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BALANCE OF

PAYMENTS

TEXTBOOK

INTERNATIONAL MONETARY FUND

© 1996 International Monetary Fund

Cataloging-in-Publication Data

Balance of payments textbook. — Washington, DC, USA :International Monetary Fund, © 1996.viii, 150 p.

Companion volume to: Balance of payments manual. 5th ed. and Balance of payments compilation guide.

ISBN 1-55775-570-1

1. Balance of payments — Statistics.I. International Monetary Fund. HG3882.B342 1996

Price: US$25.00

Please send orders to:International Monetary Fund, Publication Services700 19th Street, NW, Washington, DC 20431, USA

Telephone (202) 623-7430 Telefax (202) 623-7201Internet: [email protected]

Foreword vii

I. The Balance of Payments Conceptual Framework 1

Definition of the Balance of Payments 1Double Entry System 2Concept of an Economy 4Principles for Valuation and Time of Recording; Unit of Account and Procedures for Conversion 4Coverage of the Balance of Payments 7

II. Residents of an Economy 12

Definition of Residents 13Households and Individuals 13Enterprises 15Nonprofit Institutions 22Government 23

III. Classifying Balance of Payments Transactions 26

Structural Overview of the Standard Components 26Goods, Services, and Income 27Current Transfers 28Capital Account 28Financial Account 29International Investment Position 29Standard Components of the Balance of Payments 30Selected Supplementary Information 34Standard Components of the International Investment Position 36

IV. Goods 39

Convention for Recording Change of Ownership 40Exceptions to the Change of Ownership Rule 41Physical Movement of Goods and the Goods Component 44Time of Recording 47Valuation 48Adjustments to Basic Data 53

V. Services 60

Transportation Services 60Travel 67Other Services 69

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Contents

VI. Income 77

Definition 77Compensation of Employees 77Investment Income 79

VII. Current Transfers and the Capital Account 88

General Information on Transfers 88Current Transfers 89Capital Transfers 92Transactions in Non-Produced, Nonfinancial Assets 94

VIII. Introduction to the Financial Account 95

Definition and Coverage 95Transactions in Financial Assets 96Financial Item Changes to Be Excluded from the Balance of Payments 99Net Recording 100Valuation and Timing 100Classification 100Supplementary Classifications 103

IX. Direct Investment 107

The Concept of Direct Investment 107Motivation for Direct Investment 107Defining the Direct Investment Relationship 107Direct Investment Capital 109Direction of Investment 110Valuation 112Special Cases 113

X. Portfolio Investment 117

Equity 117Bonds and Notes 117Money Market Instruments 118Financial Derivatives 120

XI. Other Investment 124

Trade Credits 124Use of Fund Credit and Loans from the Fund 125Other Loans 125Currency and Deposits 126Other Assets and Liabilities 127

XII. Reserve Assets 129

Reserve Assets and the Adjustment Process 129The Relationship Between Reserve Assets and Liabilities 131Coverage of Reserve Assets 134Transactions with the International Monetary Fund 138

CONTENTS

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XIII. The International Investment Position 140

Balance Sheets and the International Investment Position 140The Relationship between the International Investment Position and the Balance of Payments 141Calculation of Price and Exchange Rate Changes 144Classifying the International Investment Position 145Valuation of the International Investment Position 146A Practical Example of International Investment Position Compilation 148

CONTENTS

v

The Balance of Payments Textbook (the Textbook)is the second of two companion documents to thefifth edition of the Balance of Payments Manual (theManual), which was published by the InternationalMonetary Fund in 1993. The fifth edition of theManual addresses the many important changes thathave occurred in international transactions,harmonizes (as closely as possible) balance ofpayments concepts with the revised System ofNational Accounts 1993 and other IMF statisticalmethodologies, and covers the important topic ofinternational investment position statistics. TheBalance of Payments Compilation Guide, publishedby the IMF in 1995, offers practical direction forusing established and emerging data sources andapplying or adapting a variety of methods tocompile statistics for the balance of payments andthe international investment position. Publication ofthe Balance of Payments Textbook completes thetrilogy that provides a comprehensive range ofinformation on the compilation of balance ofpayments statistics and will, it is hoped, make asignificant contribution to the understanding ofbalance of payments issues.

The Textbook is intended as one of the mainreference materials for training courses in balance ofpayments methodology. Such courses may beconducted—under the aegis of the IMF Institute—bythe Statistics Department at IMF headquarters inWashington, DC or organized externally. The

Textbook is designed to provide illustrative examplesand applications of concepts, definitions,classifications, and conventions contained in theManual and to afford compilers with opportunitiesfor enhancing their understanding of the relevantparts of the Manual.

The Textbook was produced by the IMF StatisticsDepartment under the supervision of Mr. MahinderS. Gill, assistant director, Balance of Payments andExternal Debt Division I (BOPED I). The task ofdrafting and finalizing the Textbook was undertakenby Mr. Peter Harper, an economist in BOPED I.Ms. Nancy W. Basham edited and coordinated printproduction of the Textbook, and Ms. SuzannaPersaud, administrative staff assistant in BOPED I,typed the final version.

I am hopeful that the Textbook, as part of thecomprehensive range of documentation on balanceof payments methodology now available, will makea significant contribution to the training of compilersas well as users of balance of payments statistics.

John B. McLenaghanDirector, Statistics DepartmentInternational Monetary Fund

vii

Foreword

1. Balance of payments statistics are included in abroad set of economic statistics known as thenational accounts. The System of National Accounts1993 (1993 SNA) presents the conceptual frameworkfor the national accounts, and the fifth edition (1993)of the Balance of Payments Manual (the BPM)presents the conceptual framework and the structureand classification of the balance of payments. Thehigh level of concordance between the 1993 SNAand the BPM is extremely important.1 This firstchapter of the Balance of Payments Textbook (theTextbook) presents the balance of paymentsconceptual framework and certain internationallyagreed-upon accounting conventions that haveinfluenced the shape of that framework. Theseconcepts and specific aspects of methodology areelaborated in subsequent Textbook chapters.

Definition of the Balance of Payments

2. As defined in the BPM, the balance ofpayments (BOP) is a statistical statement thatsystematically summarizes, for a specific time period,the economic transactions of an economy with therest of the world. Transactions, for the most partbetween residents and nonresidents, consist of thoseinvolving goods, services, and income; those involvingfinancial claims on, and liabilities to, the rest of theworld; and those (such as gifts) classified as transfers,which involve offsetting entries to balance—in anaccounting sense—one-sided transactions. Eachcomponent of this important definition issubsequently examined.

3. The balance of payments is concerned withtransactions and thus deals with flows rather thanwith stocks. That is, the balance of payments dealswith economic events that take place during areference period and not with outstanding totals ofeconomic assets and liabilities that exist at particularmoments in time.

4. The initial focus of the Textbook is on transactions(between an economy and the rest of the world) ingoods, services, and income. Under whatcircumstances does an international economicoccurrence constitute a transaction in the BOP senseof the word? In the framework of the nationalaccounts, transactions in goods, services, or incomeare the provision, by one party to another, of realresources of this kind. Thus defined, a transactioninvolves two parties or transactors. It is not alwaysclear, however, that there are two parties. Realresources are often transferred internationally fromone constituent unit to another within the same legalentity. (For example, real resources may betransferred between a branch and the head office ofa multinational enterprise.) It is equally difficult todetermine whether transactions take place whenindividuals migrate and transfer assets from theirformer to their new countries. How should realresources that accompany migrating individuals beregarded? Such movements of resources do notinvolve two parties although, in the process, thewealth of some economies is diminished (countriesof emigration) and the wealth of other economies isincreased (countries of immigration). Whenindividuals migrate, the economic impact of theshifts in real resources is similar to that of flows ofresources between two parties. It is thereforepossible to regard these shifts as transactions in arestricted sense. The determination of whatconstitutes a transaction must not be made strictly onthe basis of logic but through adoption of generallyagreed-upon conventions. For the sake ofconvenience, the term transaction is often usedbroadly in the BPM to refer to any sort of flow orchange that is, by convention, shown in the balanceof payments.

5. The BPM definition (see paragraph 2 on thispage) of the balance of payments also includestransactions in an economy’s external financialassets and liabilities. These transactions arise from(a) the creation or extinction of an external financialasset or liability or (b) from a change in theownership of an existing external financial asset and

1

I. The Balance of Payments Conceptual Framework

1The relationship between BOP statistics and national accounts statistics isdescribed in detail in chapter 3 of the BPM.

liability. Transactions that involve external financialassets and two resident parties and transactions thatinvolve external financial liabilities and twononresident parties are, theoretically, included in thebalance of payments.2 Often, these transactions aretransparent in the BOP presentation. However, someBOP presentations explicitly reflect thesetransactions if (for transactions in external financialassets) the two residents are in different sectors ofthe economy or if (for transactions involvingexternal financial liabilities) the two nonresidentsare residents of different countries.

6. An issue of frequent debate is whether BOPcoverage should be restricted to transactions orwhether, at the other extreme, the BOP statementshould show all changes in the value of aneconomy’s holdings of external financial items.Opinions have differed, and conventions reflectingdifferent analytic approaches have been suggested.The conventions recommended in the fifth edition ofthe BPM generally require a narrow view of BOPcoverage.

7. This narrow view of BOP coverage should beconsidered in relation to the closely connected,stock-oriented international investment position. Theinternational investment position (IIP) is astatistical statement (compiled as of a specific datesuch as year end) of the value and composition ofan economy’s claims on the rest of the world and thevalue of that economy’s financial liabilities to therest of the world. The difference between aneconomy’s stock of international financial assets andfinancial liabilities is that part of an economy’s networth attributable to, or derived from, its externalsector.

8. Those who are more interested in changes in aneconomy’s holdings of external financial items thanin transactions in these items can obtain thenecessary information by calculating the differencebetween IIP statements compiled for differentperiods. In addition to changes in BOP transactions,the difference will reflect valuation changes (such as those associated with movements in exchangerates or in prices of financial items) and otheradjustments (such as uncompensated seizures anddebt write-offs).

Double Entry System

9. The balance of payments is a statistical statementstructured in systematic fashion; data in thestatement are presented according to specificaccounting rules. The basic accounting conventionfor a BOP statement is that every recordedtransaction is represented by two entries with exactlyequal values. In a BOP statement, the two entriesare used to recognize the giving and receiving sidesof every transaction. Therefore, the BOP statement isanalogous to a typical financial statement preparedin accordance with the double entry system regularlyused for business accounting.

10. The dual entry system underlying BOPaccounting is governed by certain rules. Thus, inconformity with business and national accounting, inthe balance of payments, the term credit is used todenote a reduction in assets or an increase inliabilities, and the term debit is used to denote areduction in liabilities or an increase in assets. Thisusage has been supplemented by the rule that everyrecording of a debit movement shall be matched bythe recording of a credit movement and vice versa.For example, Dromesia borrows 200,000 units inCromanian currency from the government ofCromania and deposits the money with a Cromaniancommercial bank. Dromesia then acquires an asset(the bank balance) as well as incurring a liability(the debt to the government of Cromania). The assetaccount is debited, and the liability account iscredited. The Dromesian BOP entries to record thetransaction are:

Credit Debit

Liabilities (obligation to Cromania) 200,000Assets (bank balance in Cromania) 200,000

11. In the preceding (and in succeeding) statements,credits are entered on the left-hand side, and debitsare entered on the right-hand side. This traditionalpractice in BOP accounting differs from commercialaccounting procedure in some countries.

