To understand a financial account, let’s first have an idea of the Balance of Payments (BOP) of a country. A BOP is a systematic record of all the economic transactions between the domestic country and the foreign countries during a given period. A financial account is a part of that Balance of Payments. This is a concept of macroeconomics.
The financial account records the inflow and outflow of money caused by foreign investment.
These foreign investments take place in two forms:
Foreign Direct Investment
The investment made by an individual or entity of a country into a business of a foreign country. The ownership and control directly go to these foreign investors.
A real-life example of FDI in India- is General Atlantic, a New York-based equity firm that invested more than $900 million for a substantial stake in Reliance’s Jio Platforms’ in the year 2020.
Foreign portfolio Investment
Investments made in the foreign stocks from the stock exchange by an individual or entity are considered foreign portfolio investments. The ownership and control lie with the domestic country and only some percentage of the profit goes to the hands of the foreign investors.
Example of FPI in India – Mr. X purchased ten shares in Unacademy, an Indian Ed-Tech company from the foreign exchange.
Any foreign investment in the domestic country will be considered a liability for the domestic country. This shall be recorded as an inflow of money.
Essentially, when the domestic country makes an unfamiliar venture (foreign investment), it is considered a resource for themselves and is recorded as an outpouring of cash in the financial account.
The BOP (Balance of payments) press release for the third quarter (October-December 2021) FY 21-22 (Financial Year 2021 to 2022) by the RBI (Reserve Bank of India) stated the following facts regarding the financial account of India.
- Net Foreign direct investment (FDI) inflows at the United States $ 26.5 billion in April-December 2021 were lower than United State – US $ 41.3 billion in April-December 2020
- Portfolio investment recorded a net outflow of United States – US $ 1.6 billion during April-December 2021 as against an inflow of US$28.9 billion a year ago.
Let’s attempt to understand what these statements mean.
The first statement states that there was a Net FDI inflow. A net FDI inflow suggests that there were more foreign direct investments made in India as compared to the foreign investment made by India. This indicates the generation of more liabilities than assets because capital is a liability. Hence, there is an increase in the financial account as we have a net inflow.
The second statement states that the portfolio investment recorded a net outflow. This means that India made more investments in foreign securities as compared to the foreign countries making investments in Indian securities. This indicates the generation of more assets than liabilities. Hence, there will be a decrease in the financial account caused by a net outflow of money.