Question : When a country's current account surplus increases, its capital account balance is likely to:
Option 1: Increase
Option 2: Decrease
Option 3: Remain unchanged
Option 4: It is not related to the current account surplus
Correct Answer: Increase
Solution : The correct answer is (a) Increase.
The current account represents the balance of trade in goods and services, income flows, and unilateral transfers, while the capital account represents capital transfers and the acquisition and disposal of non-produced, non-financial assets.
When a country has a current account surplus, it means that it is exporting more goods and services, receiving more income from abroad, or experiencing fewer unilateral transfers compared to its imports, income payments, and unilateral transfers abroad. This surplus implies a net inflow of funds into the country.
Since the capital account records capital transfers and changes in ownership of non-produced, non-financial assets, an increase in the current account surplus often leads to an increase in the capital account balance. This can be attributed to higher capital inflows, such as foreign investment or loans, as investors are attracted to the country's favorable economic conditions and higher returns on investments.
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