EconomicsCBSE Class 12 · Open Economy Macroeconomics

Balance of Payments: Current Account and Capital Account (Class 12)

Updated 15 October 2026 · Fact-checked

The balance of payments records a country's transactions in goods, services and assets with the rest of the world over a period, usually a year. The current account covers trade in goods (balance of trade), services, income and transfers (invisibles). The capital account covers transactions in assets: FDI, portfolio investment, external borrowings and assistance.

Notice that goods and invisibles sit in the current account, asset deals like FDI sit in the capital account, and errors balance the books.

Illustration drawn for QuestionBuddy.

Understand Balance of Payments: Current and Capital Account

Meaning. The balance of payments (BoP) records the transactions in goods, services and assets between residents of a country and the rest of the world for a specified period, typically a year. Its two main accounts are the current account and the capital account (plus errors and omissions).

Current account: trade in goods and services and transfer payments.

Trade in goods (visibles): exports and imports of goods. Balance of Trade (BOT) = exports of goods − imports of goods (exports credit, imports debit). Surplus if exports > imports; deficit if imports > exports.
Invisibles: (a) non-factor services (shipping, banking, tourism, software services); (b) factor income (net earnings on labour, land, capital, e.g. interest, profits, wages from abroad); (c) transfers (gifts, remittances, grants received 'free', from government or private citizens abroad).
Balance on current account = BOT + net invisibles. Surplus means the nation is a lender to other countries; deficit means it is a borrower.
Imports are spending that becomes another country's income, so they reduce domestic demand; exports add to it.

Capital account: all international transactions of assets (money, stocks, bonds, government debt).

Purchase of a foreign asset is a debit (foreign exchange flows out), e.g. an Indian buying a UK car company. Sale of an asset to foreigners is a credit, e.g. shares of an Indian company sold to a Chinese buyer.
Items: Foreign Direct Investment (FDI), Foreign Institutional/Portfolio Investment (FII), external borrowings (commercial borrowings, short-term debt), external assistance, banking capital including non-resident deposits.
Balanced if capital inflows (loans received, sale of assets) = outflows (repayment of loans, purchase of foreign assets); surplus if inflows > outflows.

Credit vs debit. Credit = brings foreign exchange in (exports, receipts of income and transfers, capital inflows). Debit = sends foreign exchange out (imports, payments, capital outflows).

New classification (BPM6). The IMF's sixth manual divides BoP into current, financial and capital accounts; India has adopted it, but the RBI also publishes the old two-account form, which NCERT uses.

Worked BoP (our fictional 'Avantia', USD million). Goods exports 420, imports 560 → BOT −140. Non-factor services +90, income −25, transfers +45 → net invisibles +110. Current account −30. Capital account: FDI 18, portfolio 7, commercial borrowing 6, assistance 2, banking 4, other −9 → +28. Errors and omissions −3 → overall balance −5 (met by a reserve sale of 5).

Balance of Payments: Current and Capital Account: key facts

Balance of trade: BOT = Exports of goods − Imports of goods; Visible items only.
Net invisibles: Net invisibles = Net non-factor services + Net factor income + Net transfers; Services, income, transfers.
Current account balance: CAB = BOT + Net invisibles; Deficit = borrower; surplus = lender.
Capital account balance: KAB = Capital inflows − Capital outflows (FDI, FII, borrowings, assistance, banking capital); Asset transactions.
Overall balance: Overall balance = CAB + KAB + Errors and omissions = − Reserve change; Deficit met by reserve sale.

How to answer Balance of Payments: Current and Capital Account questions

BoP is the most-tagged Open Economy topic: 1-mark classification items, 3-mark 'BOT vs current account' and BoP-table numericals.

1For classification, ask: is it goods/services/income/transfer (current) or an asset or loan (capital)?
2Then credit or debit: does foreign exchange come in or go out?
3For tables, compute BOT, net invisibles, current account, capital account and overall balance in that order.
4Remember remittances from abroad are current-account transfers (credit); a loan from abroad is capital account (credit); repaying it is a debit.
5Interest and profits earned abroad are factor income in the current account, not capital account.

Balance of Payments: Current and Capital Account in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Remittances as transfers

Suppose your cousin working as a nurse in Dubai sends ₹40,000 home every month to her parents in Kerala.

Where does this appear in India's BoP?

Try it first, then show the solutionSolution

It is money received 'free' by residents, not for goods or services in return.
Transfers belong to invisibles in the current account.
Foreign exchange flows in: credit.

Answer: As a credit under transfers (private remittances) in the current account of India's BoP.

Memory hook: Money home from abroad = transfer, current account, credit.

Capital vs current

Imagine a Japanese company builds a car plant in Tamil Nadu (₹2,000 crore) and later sends ₹150 crore of profits back to Japan every year.

Classify both flows.

Try it first, then show the solutionSolution

Building the plant: purchase of an Indian asset by a foreigner: FDI, capital account credit.
Profit sent home: factor income paid abroad: current account debit.