12. Changes in assets are, of course, associated withmany other types of change besides changes inliabilities. An increase in one asset may be associatedwith a decrease in another. For example, Mr. Jonesin Cromania purchases goods from Mrs. Smith inDromesia but does not pay for them. Mrs. Smith’sclaim against Mr. Jones is a trade credit and an assetof Dromesia. When Mr. Jones pays this debt inCromanian currency, Dromesia’s trade credit assetsare decreased and its foreign currency assets are

THE BALANCE OF PAYMENTS CONCEPTUAL FRAMEWORK

2

2Such transactions are included for pragmatic reasons and to increase theanalytical usefulness of the statistics. For additional discussion on this topic,see paragraphs 454–455 of chapter 8 of the Textbook.

increased. According to the rule stated in paragraph10, the increase in one asset (foreign currency) isrecorded as a debit, and the decrease in the otherasset (trade credit) is recorded as a credit. As always,the debit is offset by an equal credit. If the goodspurchased by Mr. Jones are worth 1,000 units, thetwo entries in Dromesia’s balance of paymentswould be:

Credit Debit

Assets (trade credit) 1,000Assets (foreign currency) 1,000

13. An increase in one liability may be associatedwith a decrease in another. If the example inparagraph 12 is viewed from Cromania’s perspective,the trade credit owed to Mrs. Smith is a liability.When Mr. Jones pays for the goods in Cromaniancurrency, the trade credit liability ceases to exist. Inits place, the Cromanian banking system incurs aliability (in the form of a deposit in Cromaniancurrency) to a resident of Dromesia. The increase inthe bank’s liability is recorded as a credit, and thedecrease in Cromanian trade credit liability is shownas a debit. The balance of payments entries are:

Credit Debit

Liability (bank deposit) 1,000Liability (trade credit) 1,000

14. On the basis of rules stating that an increase inassets is recorded as a debit, that an increase inliabilities is recorded as a credit, and that everycredit entry is matched by a corresponding debitentry, accounting conventions can be formulated forcredits and debits in the balance of payments. Underthe conventions of the system, the compilingeconomy records credit entries for (a) exports ofgoods, provision of services, provision of the factorsof production to another economy and (b) financialitems reflecting a reduction in the economy’sexternal assets or an increase in external liabilities.Conversely, the compiling economy records debitentries for (a) imports of goods, acquisition ofservices, use of production factors provided byanother economy and (b) financial items reflectingan increase in assets or a decrease in liabilities. Inother words, for real or financial assets, a positivefigure (credit) indicates a decrease in holdings, and anegative figure (debit) indicates an increase. Forliabilities in the form of financial instruments, therule is reversed; a positive figure indicates anincrease and a negative one, a decrease.

15. Most entries in the balance of payments pertainto transactions in which economic values are

provided or acquired in exchange for othereconomic values. Offsetting credit and debit entriesrequired by the recording system are often theautomatic result of two entries of equal amountbeing made for two items that have beenexchanged. For example, a commodity import isrecorded in the statistics for goods, and payment forthat import is recorded in the banking statistics forchanges in assets or liabilities. When items aredonated or when recordings are one-sided for otherreasons, only one aspect of the transaction isrecorded automatically in source data. Special typesof entries called transfers are made in the balance ofpayments to provide the required offsets. Transfersare shown as credits when the entries for which thetransfers provide offsets are debits and as debitswhen those entries are credits.

16. In summary form, double entry accountingconventions used in the balance of payments consistof:

Credit (CR) entriesExports of goods and servicesIncome receivableOffsets to real or financial resources received without a

quid pro quo (transfers)Increases in liabilitiesDecreases in financial assets

Debit (DR) entriesImports of goods and servicesIncome payableOffsets to real or financial resources provided without a

quid pro quo (transfers)Increases in financial assetsDecreases in liabilities

17. Techniques of BOP analysis are largely based onthe double entry recording system of BOPstatements. BOP analysis identifies and groupstransactions that are autonomous (undertaken fortheir own sake) and all other transactions that canbe characterized as flows induced to financeautonomous transactions. When entries aredivided—on the basis of these or any othercharacteristics—into two groups, the sums of the twogroups will (in theory) be numerically equal andhave opposite signs.3 The principal focus of BOPanalysis is on the selection of characteristics to beisolated and the subsequent examination ofrelationships between the resultant partial balancesthat can be constructed.

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3The achievement of such equality is unlikely in practice because of errorsand omissions.

Concept of an Economy

18. In general, the balance of payments is a recordof economic flows occurring between residents ofone economy and residents of the rest of the world.An economy is defined as an economic entity havinga center of economic interest within a specificterritory. Economy is thus nearly synonymous withcountry as the balance of payments (in practice)usually deals with transactions between nations. Intheory, an economy can represent a small portion ofa large national territory. An economy may alsoconsist of more than one country—for example, theEconomic Union of Belgium and Luxembourg. Inaddition, it is possible to consider the balance ofpayments of such regional groups as the EuropeanUnion (EU) and the balance of payments of eachgroup member. (See chapter 4 of the BPM andchapter 2 of this Textbook for the definition ofresident economic entities and guidelines fordistinguishing them from nonresident economicentities.)

Principles for Valuation and Time ofRecording; Unit of Account and Procedures for Conversion

19. As BOP transactions are diverse, the BPMprovides clear guidance on how to value transactionsand in which periods the transactions should berecorded. In addition, because transactions may bedenominated in many currencies, BOP statisticiansshould be sure to select the most appropriate unit ofaccount in which to express the statement and thebest procedures for converting flows from transactioncurrencies into the unit of account.

Valuation

20. The application of a uniform principle ofvaluation to all transactions recorded in the balanceof payments is necessary for three reasons. First, aseach transaction has two aspects, the double entryaccounting rule would be violated if credit and debitentries did not possess the same values. Second, theabsence of a uniform valuation principle wouldmake it impossible to compare the BOP statement ofone country with the BOP statements of othercountries because the valuation of entries made bypartner countries would lack symmetry. Third, werea uniform valuation system not used, items recordedin the balance of payments could not be comparedwith one another, and serious problems ofinterpretation would be created for data users.

Questions concerning the valuation of transactionsare not limited to BOP statistics; similar problemsarise for compilers of national accounts. For bothBOP and national accounting systems, the solutionhas been to adopt a uniform basis for pricing.

21. The assignment of value to an economictransaction on the basis of price is by no meansstraightforward. A range of prices may exist for anyasset. For example, for commodities, there may bequoted prices or list prices at both wholesale andretail levels. The same commodity may be priceddifferently in geographically separated markets.Customs authorities of various countries maycompile price lists for use in assessing duties to bepaid. The balance sheets of enterprises may carryreal assets valued in terms of production costs (if theenterprises produced the articles), in terms ofacquisition or historical costs, in terms of depreciatedreplacement costs, or in terms of market values. Intransactions conducted between affiliated enterprises,transfer pricing may be utilized. In general, however,transactions between such enterprises will be valuedat the purchase or sales prices that would berealized in commercial exchanges made under “arm’slength” conditions.

22. Market prices are widely used in the generalfield of economics as a means to measure thedeployment of resources. The use of market pricesfor valuing transactions is therefore recommended inthe BPM and is consistent with the 1993 SNA.Admittedly, there may be some practical problems inimplementing this recommendation. Adjustmentsmay be required for the reported values of a largenumber of individual transactions, and it may bedifficult to determine suitable market price proxiesfor transactions that have not actually taken place ina market. Nevertheless, no other principle ofvaluation can measure the economic value ofresources transferred between economies in anequally meaningful way.

23. Market price is defined, for both the balance ofpayments and the national accounts, as the amountof money that a willing buyer pays to acquiresomething from a willing seller when both areindependent parties and when all considerations aresolely commercial. A market price is the price paidin one specific exchange made under the previouslystated conditions. A second exchange that involvesan identical unit and is completed under exactly ornearly the same circumstances could be made at adifferent market price. Defined in this way, a market


4

price is clearly distinguished from a price quoted inthe market, a world market price, a going price, afair market price, or any price intended to expressthe generality of prices for a class of supposedlyidentical exchanges rather than the one price thatthe goods actually fetch. Furthermore, a market priceshould not necessarily be considered equivalent to afree market price. That is, a market transactionshould not be interpreted as occurring exclusively ina purely competitive market. In fact, a market pricecould be determined in a monopolistic ormonopsonistic market or in any other market that isnot wholly free. Indeed, the market may be sonarrowly defined that it consists of a sole transactionof the kind between independent parties.

24. The essential characteristic of the market inwhich prices used in the balance of payments arefound is the absence of any relationship between theparties to a particular transaction. That is, thetransactors are independent. If this condition exists,a particular transaction can be described as amarket-oriented transaction. The criterion ofindependence between transactors is the oppositeof this definition of associated transactors:

Two persons shall be deemed to be associated inbusiness with one another if, whether directly orindirectly, either of them has any interest in thebusiness or property of the other or some third personhas an interest in the business or property of both ofthem. (Customs Cooperation Council, BrusselsDefinition of Value, Article 11)

25. In concept, all stocks of assets and liabilitiescomprising a country’s international investmentposition are recorded on the basis of market value.The underlying assumption is that such stocks arecontinuously (regularly) revalued at current pricesby, for example, reference to actual market pricesfor financial assets such as shares and bonds or, inthe case of some direct investments, by revaluedenterprise balance sheets reflecting market value.

26. Chapter 5 of the BPM contains a completediscussion of problems related to the use of marketprices for valuation of flows and stocks as well asproposed solutions to be effected through use ofproxy measures when the conditions of a markettransaction are absent.

Time of Recording

27. As previously stated, a BOP statement isconstructed on the double entry system; every

transaction is represented by a credit and a debit.Both sides of a transaction—each credit andcorresponding debit—should be recordedsimultaneously, and the same time or date ofoccurrence should be recorded by both parties to atransaction. To ensure uniformity, a principle isrequired to determine the time at which atransaction is entered in the balance of payments.The requirement for a uniform time of recording isanalogous to that for a uniform basis of valuation.

28. Each economic transaction proceeds through asuccession of stages to which specific dates can beassigned. For example, two transactors agree toconduct a set of transactions. A specific date, thetime of contract or commitment, can be assigned tothe time that the formal agreement is executed.Contract provisions are subsequently implemented.Commodities are delivered to the purchaser orservices are rendered. Claims for payment thendevolve. When payment is made, the financialclaim—which was created when the seller providedreal resources to the buyer—is settled. Specific datescan be assigned to all these events. The two mostimportant events, which are usually relevant for anycontract, are (1) the time of contract and (2) the timewhen legal ownership of the assets changes. Whilethe change in ownership is effected by the deliveryof an asset, the ensuing financial claim may not besettled until a later period.

29. Each successive stage of a contract has significancefrom an economic standpoint. At the time ofcommitment, the price—or the basis for determiningthe price—is generally fixed for each transactioncovered under the contract. The risk is therebyassigned for any price changes that may subsequentlyoccur. The date when the ownership of assets changesis of prime significance in economic analyses based onthe national accounts and the balance of paymentsbecause both are mainly concerned with recordingexchanges of economic values. By definition, suchexchanges occur when ownership of assets changes.Usually, change of ownership is also, in the accountingrecords of enterprises, the most meaningful stage incontract fulfillment. Such records are often the sourceof BOP data. Thus, for many reasons, the BPM statesthat the time at which ownership changes is the timeat which a transaction is recorded. The BOP principlefor uniform time of recording conforms with that ofthe national accounts.

30. A common transaction consists of an exchange,which is made between two enterprises, of goods

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for financial assets. Entries for such an exchange aremade in each company’s accounting records. Theentries show dates for, in the accounting records ofone company, the acquisition of goods and therelinquishment of a financial asset and, in theaccounting records of the other, the acquisition of afinancial asset and the relinquishment of goods.Ideally, both parties record their entries as of thesame date. This method of recording provides afixed point of time to which a BOP transaction maybe related.

31. Under the change of ownership criterion andthe conventions for implementing it, rules can beformulated to produce consistent times of recordingfor most other types of transactions. For furtherdiscussion of these rules and practical application ofthe change of ownership concept, see chapter 6 ofthe BPM.

Unit of Account and Procedures forConversion

32. The numerous individual transactions that makeup the balance of payments of any country are likelyto be denominated in a variety of currencies (forexample, the domestic currency, internationally usedcurrencies such as the U.S. dollar, and currencies oftrading partners). Transactions in diverse currenciesmust be converted to a single unit of account beforebeing summed and combined under the headings ofa single statement. A country’s BOP statistics arenormally expressed in domestic currency as the dataare used in conjunction with other national statistics.However, if the domestic currency undergoes majorchanges in relationship to other currencies, it mayalso be necessary to compile the national balance ofpayments in a more stable currency. Compilation ofa country’s balance of payments in a non-domesticcurrency may be useful, as well, for internationalcomparisons. Discussed in subsequent paragraphsare the selection of a currency or some other unit ofaccount for the BOP statement and procedures forconverting data expressed in transaction currenciesto domestic currency or some other unit of account.

