Current Account and Capital Account

The reason why the Current Account and Capital Account in the Balance of Payments are held so closely is due to an accounting relationship. With the Current Account on one side and the Capital Account on the other, it it similar to a Balance Sheet where the net amount is always zero. In the case where there are errors in the data aggregration does not balance, another account called ‘net errors and omissions’ is introduced. The latter shall be excluded from the discussion below as it is a balancing adjustment and the accounting relationship still holds.

The equation is given below:

Current Account+Capital Account+Official Reserves=0

Looking at the equation, we will explore a few scenarios by varying the Capital Account. Firstly, if a country has a positive Capital Account, assuming certiris paribus, we will see a Current Account deficit which means that the country is a net borrower and it is reliant on funds from other country to sustain its local investment and consumption demands. In this scenario, the country is said to have a net capital inflow where its debits are greater than its credits. In the other case where a country has a negative Capital Account, we will see a Current Account surplus which means that the country is a net lender and its domestic savings are sufficient to meet the local investment and consumption demands. In this scenario, the country is said to have a net capital outflow where its credits are greater than its debits.

In the case of Singapore, the government is very proactive in encouraging high savings and accmulation of foreign reserves. It is a country where domestic savings are more than sufficient to meet the local investment and consumption demands thus, the surplus savings is sent overseas in the form of investments in foreign stocks, bonds and real estate or as foreign direct investment.