Answer: The investment is a capital-account credit (FDI inflow); the yearly profit repatriation is a current-account debit (factor income paid abroad).

Memory hook: The asset is capital; the earnings on it are current.

Tricks to remember Balance of Payments: Current and Capital Account

Short memory aids. Say each one aloud once, then use it on a question the same day.

Current = earn and spend, Capital = own and owe
Current account: goods, services, incomes and gifts (no asset changes hands). Capital account: buying and selling assets, and borrowing and lending.
Use it when: Classification.
In = credit
If foreign exchange comes in, it is a credit; if it goes out, a debit.
Use it when: Credit vs debit.
BOT ⊂ CAB
Balance of trade is goods only; current account adds invisibles.
Use it when: BOT vs current account.

Balance of Payments: Current and Capital Account: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Classify FDI · 1 mark · MCQBoard level

Foreign direct investment in India is recorded in the:
(a) current account as a debit
(b) current account as a credit
(c) capital account as a credit
(d) capital account as a debit

Try it first, then show the solutionSolution

Asset transaction, foreign exchange inflow.

Answer: (c) capital account as a credit

Example 2: BOT vs current account · 3 marks · Short answerBoard level

Distinguish between balance of trade and balance on current account. (3 marks)

Try it first, then show the solutionSolution

BOT: goods only.
CAB: goods + services + income + transfers.
BOT is part of CAB.

Answer: Balance of trade is the difference between the value of exports and imports of goods (visible items) only. Balance on current account includes the balance of trade plus net invisibles: non-factor services, factor income and transfers. So BOT is a part of the current account balance, which is the wider measure.

Example 3: BoP table · 3 marks · Short answerHarder board level

From the following data of 'Avantia' (USD million), find the balance of trade, net invisibles and current account balance: exports of goods 420; imports of goods 560; net non-factor services 90; net factor income −25; net transfers 45. (3 marks)

Try it first, then show the solutionSolution

BOT = 420 − 560 = −140.
Net invisibles = 90 − 25 + 45 = 110.
CAB = −140 + 110 = −30.

Answer: BOT −140 (deficit); net invisibles +110; current account −30 (deficit).

Example 4: Classification of items · 4 marks · Short answerHarder board level

State whether each is a current or capital account item and credit or debit for India: (i) an Indian firm buys a hotel in Singapore; (ii) Indian software exports to the USA; (iii) interest paid by India on a World Bank loan; (iv) a loan received from the Asian Development Bank. (4 marks)

Try it first, then show the solutionSolution

(i) asset purchase abroad: capital, debit.
(ii) non-factor service export: current, credit.
(iii) factor income paid: current, debit.
(iv) borrowing: capital, credit.

Answer: (i) Capital account, debit. (ii) Current account (invisibles: non-factor services), credit. (iii) Current account (factor income), debit. (iv) Capital account (external borrowing/assistance), credit.

Example 5: Full BoP · 4 marks · Short answerHOTS / competency

Continuing the Avantia data, the capital account shows FDI 18, portfolio investment 7, commercial borrowings 6, external assistance 2, banking capital 4 and other flows −9; errors and omissions are −3. Find the capital account balance and overall balance, and state what happens to official reserves. (4 marks)

Try it first, then show the solutionSolution

KAB = 18 + 7 + 6 + 2 + 4 − 9 = 28.
Overall = −30 + 28 − 3 = −5.
Deficit of 5 met by official reserve sale; reserves fall by 5.

Answer: Capital account +28; overall balance −5 (deficit). The RBI sells USD 5 million of reserves to finance it; reserves fall by 5.

Example 6: Lender or borrower · 1 mark · Assertion-reasonHOTS / competency

Assertion (A): A country with a current account surplus is a lender to the rest of the world.
Reason (R): A current account surplus means receipts on current account exceed payments.
(a) Both A and R are true and R is the correct explanation of A.
(b) Both A and R are true but R is not the correct explanation of A.
(c) A is true but R is false.
(d) A is false but R is true.

Try it first, then show the solutionSolution

Excess current receipts are lent abroad (capital outflow).

Answer: (a) Both A and R are true and R is the correct explanation of A.

Where students lose marks in Balance of Payments: Current and Capital Account

The slips examiners see most often, and what to write instead.

Mistake: Putting interest or profits in the capital account
They relate to assets.
Wrong working
Interest paid on foreign loan: capital account debit.
Right working
Interest is factor income: current account debit; the loan itself is capital account.
Do this: Asset = capital; earnings on it = current.
Usually costs: 1 mark.
Mistake: Including services in balance of trade
BOT and current account mixed.
Wrong working
BOT = goods + services exports − imports.
Right working
BOT = goods only; services are invisibles.
Do this: BOT ⊂ CAB.
Usually costs: 1 mark.
Mistake: Calling purchase of a foreign asset a credit
Direction of forex confused.
Wrong working
Indian firm buys UK company: credit.
Right working
Forex goes out: debit.
Do this: In = credit, out = debit.
Usually costs: ½ to 1 mark.