33. It is preferable that the balance of payments beexpressed in a stable unit of account. Stability in thiscontext is specifically defined. A unit of account isconsidered stable when the prices of internationaltransactions expressed in that unit are not affectedby changes (relative to the unit) in the values of thetransaction currencies. For example, if there were—as a result of a general realignment of currency

relationships—a decrease of 10 percent in the valueof transactions conducted in deutsche marks, anincrease of 5 percent in the value of transactionsconducted in U.S. dollars, and little or no change inthe value of transactions conducted in specialdrawing rights (SDRs), the latter could be describedas a relatively stable unit of account. Transactionsexpressed in a unit that is stable in the defined sensemay nevertheless reflect price changes attributable tofactors other than exchange rate changes. That is, aseries expressed in a stable unit of account is not theequivalent of a volume or constant price series fromwhich all price variations have been isolated. Acompletely stable unit of account does not exist. Noris it possible, especially during a period of markedfluctuation in relative exchange rates of transactioncurrencies, to construct an artificial unit of accountthat is completely stable.

34. To remain consistent with principles that requiretransactions to be valued at market prices andrecorded at the time of change in legal ownership,the exchange rate used in converting valuesexpressed in a transaction currency to valuesexpressed in the unit of account is the market rateprevailing when change of ownership occurs for aparticular transaction. If this conversion method isnot used, the market value—in terms of a unit otherthan the transaction currency—is not a single,determinate value but one that varies as therelationship between transactors changes.

35. Actual dates may not be available for sometransactions that must be converted from onecurrency to another. These cases require the use ofmarket rates prevailing during the periods in whichthe transactions are recorded in the balance ofpayments. By applying these averages for limitedperiods (months are preferred to quarters andquarters are preferred to years) to data aggregatedfor use in the balance of payments, statisticians canobtain approximate equivalents in which a certaindegree of distortion must be accepted.

36. The exchange rate prevailing on the statementdate of the international investment position isrecommended for use in converting data on stocksof external financial assets and liabilities.

37. The existence of multiple official exchange ratesindicates implicit taxes and government subsidies ofeconomic units involved in transactions. Theimputed tax or subsidy can be estimated from thedifference between the actual exchange rateapplicable to a specific transaction and a rate


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calculated as a weighted average of all official ratesused for foreign exchange transactions. It issuggested that compilers use a single rate for thebalance of payments; otherwise, transactions wouldbe expressed at values that include elements oftransfers—most of which involve two residentparties. For practical reasons, this rate may be theofficial exchange rate predominant in the economyrather than the weighted average of all official rates.For transactions involving parallel (black) marketrates, actual transaction rates should be used tovalue both flows and stocks as there are no officialtaxes or subsidies implicit in these transactions. Theuse of actual exchange rates applicable to specificassets or liabilities is recommended, in the BPM, forconversions in the international investment position.

Coverage of the Balance of Payments

38. Many international transactions recorded in thebalance of payments do not involve payments ofmoney. To provide a comprehensive record of aneconomy’s transactions with the rest of the world,the balance of payments includes some transactionsthat do not give rise to immediate money paymentsand some transactions that do not elicit any suchpayments. The inclusion of transactions other thanthose involving money payments constitutes theprincipal difference between a BOP statement andan exchange record.

39. In the following paragraphs, categories oftransactions are discussed in the context of limitsthat should be set for BOP coverage.

Exchanges

40. Most transactions likely to be recorded in thebalance of payments may be characterized asexchanges in which one transactor provides aneconomic value to another transactor and receivesan equal value in return. Economic values are goodsand services; incomes receivable for use of thefactors of production; non-produced, nonfinancialassets (such as patents and copyrights); and financialresources. Within such exchanges, four types ofeconomic transactions may be distinguished.

Exchanges of Goods and Services for Financial Items

41. For example, an exporter in Coonawarra sellscommodities worth 10 units to an importer in

Pokolbin and receives payment in foreign exchange.The exporter (one transactor) thus provideseconomic value in the form of commodities to animporter (the other transactor) and, in return,receives an equivalent amount of economic value inthe form of foreign exchange. BOP entries for theeconomies of the two transactors are:

Coonawarra Pokolbin

Credit Debit Credit Debit

Commodities 10 10Financial claims 10 10

42. A convention is applied for transactionsinvolving exchanges of real resources by two partiesthat constitute a single legal entity. When a singlelegal entity is divided, according to the BOPdefinition of residence, into a domestic and anonresident enterprise (i.e., a parent company andits branch), a change of ownership is imputed evenwhen the same legal entity is both buyer and seller.

Payment for, or Receipt of Income on, theFactors of Production

43. These flows are included in the balance ofpayments if one of the transactors supplies economicvalue in the form of factors of production (e.g., laborand financial capital) and receives, in return,economic value in the form of financial resources.

Barter (Exchange of Goods and Services forOther Goods and Services)

44. BOP entries for both transactors are made in thecurrent account.

Exchanges of Financial Items for OtherFinancial Items

45. Such exchanges may consist, for example, ofsecurities sold for money or commercial debts repaidwith money. In the first case, one transactor (theseller of the securities) provides economic value tothe other transactor (the buyer) in the form of afinancial instrument representing a claim payable inmoney, which is a financial instrument as well. Inthe second case, the transactors also exchangeeconomic value in the form of financial instruments.The composition of the creditor’s asset portfolio isaffected as a result of the exchange of economicvalues, and the debtor’s indebtedness is reduced.

46. Provision of a financial item may result, not onlyin a change in the ownership of an existing claim,

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but also in the creation of a new claim or thecancellation of an existing claim. For instance, anexisting loan may be refinanced. This act is recordedin the balance of payments as the settlement of anold debt and the creation of a new one. The entriesare:

Repayment of an existing loan debitDrawing on a new loan credit

In this case, contract terms pertaining to the maturitydate of a financial item are altered by agreementbetween the parties; the refinancing extinguishes theclaim under the original contract and replaces it witha different one.

47. The four types of exchanges discussed inpreceding paragraphs are covered by the balance ofpayments if the transactors are residents of differenteconomies or if both transactors are not residents ofthe economy that is the debtor for the financial itemin which the transactors are dealing. The balance ofpayments primarily registers changes in economicrelationships between transactors residing indifferent countries or economies. The structure ofthe BOP financial account provides for certainfinancial flows to be differentiated by economicsectors. If two resident transactors from differentsectors in the reporting economy enter into anexchange involving financial claims on anonresident, this intra-residential transaction inexternal financial assets would be recorded in thebalance of payments. For example, banks of areporting economy could acquire treasury bills offoreign governments from the private sector of theeconomy. This strictly domestic exchangenonetheless requires a BOP entry because of theway the financial account is structured. Theentries are:

Short-term assets of private sector creditShort-term assets of banks debit

48. The possibility of two resident transactorsengaging in an exchange of liabilities is very slim; itis not likely that the debtor would be able to transferhis debt to another entity without the expressconsent of the creditor. The acquisition, by oneresident entity, of the liabilities of another resident istherefore viewed as two separate transactions. Thefirst resident redeems his indebtedness to thenonresident party who, in turn, re-lends to thesecond resident entity. For the debtor economy, theBOP entry is:

First resident’s liabilities debitSecond resident’s liabilities credit

Transfers

49. When, from the points of view of bothtransactors, the provision and acquisition ofeconomic values is two-sided, the transaction ischaracterized as an exchange. However, onetransactor sometimes provides an economic value toanother transactor and does not receive anequivalent value in return. The lack of economicvalue on the one side must be balanced by an entryreferred to in BOP and national accounts as atransfer. A transfer is simply a contra entry to theone-sided provision or acquisition of economicvalues.

50. For instance, if Coonawarra furnishes freeclothing and food to alleviate the plight ofearthquake victims of Nostaw, Coonawarra is notengaged in an exchange but in a one-sidedprovision of economic value. As a result of thisaction, Coonawarra’s resources are diminished whilethose of Nostaw are augmented. Coonawarrareceives no economic value in return, and Nostawgives up no economic value in payment.Coonawarra might, of course, be said to receive anintangible return (gratitude or good will) for the realresources provided to Nostaw, but such intangiblesare not tradable as economic values are.

51. Funds or goods recorded as transfers are notprovided in exchange for specified amounts ofgoods, or services purchased voluntarily, or paymentof loans or contractual obligations. Transfersbetween private parties are voluntary, but those toor from governments usually arise from legalobligations to, or legal commitments of, thosegovernments. Whether voluntary or undercommitment, the provision and receipt of aneconomic value without a quid pro quo is shown,by means of a contra entry, as a transfer in thebalance of payments.

Territorial Change and Migration

52. The balance of payments deals primarily withtransactions between residents of an economy andresidents of other economies. As, for BOP purposes,an economy comprises the economic entitiesassociated with its territory, the scope of aneconomy could be affected by changes in itsterritory or by changes in the status of entitiesassociated with the economy.

53. A change in the territory of an economy resultsin a change in the status of any entities associated


8

with that territory. That is, with respect to theformer economy, residents become nonresidentsand, with respect to the new economy,nonresidents become residents. For example, theeconomy of Clintonstan extends its territory intoarea X, which is part of the economy of Bushland.Entities resident in area X become part ofClintonstan. With the change in territory, formerdomestic claims on area X are classified, from theperspective of Bushland, as external claims.Clintonstan acquires additional productive facilities,as well as the claims of area X on Bushland. Ineffect, the net worth of entities associated with areaX is transferred from Bushland to Clintonstan.Therefore, if the real resources and capital that aneconomy provides to or receives from the rest ofthe world as a result of a change in territory arerecorded in the balance of payments, a counterpartentry reflecting the transfer of net worth is alsorequired, from the perspective of the new economy,to balance the statement.

54. The effect of the change in territory can beillustrated by the balance sheet of an enterpriselocated in area X.

Assets Liabilities

Fixed assets 1,000Deposits in a commercial bank

in Bushland 500Net worth of owner 1,500

Were it considered desirable to portray in thebalance of payments the shift in resources stemmingfrom a territorial change, these entries would bemade in the BOP statement of Clintonstan:

Credit Debit

Goods 1,000Financial assets 500Counterpart to territorial change 1,500

55. However, it is recommended in the BPM thatchanges occurring in an economy’s real and financialassets as a result of territorial changes be excludedfrom BOP coverage. The rationale for the exclusionis that territorial changes occur infrequently and canbe appropriately viewed as changes in the coverageof reporting economies. Such changes will, however,be reflected in the reporting economy’s IIP statistics.The BPM treatment of territorial change extends tothe creation of new economies from the territory ofexisting economies (for example, Slovenia, whichwas created from the former Yugoslavia) or the fullabsorption of one economy by another (for example,East and West Germany).

56. In contrast to infrequent territorial changes,changes in the residence of individuals arecommonplace. The impact of migrating individualsis, however, somewhat similar to that of the cessionor acquisition of territory because internationalcreditor or debtor positions are affected by a changein the coverage of individuals comprising aneconomy. Movable property owned by a migrant is,in effect, imported into the new economy. Fixedassets owned by the migrant and located in theformer economy become claims of the neweconomy on the former economy. The migrant’sclaims on, or liabilities to, residents (including thoseof the former economy) of an economy other thanthe new economy become external claims orliabilities of the new economy, and the migrant’sclaims on, or liabilities to, residents of the neweconomy cease to be claims on, or liabilities to, therest of the world for any economy. The net sum ofall these shifts is equal to the net worth of themigrant.

57. The following example illustrates changesresulting from the migration of an individual. Prior tomigration, a resident producer in Daniherlandoperated a business.

