assets and liabilities. It is concerned with all international trade transactions between citizens of a one country and those in other countries.

The components of the capital account include foreign investment and loans, banking and other forms of capital, as well as monetary movements or changes in the foreign exchange reserve. The capital account flow reflects factors such as commercial borrowings, banking, investments, loans, and capital.

A surplus in the capital account means there is an inflow of money into the country, while a deficit indicates money moving out of the country. In this case, the country may be increasing its foreign holdings.

In other words, the capital account is concerned with payments of debts and claims, regardless of the time period. The balance of the capital account also includes all items reflecting changes in stocks.

The term capital account is also used in accounting. It is a general ledger account used to record the contributed capital of corporate owners, as well as their retained earnings. These balances are reported in a balance sheet's shareholder's equity section.

The International Monetary Fund divides capital account into two categories: The financial account and the capital account.

Key Takeaways

  • The current and capital accounts are two components of a nation's balance of payments.
  • The current account is the difference between a country's savings and investments.
  • A country's capital account records the net change of assets and liabilities during a certain period of time.