Circles round small lake in capital (4)
I believe the answer is:
oslo
'capital' is the definition.
(Oslo is an example)
'circles round small lake' is the wordplay.
'circles' becomes 'oo' (resembles two O's**).
'round' indicates putting letters inside.
'small' becomes 's' (abbreviation - e.g. clothes size).
'lake' becomes 'l'.
's'+'l'='sl'
'oo' enclosing 'sl' is 'OSLO'.
'in' is the link.
(Other definitions for oslo that I've seen before include "foreign port" , "European capital in go-slow" , "Northern capital of Czechoslovakia?" , "Norway's capital city" , "Nordic city" .)