Balance Sheet of a Resident Enterprise of Daniherland

Domestic Assets Domestic Liabilities

Machinery and equipment 5,000 Bank loans 2,000Inventories 1,500 Trade credits 1,500Cash 200Securities 500_____ _____

7,200 3,500

External Assets External Liabilities

Claims on residents of Trade credits due to Essendonia 800 residents of

Essendonia 1,200Claims on residents of Funds borrowed from

Nostaw 1,200 residents of Nostaw 800_____ _____2,000 2,000

Net worth of proprietor 3,700

Total liabilities and netTotal assets 9,200 worth 9,200

58. The producer ceases business activity inDaniherland and migrates to Essendonia with theintention of engaging in a similar line of economicactivity there. The migrating producer takes thecapital goods (machinery, equipment, andinventories) used by the enterprise in Daniherlandand converts holdings of domestic financial assets

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into foreign exchange. The producer also transfersher indebtedness and external financial claims to thenew enterprise in Essendonia. As a result, theinternational investment position of both the countryof emigration and the country of immigration areaffected. Daniherland, the country of emigration,loses real resources in the form of capital goods andforeign exchange and no longer has 2,000 units ofexternal assets in the form of migrant claims onresidents of Essendonia and Nostaw. Simulta-neously, Daniherland ceases to have externalliabilities to Essendonia and Nostaw. However,Daniherland now has new external assets, in theform of claims on the migrant, of 3,500 units.Essendonia, the country of immigration, acquiresreal resources of 6,500 units, foreign exchange of700 units, and external assets (claims on Nostaw) of1,200 units. Essendonia also assumes externalliabilities of 4,300 units (the migrant’s debts toresidents of Daniherland and Nostaw) and ceases tohave external liabilities that were due to amounts(800 units) owed by Essendonian residents to themigrant and external assets (1,200 units) that otherresidents of Essendonia had extended in tradecredits to the migrant. To record these shifts in thebalance of payments, the following entries arerequired:

Daniherland EssendoniaCredit Debit Credit Debit

Goods 6,500 6,500Financial assets 800 700Financial liabilities 2,000 3,500Transfer of net worth 3,700 3,700

59. In the BPM, it is suggested that all such changesbe recorded in the balance of payments. Thus,changes in assets and liabilities that are due to themigration of individuals from one economy toanother are covered by the balance of payments.The net sum of all these shifts is equal to the networth of the migrant, which must be recorded as anoffset if the other shifts are recorded. This offset isconventionally included with transfers in the balanceof payments.

60. Should transfers that are associated withmigration and involve the movement of real andfinancial resources from one economy to another beconsidered transactions? In a national accountingsense, a transaction consists of the provision ofeconomic value by one party to another. In thissense, migrants’ transfers can be deemed transactionsif the migrant is theoretically divided into twopersons—one of whom is a resident of the former

country and the other, a resident of the new country.Any transfer of real and financial resources from oneof these persons to the other is considered atransaction as there is both a provision and anacquisition of economic value. Assigning the migrantdual status as a resident and a nonresident is adevice by which migrants’ transfers can be includedin the balance of payments.

61. The effect of territorial changes on a country’screditor/debtor position and the effect of changesresulting from the migration of individuals aretreated differently. Territorial changes occurinfrequently and can be viewed as changing thecoverage of the reporting economy; the migration ofindividuals occurs continually. Over a long period,wealth in the form of financial items or real capitalbrought into a country by immigrants may be asignificant source of foreign exchange for thecountry’s monetary authorities or may contributesubstantially to the country’s domestic capitalformation. Conversely, wealth taken out of a countryby emigrants may be a substantial drain on theresources of that country. It is therefore useful andappropriate to account, in the balance of payments,for international transfers of wealth accompanyingmigration.

Reclassification of Claims and Liabilities

62. The classification scheme used in the BOPfinancial account accentuates characteristics thatreflect the motivation of the investor. The underlyingintentions of the investor may vary over time andthereby affect the character of the investment and itsclassification—as can be seen from the distinctionsmade among direct investment, portfolio investment,other investment, and reserve assets. For example,several independent holders of equity capital in anenterprise located abroad decide to associate toacquire entrepreneurial control over the enterprise.As a result, the character of the investment changesfrom portfolio investment to direct investment.According to the BPM, reclassifications of this typeare not reflected in the balance of payments but arerecorded in IIP statements at the ends of the periodsin which the reclassifications occur. Similarly, centralmonetary authorities may relinquish or assumeeffective control over the foreign exchange holdingsof deposit money banks, and reclassification fromreserve assets to other investment-assets-currency anddeposits-banks (or vice versa) are therefore recorded


10

in the international investment position but not inthe balance of payments.

Valuation Changes

63. The values of real resources and financial itemsare constantly subject to variation. Alterations invalues may be due to either or both of two factors.One factor is price changes. The price at which acommodity transaction (or any other transaction)takes place may be subject to change in terms of thecurrency in which the transaction is quoted. Theother factor is exchange rate changes. There may bea change in the exchange rate between thetransaction currency and the unit of account in whichthe balance of payments is recorded. Valuationchanges are included in the international investmentposition but not in the balance of payments. Realizedcapital gains and losses are, however, indirectlyrecorded in the balance of payments.

64. The following example illustrates the differencebetween realized capital gains and losses, which arerecorded in the balance of payments, and unrealizedvaluation changes, which are excluded. During thecourse of a year, a financial asset (such as a securityissued by a nonresident enterprise) is acquired fromabroad for 50 units. At the end of the reportingperiod, the purchaser still holds this asset, the valueof which has risen to 80 units. In accordance withthe BPM, the security purchase should be recorded

in the balance of payments as a debit of 50 units.The total change in holdings of financial assets is 80units, of which 30 units constitute a valuation gain.This valuation gain is excluded from the balance ofpayments but reflected in the internationalinvestment position where the level of theinvestment at the end of the reporting period isrecorded at the market value of 80 units. Thedifference between the level at the beginning of theperiod, which is nil, and the level at the end of theperiod comprises a transaction of 50 units and avaluation change of 30 units. Had the purchaser soldthe asset for 80 units before the end of the reportingperiod, the balance of payments would show a netcredit transaction in securities of 30 units (purchase,50 units; sale, 80 units). The net entry relates to therealization of capital gains but is neverthelessincluded in the statistics as it is the net result of twotransactions (a purchase and a sale) recorded atmarket values.

65. In the BPM, it is recommended that write-offs ofbad debts be regarded as valuation changes andconsequently excluded from BOP coverage. Thewrite-off, by the creditor, of a bad debt ispresumably prompted by the unwillingness orinability of the debtor to redeem his debt. Theexpropriation of property without compensation isanalogous to a write-off of a bad debt; the formershould be thought of as a valuation adjustment andexcluded from the balance of payments.

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66. The BPM broadly defines the balance ofpayments as recording (a) transactions—which takeplace between an economy and the rest of theworld—in goods, services, and income and (b)changes of ownership in that economy’s monetarygold, special drawing rights (SDRs), and claimson/liabilities to the rest of the world. It is thereforeessential to know how an economy is defined forBOP purposes. In chapter 2 of the BPM, theeconomic territory of a country is defined as ageographic territory administered by a governmentwithin which persons, goods, and capital circulatefreely. For maritime countries, geographic territoryincludes any islands subject to the same fiscal andmonetary authorities as the mainland. This conceptis elaborated in chapter 4 of the BPM, which statesthat the economic territory of a country includes:

air space, territorial waters, and continental shelf overwhich a country enjoys exclusive rights or over whicha country has jurisdiction in respect of the right tofish or exploit fuels or minerals below the sea bed;

territorial enclaves, which are clearly demarcatedareas of land that are owned or rented by a foreigngovernment for diplomatic, military, scientific, orother purposes with the formal political agreementof the government of the country in which theterritorial enclaves are physically located;

any free zones, bonded warehouses, or factoriesoperated by offshore enterprises under customscontrol. (These are part of the economic territories ofthe countries in which they are physically located.)

67. A special type of economic territory is that ofinternational organizations. Internationalorganizations are mostly political, administrative,economic, social, or financial institutions in whichthe members are governments or other internationalorganizations. The economic territory of aninternational organization consists of the territorialenclaves that the organization has jurisdiction overand uses for organizational purposes formally agreedupon with the countries in which the enclaves arephysically located. For example, the economicterritory of the International Monetary Fund (IMF)

includes the headquarters building at 700 19th Streetin Washington, DC. This building is not part of theeconomic territory of the United States. (Internationalorganizations are further discussed in paragraphs137–140.)

68. It is also important to consider the economicunits that operate within an economic territory. Aneconomic unit that has a center of economic interestin the economic territory of a specific country is aresident of that country. This chapter focuses on thenature of such units and how a unit’s center ofeconomic interest is determined in practice.

69. Because of the scope of the balance ofpayments, the determination of resident units hasimportant implications for recording and classifyingtransactions within an economy. For example, aworker employed by a corporation in the economyof Nostaw is paid a wage of 1,000 units during thereporting period. The worker spends 500 units onconsumption of goods and services within Nostawand saves 500 units, out of which he remits 300 units to relatives living in Coonawarra anddeposits 200 units in a commercial bank in Nostaw.

70. If the worker is classified as a resident of Nostaw,the following BOP entries should be made for Nostaw:

Credit Debit

Personal remittance (in cash) 300Commercial bank’s external assets 300

71. Presumably, the worker remitted his fundsabroad through a bank draft payable in foreignexchange. The only entries are the worker’s transferof funds abroad (debit) and the reduction, by anequivalent amount, in a commercial bank’s externalassets (credit).

72. Conversely, if the worker is classified as anonresident, the following BOP entries should bemade for Nostaw:

Credit Debit

Wages 1,000Expenditure on travel services 500Commercial bank’s external liabilities 200Commercial bank’s external assets 300

12

II. Residents of an Economy

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73. The 1,000–unit debit represents the import ofnonresident labor by Nostaw. The 500–unit creditrepresents the amount expended by the worker ontravel services in Nostaw. As a nonresident, theworker is classified as being in travel status (seeparagraph 84). The increase in the worker’s balancewith a commercial bank in Nostaw is considered anincrease of 200 units in external liabilities becausethe worker is a nonresident. The last entryrepresents the sale of the bank draft to the worker.

74. Under either assumption, the BOP statement isin balance and the requirements of the double entrysystem used to construct the statement are satisfied.

75. The types of transactions and the gross amountsrecorded under the assumption that the worker is aresident of Nostaw differ greatly from those that arerecorded if he is assumed to be a nonresident.Under the first assumption, only two entries arerequired in the balance of payments—a transfer(debit) and a change in the commercial bank’sexternal assets (a credit denoting a reduction). Underthe second assumption, the same transactionsrequire four BOP entries—use of labor (debit),provision of travel services (credit), an increase inthe commercial bank’s external liabilities (credit),and a reduction in the commercial bank’s externalassets (credit).

76. To ensure that BOP statistics are compiled on auniform basis, economies must be delimitedaccording to standard definitions. The BPM containsguidelines that enable IMF member countries toreport BOP data that are closely comparable to thosereported by other member countries. One of themost important guidelines is that which defines theresidents of an economy.

77. It is also important for the BOP concept andcoverage of residents to harmonize with those ofother macroeconomic statistical statements. To thisend, the definition of residence presented in theBPM is identical to that contained in the 1993 SNA.

Definition of Residents

78. The residents of an economy comprise thefollowing types of economic units:

households and individuals who make up ahousehold;

enterprises (which are corporations and quasi-corporations, such as branch offices of nonresidentdirect investors);

nonprofit institutions;

the government of the economy.

To be a resident of an economy, an economic unitmust have a center of economic interest in thateconomy. A unit has a center of economic interestwithin a country when there exists some location(dwelling, place of production, or other premiseswithin the economic territory of the country) on, in,or from which the unit engages and intends tocontinue engaging (either indefinitely or over a finitebut lengthy period of time) in economic activitiesand transactions on a significant scale. Subsequentparagraphs present a detailed discussion of how toapply the concept of economic interest for each typeof economic unit.

