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Difficulty: MediumIndustrial Policies, Infrastructure Sector, Balance of Payments, and External Trade

Consider the following statements regarding the accounting classification of transactions in India's Balance of Payments (BoP):

1. Interest payments servicing foreign commercial borrowings are recorded under the Capital Account.
2. Foreign Portfolio Investment (FPI) inflows into domestic equity markets are recorded under the Capital Account.
3. Remittances of profits by foreign enterprises operating in India are recorded under the Current Account.

Which of the statements given above are correct?

  1. A
    1 and 2 only
  2. 2 and 3 onlyAnswer
  3. C
    1 and 3 only
  4. D
    1, 2 and 3

Answer

Statements 2 and 3 are correct. Foreign Portfolio Investment (FPI) is a capital account transaction, while profit remittances and interest servicing on loans are factor income transactions classified under the current account (invisibles).
The statement regarding Foreign Portfolio Investment is correct because portfolio flows involve ownership changes of financial assets, placing them in the Capital Account. The statement regarding profit remittances is also correct because earnings from foreign assets represent factor income (invisibles), which forms part of the Current Account. The statement regarding interest servicing is incorrect because interest paid on foreign loans is categorized under primary investment income in the Current Account, whereas only the loan principal itself belongs to the Capital Account.

Step-by-Step Solution

1
Analyze Statement 1 regarding interest payments on loans.
Statement 1 is incorrect.
Although borrowing principal amounts (External Commercial Borrowings) fall under the Capital Account, the servicing of debt (interest payments) represents investment income paid abroad, which is recorded under the Invisibles section of the Current Account.
2
Analyze Statement 2 regarding Foreign Portfolio Investment (FPI).
Statement 2 is correct.
Capital flows like FDI and FPI involve cross-border movement of financial assets and debt/equity instruments, which directly alter the country's external asset/liability profile and belong in the Capital Account.
3
Analyze Statement 3 regarding remittances of profits.
Statement 3 is correct.
Profit remittances by foreign firms constitute primary income transfers (investment income outgo) and are classified under the Current Account.

Key Concept

Classification of Balance of Payments (BoP) Transactions between Current Account and Capital Account
Estimated Time:1m 15s
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Topics

Industrial Policies, Infrastructure Sector, Balance of Payments, and External Trade