Exam tips

Balance of payments items are the most frequent in Open Economy (about 11 tagged items in the PYQ bank).
Expect a classification question every year; always state account and credit/debit.
Know the BPM6 note: India uses current, financial and capital accounts, but NCERT teaches the two-account form.

Practice questions on Balance of Payments: Current and Capital Account

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
Which of the following is recorded in the current account?
(a) Foreign direct investment
(b) External commercial borrowing
(c) Remittances from abroad
(d) Purchase of foreign shares
Hint
Transfers.
Answer
(c) Remittances from abroad
Q2 · 1 mark · Short answerBoard level
Define balance of payments. (1 mark)
Hint
Residents and rest of world.
Answer
The record of transactions in goods, services and assets between residents of a country and the rest of the world over a specified period, usually a year.
Q3 · 3 marks · Short answerBoard level
State the components of the current account. (3 marks)
Hint
Goods, services, income, transfers.
Answer
(1) Trade in goods: exports and imports (balance of trade). (2) Non-factor services: shipping, banking, tourism, software. (3) Factor income: net earnings on labour, land and capital. (4) Transfers: gifts, remittances, grants. Items (2)-(4) are invisibles.
Q4 · 2 marks · Short answerHarder board level
Exports of goods are USD 340 million, imports of goods USD 410 million and net invisibles +USD 55 million. Find BOT and current account balance. (2 marks)
Hint
BOT first.
Answer
BOT = 340 − 410 = −70 (deficit); current account = −70 + 55 = −15 (deficit), USD million.
Q5 · 3 marks · Short answerHarder board level
State the components of the capital account. (3 marks)
Hint
FDI, FII, borrowings, assistance.
Answer
Foreign direct investment, foreign institutional (portfolio) investment, external borrowings (commercial borrowings, short-term debt), external assistance, and banking capital including non-resident deposits.
Q6 · 2 marks · Short answerHarder board level
Explain why imports reduce and exports raise domestic demand for goods. (2 marks)
Hint
Whose income?
Answer
Spending on imports becomes income of foreign producers, so it leaks out of domestic demand. Exports are foreigners' spending on domestic goods, which adds income and demand at home.
Q7 · 1 mark · Assertion-reasonHarder board level
Assertion (A): Purchase of a UK company by an Indian firm is a debit in India's capital account.
Reason (R): Purchase of assets abroad causes an outflow of foreign exchange.
(a) Both A and R are true and R is the correct explanation of A.
(b) Both A and R are true but R is not the correct explanation of A.
(c) A is true but R is false.
(d) A is false but R is true.
Hint
Out = debit.
Answer
(a) Both A and R are true and R is the correct explanation of A.
Q8 · 3 marks · Short answerHarder board level
Classify as visible or invisible, and current or capital: (i) export of tea; (ii) fees paid to a foreign university; (iii) sale of Indian government bonds to a foreign bank. (3 marks)
Hint
Goods, services, assets.
Answer
(i) Visible, current account (goods export, credit). (ii) Invisible, current account (service import, debit). (iii) Capital account (sale of an asset to foreigners, credit); not a visible or invisible trade item.
Q9 · 3 marks · Short answerHOTS / competency
Suppose India's trade deficit is large but its current account deficit is much smaller. What could explain this? (3 marks)
Hint
Strong invisibles.
Answer
A large surplus on invisibles: high receipts from software and other services exports (non-factor services) and large private remittances (transfers) from Indians working abroad offset much of the deficit in goods trade, so the current account deficit is smaller than the trade deficit.
Q10 · 3 marks · Short answerHOTS / competency
A country runs a current account deficit for many years, financed by foreign loans. Evaluate the risk. (3 marks)
Hint
Borrower; future interest.
Answer
A current account deficit means the country is a borrower from the rest of the world. Financing it by loans builds external debt; interest payments later add to current-account debits (factor income paid), worsening the deficit. If lenders lose confidence, the country may have to use reserves or face a crisis. Deficits used for productive investment are less risky than those financing consumption.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Two main accounts of BoP?Show answer
Current account and capital account.
2.What does BOT include?Show answer
Exports and imports of goods only.
3.Name three invisibles.Show answer
Non-factor services, factor income, transfers.
4.Is an external loan received a current or capital item?Show answer
Capital account, credit.
5.What does a current account deficit make a country?Show answer
A borrower from other countries.

Balance of Payments: Current and Capital Account: frequently asked questions

What is the balance of payments?

A record of all economic transactions in goods, services and assets between a country's residents and the rest of the world during a period, usually a year.

What is the difference between the current and capital account?

The current account records trade in goods and services, factor income and transfers; the capital account records transactions in assets and loans such as FDI, portfolio investment and borrowings.

What is balance of trade?

The difference between the value of exports and imports of goods (visible items) in a period.

Are remittances current or capital account?

Current account: they are transfers, part of invisibles.