Households and Individuals

79. The BPM states that a household has center ofeconomic interest when members of that householdmaintain, within a country, a dwelling or successionof dwellings that the members treat and use as theirprincipal residence. All individuals who belong tothe same household must be residents of the sameeconomy. As applied to individuals, the concept ofresidence is designed to encompass all persons whomay be expected to consume goods and services,participate in production, or engage in othereconomic activities in the territory of an economy ona continuing (that is, not temporary) basis. Amember of a resident household who leaves theeconomic territory and returns to that samehousehold after a limited period of time continues tobe a resident even if that individual makes frequentjourneys outside the economic territory. These arethe persons who have centers of economic interestin a particular economy. For individuals, the conceptof residence is economic rather than legal. Anindividual considered, in accordance with the BOPdefinition, to be a resident of a particular economymay not necessarily be a citizen of that country. Themeaning of the term resident in the context ofexchange control regulations or laws may also differfrom the BOP definition.

80. In most instances, an individual’s associationwith a country is determined by fairly simple criteria:where he lives, where he works, his citizenship, thelanguage he speaks. All are factors indicating theextent of such an association. For some individuals,though, the determination may not bestraightforward. A Dutch citizen may have lived all

RESIDENTS OF AN ECONOMY

14

her life in Indonesia; an army officer stationedabroad may not have seen his own country in manyyears; or an ambassador’s children born abroad maynever have been in the country of their citizenship.Of course, the number of such persons may be sosmall that determination of their associations withparticular countries has a negligible effect on thebalance of payments. However, the treatment ofentire groups—such as diplomatic personnel abroad,an army overseas, or very wealthy individuals—mayhave significant effects.

81. The difficulty of making determinations inborderline cases is aggravated by the fact that themost satisfactory solution for one user of thestatistics may not suit the requirements of anotheruser. One statistician may consider persons living inBelgium but crossing the frontier daily to work in aFrench factory as residents of Belgium who sell theirlabor to France; another may consider them Frenchresidents who are buying travel services fromBelgium. As many of these differences are minor, thebenefits of using a particular definition for aparticular analysis are generally outweighed by theadvantages of using a commonly accepted definitionthat permits comparisons of results. Therefore, thedefinition of residence must be one that is widelyacceptable, one that may be consistently applied formost purposes, and one that is consistent with thenational accounts. (As BOP and national accountingsystems are closely related, serious difficulties wouldarise if each system referred to a different set ofpersons and households.)

82. It is evident that citizens of a country who livethere permanently have their centers of interest inthat country. Diplomatic representatives, members ofthe armed forces, and patients undergoing medicalcare abroad do not change their centers of interestand therefore remain residents of their homeeconomies. On the other hand, a businessmanemployed in another country may find it necessaryto establish a home there. For BOP purposes, he hasshifted his center of interest and, hence, hisresidence—even though he may retain his previouscitizenship, may send his children to schools in hiscountry of origin, and may be more interested inthat country’s politics than in those of the newcountry. Important factors in this determination are(1) the businessman is permanently living in the newcountry and (2) the product he creates can mostrealistically be considered part of the domesticproduct of that country. The most relevantconsideration for ascertaining the resident status of

an individual is whether he or she is expected to beinvolved in the productive and consumptive processof an economy with some degree of permanence.

83. The BPM criterion (which conforms with that ofthe 1993 SNA) for permanence is a period of oneyear. Thus, if an individual stays in an economy fora year or longer, or intends to stay in an economyfor a year or longer, he or she is considered aresident of that economy. If not, he or she isconsidered a nonresident. Exceptions to this rule arediscussed subsequently. The one-year length of stayis an objective, if arbitrary, benchmark fordetermining a person’s resident status. Nevertheless,the consistent application of such a convention inthe determi-nation of residence significantlyenhances the analytical usefulness of BOP and othermacroeconomic statistics.

84. Visitors (that is, persons remaining in aneconomy for less than one year for business;recreation or holiday; religious observances; familyaffairs; and participation in international sportsevents, conferences, meetings, study tours, orstudent programs) are classified as nonresidents fromthe standpoint of the host economy and,consequently, as residents of their home economies.All such individuals are classified as being in travelstatus and as having their centers of interest outsidethe economies to which they have traveled.

85. An exception to the one-year rule is made indetermining the resident status of students becauseapplication of the one-year rule could lead toproblems with interpretation and availability of data.Students are generally expected to return to theirhome economies upon completion of their studies.Consequently, their centers of interest may not beclosely related to the length of stay abroad.Therefore, however long they study abroad, studentsshould be treated as residents of their countries oforigin if they maintain economic attachments to theircountries. The factors to be considered indetermining whether such an attachment ismaintained include whether a student is dependenton a household, a nonprofit institution, or thegovernment of the country of origin for the fundsthat finance his or her studies; whether he or she isfunded by the host country under foreign aid orsimilar programs; and whether he or she plans toreturn to the country of origin on completion of hisor her studies. Medical patients abroad are treated,in the balance of payments, in the same manner asstudents. That is, they are considered—regardless of

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the length of stay in the economies in which theyare receiving treatment—to be residents of theireconomies of origin.

86. Crew members of vessels or aircraft are notconsidered residents of economies in which they arestopping or lying over but not living. Similarly,commercial travelers who stay in an economy forless than one year are not considered residents ofthat economy, and employees of nonresidententerprises who go to an economy for less than oneyear for the purpose of installing machinery orequipment purchased from their employers areregarded, from the standpoint of the economy wherethe machinery is installed, as nonresidents.

87. Foreign officials, diplomats, consularrepresentatives, members of foreign armed forces,and other foreign government personnel (except fortechnical assistance personnel) stationed in aneconomy are—under all circumstances—to beassociated with their home economies. Thesepersons and their dependents are therefore treated,from the viewpoints of the economies in whichthese persons are stationed, as nonresidents. Thistreatment is an exception to the general rule that aone-year sojourn constitutes resident status.Diplomats and military and similar personnel do not,for BOP purposes, change their centers of interestwhen they are stationed abroad. For instance, a U.S.army major stationed in Germany continues to be aresident of the United States even though he mayhave been stationed outside that country for morethan one year. However, the residence of technicalassistance personnel should be based on the one-year rule. Technical assistance personnel on long-term assignments should be treated as residents ofthe economies in which they work. A transfer offunds to cover the cost of salaries and allowancesshould be imputed to the host government from thegovernment (or international organization) thatemploys the experts.

88. Employees of international organizations areregarded as residents of the economies in which theemployees live if they have lived, or expect to live,there for one year or more. In most cases, thateconomy is the one in which the international unitthat they work for is located or the economy inwhich the employees are engaged in technicalassistance or other activities on behalf of theinternational organization. For example, a Swedishnational who is permanently employed at UnitedNations headquarters in New York is considered to

be a resident of the United States. However, if she isengaged in a technical assistance project of severalyears’ duration in Indonesia, she would (for BOPpurposes) be designated an Indonesian resident.Employees of international bodies and foreigngovernments who undertake technical assistancework of less than one year’s duration are classified,not as residents of the economies receiving thetechnical assistance, but as residents of theeconomies in which the employees normally live. Ifthe United Nations employee undertook technicalassistance work for a period of less than one year inMalawi, she would retain her status as a resident ofthe United States.

89. Seasonal workers who enter economies for thesole, explicit purpose of harvesting a crop orworking in hotels during the tourist season aretreated as residents of their home economies ratherthan residents of the economies where they areemployed for the season. For example, Italianresidents working in Switzerland during prime touristperiods are classified as residents of Italy rather thanresidents of Switzerland. Border workers—personswho cross the border between two economies on aregular, frequent basis because they work in oneeconomy but have homes in the other—are residentsof the economy in which they have their homes andnot of the economy in which they are employed.Workers living in Belgium but crossing daily into andout of France would be regarded as residents ofBelgium rather than residents of France.

90. Refugees are considered residents if they stay, orare expected to stay, for one year or more in theirhost countries. Persons taking refuge in anothercountry for only a short period remain residents oftheir home economies.

91. The basis for determining the residence ofindividuals may sometimes seem artificial, butspecific guidelines are necessary to achieveconsistency. The division between residents andnonresidents is based on a convention supported bythe international community of BOP and nationalaccounts statisticians.

Enterprises

Overview

92. The BPM states that an enterprise has a centerof economic interest and is a resident unit of acountry (or economic territory) when the enterprise


16

is engaged in (1) a significant amount of productionof goods and/or services there or (2) transactions inland located there. A significant amount ofproduction means that the enterprise maintains atleast one production establishment in the countryand plans to operate that establishment indefinitelyor over a long period of time (that is, one year ormore). However, other considerations—such aswhether there is a complete and separate set of localaccounts, whether taxes are paid to the hostgovernment, or whether funds for the localoperation are locally managed—must be consideredin determining the residence of an enterprise. Inpractice, these conditions are generally satisfied forenterprises engaged in longer-term activity.

93. The term enterprise includes (1) corporations,which are entities engaged in production for profitand recognized as legal entities separate from theowners, and (2) quasi-corporations, which areunincorporated entities owned by resident ornonresident institutional units and managed asseparate entities.

94. Determining whether an enterprise is a residentor nonresident is synonymous with deciding whetherenterprise production should be assigned to aspecific economy or to the rest of the world.Classifying a particular entity as a resident of aneconomy is tantamount to ascribing the entity’sproduction to the domestic product of that economy.Conversely, to assign nonresident status to aparticular entity is to attribute its production to thedomestic product of the rest of the world. Thus, thecrucial factor in determining that a particularenterprise is a resident entity is whether or not theenterprise is engaged in significant productive activitywithin the domestic territory of an economy. Beforedetermining that any entity significantly involved inproducing goods and services within that territory isa resident of that economy, it is, of course, necessaryto define the territory of an economy. (Refer toparagraphs 66–67 for a discussion of economicterritory.) Enterprises may still be classified asresidents even if, for example, the enterprisesprocess—in an area designated by the government asa “free zone”—imported raw materials for re-exportor mine the ocean bed off the shores of a country’sphysical territory.

95. There are two reasons that resident status isassigned to an enterprise only when the enterpriseengages in significant production activity within theterritory of an economy: (1) to ensure that the

balance of payments and the national accountsremain analytically useful and, simultaneously, (2) toavoid practical problems associated with treating asresidents those enterprises having limited activities ina particular economy (for example, short-termconstruction or installation activity). The treatment ofenterprises engaged in these types of activities issubsequently described in more detail.

96. Resident enterprises are defined as including allactual or notional entities engaged in transactions inland. In accordance with conventions presented inthe 1993 SNA and in the BPM, land can be ownedonly by a resident entity. Consequently, whenever anonresident acquires land, the transaction isaccounted for through the creation of a notionalresident unit. For BOP purposes, the legal owneracquires a financial investment (equity) in a residentunit which, in turn, acquires ownership of the land.From the standpoint of BOP recording, such atransaction would be construed as an increase inexternal financial investment in the economy inwhich the land is situated. For that economy, entriesin the financial account would be:

External liabilities creditReserve assets (or other appropriate financial

account item) debit

97. The previously stated definition of residententerprises has some special implications for certaintypes of enterprises. These enterprises comprisesingle enterprises operating in more than oneeconomy, enterprises operating mobile equipment,enterprises leasing equipment, enterprisesregistered—as a result of legislation—in more thanone country, commercial agencies, installationservices, and construction enterprises.

Single Enterprises Operating in More ThanOne Economy

98. The general rules for determining the residenceof an enterprise may necessitate the partitioning of asingle legal entity (such as a parent companyoperating in one economy and an unincorporatedbranch operating in another economy) or a singleeconomic or technical entity (such as a railwaysystem or a pipeline spanning the territory of two ormore economies) into two or more separateenterprises. For example, an automobilemanufacturing company incorporated in the UnitedStates and engaged in assembly operations inCanada may be organized as a single legal entity. InBOP accounting, this legal entity must be divided.

The parts of the company that are engaged inoperations in particular economies are assignedresident status in those economies. Thus, the parentcompany would be treated as a resident of theUnited States, and branch activity would beattributed to a resident producer unit in Canada. Allflows between the executive office of the parentcompany and the unincorporated branch wouldconstitute BOP transactions.

99. Each section of an oil pipeline running throughseveral economies should be regarded as a separateunit of economic production. A section that is locatedin the territory of a particular economy should betreated as domestic fixed capital in that economy,and a notional resident production unit should becreated in the national accounts and in the balance ofpayments. Ownership of the fixed assets in eachcountry should be attributed to the residentproduction unit. The local part of the pipeline isviewed as rendering a transportation service(shipping oil) to nonresidents and as earning, for thepipeline’s actual owners, income equal to the valueof this service and of any service the pipeline mayprovide to residents. (The income earned is net ofproduction costs, including depreciation and taxes.)A railroad enterprise operating in two or moreeconomies is treated similarly. The enterprise shouldbe divided into parts; each part should be regardedas a resident of the economic territory within whichenterprise operations are carried out. The head officeof the enterprise should be viewed as having afinancial investment in the local enterprise(s).

100. In the BPM, it is suggested that costs andearnings of production units operating in economiesother than those of the entities that direct unitoperations be calculated at market prices. However,some or most or all of the economic valuestransferred between the units of an internationalcomplex of this type may be omitted from unitrecords or entered only at nominal values. Valuesreported to compilers may have to be replaced bycompiler estimates of values. Additionally, BOPentries for each of the relevant economies shouldreflect the allocation–to each member of theinternational complex–of an appropriate share of anycommon operating costs, including head officeexpenses and charges for mobile equipmentoperating in more than one economic territory.

101. Recommendations presented in precedingparagraphs may be clarified by an example thatrelates the recommendations to specific BOP entries.

A railway enterprise with headquarters in Nostawoperates in three adjacent economies: Nostaw,Daniherland, and Dromesia. According to the rulesfor determining the resident status of enterprises, thesingle unit is, for BOP purposes, divided intoresident production units in Nostaw, Daniherland,and Dromesia. Data are assembled on the revenuecollected by the resident production unit of therailway in each economy and on the associatedcosts. The revenue collected in each economy is fordomestic transportation (that is, for transportationwithin the borders of the economy) and thetransportation is purchased by residents only.Compensation of employees represents local laborcosts only. The head office is able to calculatecommon operating costs and apportion thembetween the branch in Daniherland and the branchin Dromesia. Common operating costs consist of fuelcosts, repair costs, depreciation on the rolling stock,and the cost of management services provided bythe head office. Information exists on the investmentin capital formation (such as construction of newrailway stations and acquisition of office machinery)in each of the territories. All cash received andpayments made in Daniherland and Dromesia aredeposited to or made from accounts that are held bythe head office with Nostaw banks. The data are:

Head Office Branch in Branch inin Nostaw Daniherland Dromesia

Value of local production 1600 1000 1300

Export of services* 250____ ____ ____1850 1000 1300

Minus cost of production

Local materials 550 300 450Local wages 800 300 450Import of services* 100 150____ ____ ____

Operating surplus 500 300 250

*This item signifies common operating costs that are incurred by the headoffice and attributed to branches in Daniherland and Dromesia.

In addition, the head office provided funds of 210units to Daniherland and 300 units to Dromesia forcapital formation.

102. The BOP entries show that the singleenterprise has been separated into a parentorganization and subsidiary units and that each unithas been assigned resident status in the economy inwhich the unit is operating. The income generated(operating surplus) by subsidiary units is attributedto the head office and is recorded as investmentincome debits in the balance of payments of the

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countries where the branches are located. Thebalance of payments of Nostaw shows receipt, bythe head office, of entrepreneurial income and theexpansion of external investment through additionalcapital outlays in branches located abroad is alsoshown. Common operating costs are recorded asmiscellaneous services performed by residents ofNostaw for residents of Daniherland and Dromesia.

Balance of Payments of Nostaw

Credit Debit

Investment income 550Miscellaneous services 250Direct investment-abroad 510Reserve assets (or other appropriate

financial account item) 290

Balance of Payments of Daniherland

Credit Debit

Investment income 300Miscellaneous services 100Direct investment-in reporting economy 210Reserve (or similar) assets 190

Balance of Payments of Dromesia

Credit Debit

Investment income 250Miscellaneous services 150Direct investment-in reporting economy 300Reserve assets (or other appropriate


Operation of Mobile Equipment

103. The attribution—in terms of the residency—ofservices provided by mobile equipment (such asaircraft, ships, highway and railway rolling stock,fishing vessels, and gas and oil drilling rigs) is basedon the resident status of the enterprise operating theequipment in the production process. (Theenterprise owning the equipment may or may not bethe operator.) The residence of an enterpriseoperating mobile equipment outside any nationalterritory (that is, in international waters or air space)is attributed to the economy in which the mobileequipment is, in some sense, based. In determiningthe residence of such an enterprise, considerationshould be given to such attributes as the location ofthe company directing enterprise operations;whether the equipment is subject to the laws,regulations, and protection of a particular nationaleconomy; or whether the equipment is linked moreclosely to one economy than to another. Forexample, as a corporation engaged in internationaltransportation, British Airways would be classified asa resident of the United Kingdom because the

airline’s operations are governed mainly by the lawsof that country, and British Airways is more closelyassociated with the economy of the United Kingdomthan with other economies. The aircraft owned bythe company and operated in internationalcommerce would be attributed to British Airwaysand would therefore constitute a portion of the realassets of the United Kingdom.

104. How should the residence of equipment thatfrequently moves among various economic territoriesbe determined? For example, the rolling stock of therailroad enterprise operating in Nostaw, Daniherland,and Dromesia is regularly used in all threeeconomies. Should the rolling stock be attributed tothe head office in Nostaw? Or, for the periods thatthe rolling stock moves through Daniherland andDromesia, should the stock be attributed toenterprises to which residence in Daniherland andDromesia is ascribed? It is recommended thatcompilers consider such equipment to be operatedby an enterprise in the economy in which theactivity relating to that equipment occurs only if theequipment is accounted for separately by theoperator and is separately recognized by local taxand licensing authorities. Otherwise, the activityshould be attributed to the country of residence ofthe actual operator. It is unlikely that the actualoperator of equipment moving frequently betweenor among economies will maintain separate accountsfor each of the economies in which the equipmentoperates. Therefore, the economy of the actualoperator is, generally, also the economy to whichthe production resulting from the use of the mobileequipment is attributed. In the example of therailroad operating in three economies, the operatorof the mobile equipment would, for BOP purposes,most likely be the enterprise in Nostaw.

105. The treatment of mobile equipment operatingoutside the economy of the operator for a longperiod of time is subject to similar considerations.That is, compilers should consider the equipment tobe operated by an enterprise in the host economy ifthe equipment is accounted for separately by theoperator and separately recognized by local tax andlicensing authorities. Otherwise, the activity shouldbe attributed to the country of residence of theactual operator.

106. For example, an aircraft is operated by aresident of Cromania primarily within the borders ofEssendonia. For BOP purposes, operation of theaircraft is attributed to Essendonia if aircraft


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operations are separately accounted for andrecognized by Essendonian authorities as part of thatcountry’s capital stock. A notional enterprise inEssendonia must be created in respect of theownership of the aircraft used in the productionoutput of that economy. The actual operator, who isa resident of Cromania, is construed to have afinancial investment in the notional enterpriseoperating in Essendonia. Income earned from thisinvestment by the Cromanian owners should berecorded (net of depreciation) as investment income,and the depreciation should be recorded as awithdrawal of investment. (The treatment of mobileequipment is further discussed in paragraphs552–554 of chapter 9 of the Textbook. See alsoparagraphs 442–451 and 495–502 of the Balance ofPayments Compilation Guide.)

Leasing of Equipment

107. The rules described in the precedingparagraphs should be used whether the enterpriseoperating the equipment is using leased or ownedequipment. However, the leasing of mobile, or anyother, equipment raises an additional issue. Towhich economy should ownership, in a BOP sense,of that equipment be attributed? Attribution ofownership is important because transactions arerecorded in the balance of payments when thingsthat have economic value change ownership.

108. There are, in a broad sense, two types ofleases: financial leases and operational leases.Financial leases are those in which substantially allof the risks and benefits of ownership of an asset aretransferred from the lessor (legal owner) to thelessee. Financial leases are characterized byarrangements that provide for the recovery of all, orsubstantially all, of the cost of goods and forcarrying (finance) charges. Leases that are notclassed as financial leases are considered operationalleases.

Financial Leases

109. With regard to financial leases, it isrecommended in the BPM that a change ofownership of the good being leased be imputed atthe inception of the lease. In the balance ofpayments of the economy of the lessee, the entry forimports would be matched by an entry in thefinancial account for an increase in financialliabilities. The equipment would, of course, bevalued at market value. The lease payments contain

two elements: (1) interest on the outstanding liabilityand (2) repayments (amortization) of the liability.Upon termination of the lease, it may be necessaryto reverse the entries recorded at inception. In thebalance of payments of the lessee, the entries wouldthen consist of an export of goods (credit) and areduction in liabilities (debit). An example of afinancial leasing arrangement follows.

110. At the commencement of a lease, the marketvalue of equipment being leased is estimated to be1,000 units. Lease payments are due over nine yearsat an annual rate of 100 units. Ten percent of the100 units is estimated to be the interest elementinherent in the lease payments.4 The lease contractcalls for the return of the goods to the lessor at thetermination of the lease. In the first year, the BOPentries are:

Lessee’s Balance of Payments—Year 1

Credit Debit

Goods 1,000Investment income 10Loans 1,000 90Reserve assets (or other appropriate


In subsequent years (prior to the final year), theentries would be:

Lessee’s Balance of Payments—Years 2–8

Credit Debit

Investment income 10Loans 90Reserve assets (or other appropriate


111. At the end of the lease, the market value of theasset is estimated to be 300 units, and the outstandingloan would thus have to be revalued from 190 units(the difference between the original 1,000 units andtotal repayments of 810 units) to 300 units.5 In thebalance of payments, the full market value of theequipment (300 units) must be shown as an export.

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4This is a simple calculation of the interest. In practice, the calculation ofinterest in each period will be based on the outstanding liability during theperiod. By comparison with those for later years, higher interest payments(and lower repayments) will be due in earlier years.

5Such revaluations should be undertaken at regular intervals. Any unrealizedgain or loss in the value of the loan outstanding would be reflected in theinternational investment position but not in the balance of payments.However, if the lease contract specified that the lessor could purchase thegoods for a fixed value at the end of the lease and the fixed value was equalto the written-down value of the good, the lessee’s liability at any pointduring the lease would be the written-down value of the good. This resultmay seem to violate the market price principle; however, it is the lessee’sfinancial liability, which is not necessarily the same as the value of the goodbeing leased, that is being valued.

The reduction in loans accompanying the return ofthe equipment would also be 300 units. Hence, BOPentries for the final period would be:

Lessee’s Balance of Payments—Final Year

Credit Debit

Goods 300Loans 300

Operational Leases

112. Operational leases are treated straightforwardlyin the balance of payments. The lessor (legalowner) is deemed to be providing a service to thelessee (operator) in the form of the temporaryprovision of an asset; the value of that service isequal to the lease payments. For example, anenterprise located in Pokolbin hires an aircraftbelonging to an enterprise in Longa for operationscarried out primarily in Pokolbin. The transaction isclassified as a fee for a charter service; the producerof the charter service is Longa, and the productionof that service is attributed to Longa. In Pokolbin’sBOP statement, the following entries would bemade:

Charter fees debitReserve assets (or other appropriate financial

account item) credit

Registration of an Enterprise in More ThanOne Economy

113. Issues regarding the determination of residencemay also arise when an enterprise operating aircraft,ships, or fishing fleets entirely in internationalcommerce is jointly organized and owned by anumber of governments and, under speciallegislation, registered in more than one country. Forexample, the Scandinavian Airlines System (SAS) isjointly owned and operated by Norway, Sweden,and Denmark. Three-sevenths of the capital of SAS isheld by Sweden, and Denmark and Norway eachhold two-sevenths. SAS personnel are divided amongthe three countries in approximately the sameproportions. There are two methods of treating suchan enterprise. One is to treat the enterprise as aresident of all the participating countries. Enterprisetransactions are then attributed to the economies ofowners in proportion to shares owned in thefinancial capital of the enterprise. Three-sevenths ofcompany transactions are attributed to Sweden, andtwo-sevenths each are attributed to Denmark andNorway. If a resident of Sweden travels by SAS,three-sevenths of his fare represents a domestic

transaction, and four-sevenths represents aninternational transaction. A second method is to treatthe corporation as a resident of the economy inwhich headquarters are located and the premises ofthe corporation in other countries as branches (directinvestment enterprises) that are residents of thecountries in which they are located. On balance, thefirst method is preferred, but both treatments areconsistent with the general principles of the BPMand the 1993 SNA. The choice between treatmentsmay be made, with reference to consistent treatmentby partner countries, on the basis of statisticalconvenience. (Paragraphs 449–450 of the Balance ofPayments Compilation Guide provide additionalinformation on these treatments.)

Commercial Agencies

114. How should the resident status of commercialagencies be determined? Agencies transactingbusiness on behalf of nonresident principals shouldbe treated as resident producers in the economies inwhich the agencies are located. Services rendered byan agent to the enterprise that the agent representsshould be attributed to the economy in which theagent is a resident. Transactions conducted by anagent on behalf of a nonresident principal should,without exception, be attributed to the economy ofthe principal. For example, an exporter (a1) inDomestica engages an agent (b1) in Central Paradisoto sell a product to other enterprises (b2) in CentralParadiso. The transaction in commodities is betweenthe exporter (a1) and the other enterprises (b2); thetransaction in services is between the exporter (a1)and the agent (b1).

Installation Services

115. Sometimes the employees of an enterprise goabroad to install machinery or equipment that theenterprise has sold to residents of another country.The residency of such enterprises determineswhether the installation services are entered in thedomestic production accounts of the economy thathas sold the equipment or whether the services areentered in the accounts of the economy that haspurchased the equipment. As previously stated, thecrucial consideration for deciding the resident statusof an enterprise is whether the enterprise is engagedin a significant amount of production of goods andservices within the domestic territory of an economy.Key tests include whether a complete and separateset of accounts is maintained in respect of local


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activities and whether the operations are carried onover a long period of time.

116. For example, an enterprise located in theeconomy of Cromania sells equipment to theeconomy of Essendonia and sends employees toinstall the equipment in Essendonia. The work iscompleted in a period of less than a year, and thefee for installation amounts to 1,000 units. Inperforming the installation, the enterprise engageslocal labor for which it pays 100 units. Employeeswho are residents of Cromania spend 500 units onconsumption of goods and services in Essendonia.Because the task is completed in less than a year,the installation services are viewed as beingprovided by Cromania. These entries would bemade:

Essendonia’s Balance of PaymentsCredit Debit

Value of installation services 1,000Goods and services acquired by

nonresident workers (travel) 500Compensation of employees 100Reserve assets (or other appropriate


117. However, it could be assumed that installationtook more than a year to complete. The costamounted to 6,000 units—of which 3,000 units werepaid to local labor. Cromanian employees sent towork in Essendonia were paid 2,000 units in thecurrency of Essendonia. There were no other costsassociated with the provision, by the Cromanian firm,of installation services to the Essendonian firmpurchasing the services. Furthermore, it could beassumed that the Cromanian enterprise maintained aseparate set of accounts in respect of its operations inEssendonia. Under these assumptions, productionwould be allocated to a resident production unit inEssendonia, and entries recorded in Essendonia’sbalance of payments would differ from those recordedunder the assumptions listed in paragraph 116.

118. The creation of a resident production unit inEssendonia requires the recording of a financialinvestment relationship between the firm inCromania (the parent) and the resident unit that hasbeen created. The firm in Cromania receivesentrepreneurial income as a result of its investmentin Essendonia. The profit of the firm is 1,000 units,which are recorded as investment income. TheCromanian employees sent to Essendonia areregarded as residents of Essendonia by virtue of thelength of stay. These employees spend 900 units inEssendonia and save 1,100 units, which they deposit

with a commercial bank in Essendonia. Thesetransactions are domestic to Essendonia and aretherefore not recorded in the balance of payments.Upon completion of their work, the Cromaniannationals return to their home economy and thuschange their country of residence. The changerequires that they be treated, for BOP purposes, asmigrants. They repatriate their savings to Cromaniain the form of foreign exchange. The BOP entryshowing the decrease (credit) in Essendonia’sreserve assets, which is assumed to be the result of the repatriation of savings, is offset by acounterpart entry in migrants’ transfers. The BOPentries would be:

Essendonia’s Balance of Payments

Credit Debit

Investment income 1,000Migrants’ transfers 1,100Reserve assets (or other appropriate

financial account item) 1,0001,100

119. An entry for migrants’ transfers is alwaysmade, regardless of whether there is an actualtransfer of funds, when an individual shifts hisresidence. For example, the individual workers inthe example in paragraph 118 may choose not torepatriate their funds from Essendonia. Theirdeposits with commercial banks in Essendoniawould then be recorded as an increase inEssendonia’s external liabilities at the time of theworkers’ migration rather than as a decrease inEssendonia’s reserve assets. In either case, a contraentry is made in migrants’ transfers. The contraentry constitutes the offset to the transfer of networth occasioned by the migration of the individual.

Construction Enterprises

120. Determination of residence for enterprisesengaged in construction activity is oftenproblematical for BOP compilers. However, therules governing determination of residence for otherenterprises also apply to construction enterprises.The initial determination to be made is the economyto which production should be attributed. Once thisdecision is made, the relevant BOP entries can bedetermined. Two examples may help to explain thetreatment of enterprises engaged in constructionactivity. (For additional information on the treatmentof construction activity, see paragraphs 340–342 ofchapter 5 and paragraphs 545–549 of chapter 9 inthe Textbook and paragraphs 452–455 of theBalance of Payments Compilation Guide.)

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121. An enterprise located in Clintonstan is awardeda construction contract worth 10,000 units for aproject located in the economy of Algornia. Thecontract is implemented over a six-month period,and the following expenditures are incurred by theenterprise:

Materials purchased in Algornia 5,000Wages paid to residents of Clintonstan 2,000Wages paid to residents of Algornia 1,000Taxes paid to government of Algornia 1,000

122. Because the project is completed in less thanone year, production should be attributed to aresident of Clintonstan. Accordingly the followingentries would be required:

Algornia’s Balance of Payments

Credit Debit

Other business services 5,000Construction services 10,000Compensation of employees 1,000Transfers (taxes) 1,000Reserve assets (or other appropriate

financial account item) 3,000

123. An enterprise from Nostaw is awarded aconstruction contract worth 50,000 units for aproject located in Coonawarra. The contract isimplemented over a two-year period. Because of the long-term nature of the project, the enterprisesets up a site office in Coonawarra and maintains acomplete set of accounts for its operations in thateconomy. To implement construction, the enterprise in Nostaw sends machinery worth 20,000 units to Coonawarra. At the end of the firstyear, the work in progress is valued at 22,000 units.This amount is paid by the Coonawarran client and used to cover expenditures incurred inCoonawarra. The balance is remitted to Nostaw. Atthe end of the second year, the remaining 28,000units are paid by the client. The balance afterpayment for expenditures in the second year isremitted to Nostaw. Expenditures incurred for theproject are:

Year 1 Year 2

Value of construction work 22,000 28,000Materials purchased in Coonawarra 4,000 8,000Wages paid to residents of

Coonawarra 6,000 3,000Wages paid to residents of Nostaw* 3,000 2,000Depreciation on machinery 2,000 1,000Taxes paid to government of

Coonawarra 1,000 4,000______ ______Net profit 6,000 10,000

*Wages paid to Nostaw residents who work on the project for short (lessthan one year) periods of time

124. In the example in paragraph 123, criteria forattributing production to a resident of Coonawarraare satisfied. The following entries would be made:

Coonawarra’s Balance of Payments—Year 1

Credit Debit

Goods (machinery) 20,000Compensation of employees 3,000Investment income 6,000Direct investment—provision of

machinery 20,000Direct investment—depreciation 2,000Reserve assets (or other appropriate


Coonawarra’s Balance of Payments—Year 2

Credit Debit

Goods (machinery) 17,000Compensation of employees 2,000Investment income 10,000Direct investment—return of

machinery 17,000Direct investment—depreciation 1,000Reserve assets (or other appropriate


Nonprofit Institutions

125. Like enterprises, nonprofit bodies are residententities of the economic territories in which thenonprofit bodies are located or conduct their affairs.Nonprofit bodies are generally engaged in furnishingeducational, health, cultural, recreational, and othersocial and community services free of charge or atsales prices that do not fully cover the costs ofproduction. Examples of nonprofit bodies are suchentities as private hospitals, churches, culturalsocieties, foundations, universities, colleges, and theRed Cross.

126. In practice, the residence of the vast majorityof nonprofit institutions may be determined withoutambiguity. However, when such an institution isengaged in charity or relief work on aninternational scale, it is necessary to specify theresidence of any branches the institution maymaintain in individual countries. In this case, it isappropriate to use the guideline of length of time todetermine the residence of such branches. If anonprofit institution maintains a branch, or similarunit, for a year or more in a particular country, thatbranch should be considered a host countryresident that is financed largely or entirely bytransfers from abroad.


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Government

127. This chapter concludes with an examination ofthe economic entities classified under generalgovernment. What is the scope of the residentgeneral government sector? According to the BPM,the general government agencies of an economyinclude all central, state, and local governmentdepartments, establishments, and bodies located inthe economic territory and all general governmentembassies, consulates, entities, and militaryestablishments located elsewhere.

128. General government agencies comprise publicauthorities not classified as enterprises or as privatenonprofit bodies serving households. Governmentalagencies engaged in enterprise activity (for example,a government telecommunications department,postal authorities, or a government port authority)are not considered part of the general governmentsector. Classified in the general government sectorare:

bodies with such governmental functions asadministration, defense, regulation of the publicorder, promotion of economic growth and welfare,technological development, and the provision ofeducation, health, cultural, recreational, and othersocial and community services rendered to thepublic free of charge or at sales prices that do notfully cover the costs of production;

other nonprofit organizations that are wholly, ormainly, financed and controlled by the government;

agencies for social security arrangements that areimposed, controlled, or financed by the government;

public saving and lending authorities that arefinancially integrated with a government.

129. A useful criterion for distinguishing betweenagencies to be classified in the general governmentsector and in the enterprise sector is whether theagency’s product is characteristically sold in themarket. If so, there is a strong case for including theagency in the enterprise sector.

130. Embassies and similar institutions are treated asresidents of the economies they represent—ratherthan as residents of the economic territories in whichthey are physically situated—because of the affinitybetween such embassies and institutions and thegovernments of countries they represent. Forexample, the French embassy in the United States islinked much more closely to the French government

than to the U.S. government. Therefore, entities suchas embassies, consulates, military establishments, andother bodies of general government located abroadare considered extraterritorial and not parts of theeconomies in which the entities are physicallysituated.

131. As these embassies and similar institutions areconsidered resident entities of the countriesrepresented, embassy transactions with residents ofthe economies in which the embassies are located(as well as embassy transactions with othereconomies) constitute a portion of the BOPtransactions of the embassies’ countries with the restof the world. For instance, the construction ofembassies, structures, and other works inextraterritorial enclaves by resident producers of theeconomy in which the enclaves are located wouldform part of the production and exports of the hosteconomy. Wages and salaries paid to locallyrecruited staff of foreign diplomatic, military, andother establishments are also credits in the balanceof payments of the host economy and debits in thebalance of payments of the country represented bythe embassy or other establishment.

132. A hypothetical case may be used as anillustration. For the Nigerian embassy in France, theNigerian government arranges for a Frenchconstruction firm to construct a building worth 20 million units. The building is completed duringthe reporting period, and payment is made in U.S.dollars. As the Nigerian embassy is treated as aresident of Nigeria, the construction of the embassygives rise to BOP transactions for both France andNigeria. Accordingly, in the French balance ofpayments, the value of the construction work isshown as a credit (that is, an export of theproduction of the construction industry in France).The increase in French holdings of U.S. dollars isshown as a debit. Thus, France’s balance ofpayments shows the following entries:

French Balance of Payments

Credit Debit

Value of construction work 20U.S. dollar holdings 20

133. Conversely, in the Nigerian balance ofpayments, the acquisition of the embassy building isshown as a debit reflecting the increase—which hasbeen brought about not through domesticproduction but through an import—in the stock offixed capital assets owned by Nigeria. The financial

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counterpart to the increase in real assets (debit) isshown as a decrease in holdings of U.S. dollars(credit).

Nigerian Balance of Payments

Credit Debit

Acquisition of embassy building 20U.S. dollar holdings 20

Similar BOP entries would be made if Nigeriapurchased an existing building. For Nigeria, thetransaction would still represent capital formationand, for France, negative capital formation.

134. While the acquisition of an embassy building isrecorded straightforwardly in the balance ofpayments, there is a variation in principle forrecording the purchase of land by a foreigngovernment when an embassy building is to beerected on the land or the land is purchased forsome other general government use. Under theconventions of the BPM and the 1993 SNA, land isalways deemed to be owned by a resident of thecountry in which the land is located. However, whenland is purchased by a foreign embassy or a similarinstitution, the land is considered to shift from oneeconomic territory to another. The land is thenlocated in the economic territory of the country ofthe embassy and is no longer part of the economicterritory of the host country. In these relatively rareinstances, a transaction in land is recorded as takingplace between residents and nonresidents. Thistransaction is shown, in the capital account of the balance of payments, as the exchange of a non-produced, nonfinancial asset. The sale ofembassy and similar land is treated in a like manner.In the previous example, when the Nigeriangovernment bought a parcel of land (worthapproximately US$5 million) for the construction of an embassy, that government was deemed tohave purchased a non-produced, nonfinancial assetfrom France. Entries for the transaction would beshown as:

Nigerian Balance of Payments

Credit Debit

Non-produced, nonfinancial assets 5U.S. dollar holdings 5

In the French balance of payments, the same entrieswould be made with reversed sign.

135. While the previously stated recommendationsalways apply in principle, the purchase of anexisting building will, in practice, be recorded at its

total cost (including cost of land). The entiretransaction should be classed as the acquisition of aproduced asset and recorded in the currentaccount.

136. It may also be useful to consider the Nigerianembassy’s other transactions in France. When theembassy recruits residents of France as typists,chauffeurs, etc., the salaries and wages paid to suchstaff constitute part of the balance of payments ofboth countries. The salaries and wages received areshown as a credit item (export of labor) in theFrench balance of payments and as a debit item(import of labor) in the Nigerian balance ofpayments.

137. In some ways, international organizationsreceive the same BOP treatment as embassies.International bodies that cannot be classed asenterprises are treated as nonresidents in the balanceof payments. Institutions in this category comprisemost political, administrative, economic, social, orfinancial institutions in which the members aregovernments. Examples of such international bodiesare the United Nations and its specialized agencies(such as the Food and Agriculture Organization), theInternational Labor Organization, the World Bank,the International Monetary Fund, and the regionaleconomic commissions. Many regional organizations(for example, the African Development Bank, theCentral American Clearing House, the institutions ofthe European Community, and certain intergovern-mental commodity organizations) must be treated inthe same way.

138. To be classified as nonresidents, internationalbodies must be intergovernmental organizations andmust not be engaged primarily in enterprise activity.For example, although the International Tin Councilis intergovernmental in membership, the councilnevertheless functions as an enterprise. Among otherthings, the council is concerned with pricestabilization for tin through the operations of abuffer stock. (For rules governing the resident statusof enterprises, refer to paragraphs 92–97.)

139. From the standpoints of the economies inwhich international and regional bodies are located,such bodies should be given the same statisticaltreatment as foreign embassies and other agencies offoreign governments. (However, employees of thesebodies are residents of national economies and not“residents” of international organizations.)Transactions of international organizations with theeconomies in which the organizations are physically


24

situated constitute BOP transactions. However,unlike embassies (which are parts of the economiesof the countries represented), international andregional bodies are not part of any nationaleconomy. Therefore, any worldwide balance ofpayments system is incomplete without estimates ofthe transactions of international organizations.

140. Another category is that of regional centralbanks—international financial institutions that act ascommon central banks for groups of membercountries. The official national offices of a regional

central bank are resident units in the economy inwhich the offices are located. The financial assetsand liabilities of a regional central bank should beallocated among the national offices in proportion tothe claims that member governments have on thebank’s collective assets.6

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6This recommendation could be a source of asymmetry. The partnercountries to transactions involving regional central banks are likely, in theirBOP statements, to allocate these transactions to notional countriesrepresenting regional central banks rather than apportioning thetransactions to member countries of regional central banks.

141. BOP statistics are arranged within a coherentstructure to facilitate analysis, which is undertakenfor many reasons—including policy formulation,policy monitoring, projections, studies of thebehavior of real and financial markets, and bilateraland multilateral comparisons. The list of standardcomponents contained in the BPM provides aninternational standard for the structural system withinwhich BOP statistics are compiled. This chapterfocuses on classifying international transactionsaccording to the system of standard components.

142. The list of BOP standard components, whichappears at the end of this chapter, reflectsconceptual and practical considerations. Theopinions of national BOP experts, generally acceptedviews of BOP analysis, and structures andclassifications used in other international statisticalsystems (such as the national accounts) influencedthe development of the list.

143. The selection of standard components wasbased on a number of considerations. Those giventhe greatest weight were:

Components should separately identify transactionsthat show distinctive economic behavior. Forexample, financial transactions are separated fromtransactions in real assets as the two types oftransactions are generally undertaken forfundamentally different economic purposes.Conversely, transactions in bonds and transactions indebentures are grouped together in the samecomponent as these two types of financialinstruments are very similar.

Each standard component should be significant—interms of the absolute size of transactions or becausethe transactions exhibit unusual variability—for anumber of countries. For example, travel is asignificant element of the balance of payments ofmany countries and, accordingly, travel is one of thestandard components. On the other hand,international transactions in life insurance areinsignificant for most countries; therefore, thesetransactions are recorded under the broaderinsurance services item.

Information about a standard component should beobtainable without undue difficulty. The desirability,in terms of other considerations, of collectingstatistics for an item should not be the sole reasonfor its inclusion.

The item should be required for other purposes (suchas incorporation into, or reconciliation with, thenational accounts). For example, sectoralclassifications applied in the financial account arenecessary to satisfy national accounts requirementsfor financial accounts for each domestic sector.

The list of standard components should not beunduly long. While some countries would becapable of providing BOP information for a moreextensive list of standard components, countries thatare less statistically advanced would find it difficultto meet IMF reporting requirements if the list wereexpanded.

To the extent practicable, standard componentsshould be in concordance with other internationalstatistical systems. For example, the standardcomponents in the current account of the balanceof payments are designed to harmonize as fully aspossible with the structure of the production andincome accounts of the national accounts.

144. The list of BOP standard components shouldnot constrain countries from compiling andpublishing additional information of nationalimportance. Most countries, for example, publishdata on international trade in goods in addition tothat required in the standard components.

Structural Overview of the StandardComponents

145. The standard components are grouped undertwo major headings: the current account and thecapital and financial account. The current accountis further subdivided into three broad categories:goods and services (which is subdivided intogoods and servies), income, and currenttransfers. The capital and financial accountincludes, in the capital account, capital transfers

26

III. Classifying Balance of Payments Transactions

and transactions (purchases/sales) in an economy’snon-produced, nonfinancial assets (such as patentsand copyrights) and, in the financial account,transactions in an economy’s external financial assetsand liabilities.

146. The BPM describes transactions to be recordedas specific items under major BOP standardcomponents and subcomponents. In this Textbook,BPM definitions are examined and illustrated.

Goods, Services, and Income

147. The standard components covering goods,services, and income are designed to reflect theprovision or acquisition of real resources by thereporting economy to or from the rest of the world.Flows recorded as credits measure that portion ofthe reporting economy’s domestic product providedto other economies (exports of goods and services)as well as the reporting economy’s factors ofproduction (compensation of employees andinvestment income) used in the productive processin the rest of the world. Flows recorded as debitsmeasure acquisition of the rest of the world’sdomestic product (imports of goods and services inthe reporting economy’s balance of payments) andthe reporting economy’s use of nonresident factorsof production. According to the BPM, transactions ingoods, services, and income should be presented ona gross basis; that is, debit entries are shownseparately from credit entries.

148. Effective compilation of data on goods,services, and income for the balance of paymentsrequires classification as well as definition. While itis usually important to know the total value of aneconomy’s exports, any meaningful analysis of year-to-year changes in the export total will requiredisaggregation. Total goods, services, and incomerepresent an aggregate of many different elementsresponding to widely varying economic influences,and analysis of the separate movements of the majorelements is obviously necessary. However, thebalance of payments would become most unwieldyif every commodity traded, every service performed,and every type of income receivable were listed asseparate components. Goods, services, and incomemust therefore be classified—that is, grouped intocategories containing items that behave similarly inresponse to a particular stimulus. Also, it may benecessary to combine elements that are not entirelysimilar to prevent the creation of an unwieldy BOPstatement. For this reason, flows of goods, services,

and income that behave with only a certain degreeof similarity may be classified in the same standardcomponent or subgroup. Furthermore, classificationon the basis of economic criteria must often bemodified for statistical convenience. Transactionstypically recorded together in source data may haveto be classified in the same standard component.

149. The goods and services and incomecomponents cover three types of transactions: (1) changes in ownership—which can be legal orimputed—of goods, (2) performance of services, and(3) accrual of income. In spite of the cleartheoretical distinction between commodities andservices, it is sometimes difficult in practice to makethe classification. For example, how should the saleof electricity be treated? Are Swiss generating plantsthat transmit power to France providing goods orservices? Electricity may be considered a servicebecause no physical commodity changes hands.However, gas, which has physical characteristics andis generally considered a commodity, is included ingoods. Should electric power, by analogy, beincluded in goods? (In fact, electric power isclassified under goods in the BOP standardcomponents.)

150. The general merchandise item, which—formost countries—represents the majority oftransactions in goods, is a prime example of thegrouping of transactions that are not all similar.Some goods are less durable than others. Somegoods are so perishable that they must be soldimmediately or be lost; other goods may be storedto await stronger demand. Exports and imports offoodstuffs follow patterns of production and demandthat differ greatly from those of capital goods.

151. The classification of all general merchandise inone item is purely the result of practicalconsiderations. In the first place, almost everycountry is able to provide—as part of itsinternational trade statistics—a detailed commoditybreakdown, and these data will generally meet therequirements of those wishing to analyze trademovements on a commodity-by-commodity basis.To facilitate studies that take into account bothinternational trade statistics and the goodscomponent of the balance of payments, the Balanceof Payments Statistics Yearbook published by theIMF customarily contains, for each country, areconciliation of the BOP trade component withinternational trade statistics. In the second place, astandardized analysis of goods is almost an

CHAPTER III

27

impossibility. To facilitate internationalcomparability, the standard components of thebalance of payments were selected on the basis ofrelevance in most, rather than a few, countries.Thus, while rice may be an important export andwarrant separate mention in the BOP statement ofThailand, rice would not be prominent in the BOPstatement of Iceland. Only at the level of totalexports can the trade in goods of the two countriesbe meaningfully compared.

152. For reasons such as these, the generalmerchandise item covers most of an economy’sexports and imports of goods. However, some of aneconomy’s transactions in goods should beseparately identified (for example, transactions innonmonetary gold and goods for processing). Therationale for separate identification (which enhancesthe analytic usefulness of the standard components)of these items is explained in chapter 4.

153. Transactions in services are similar totransactions in goods in the sense that both areoutputs from the process of production and bothare consumed—on an intermediate (input for furtherproduction) or final basis. However, a close—if not immediate—relationship generally existsbetween the production and consumption ofservices. Once produced, services generally cannotbe stored for future consumption. The BOP standardcomponents classification of services groupstransactions in services by nature of productionrather than by type of consumer. For example, afinancial service provided to the insurance industryis classified as a financial, rather than an insurance,service. However, services and goods acquired bytravelers are classified under services-travel ratherthan the produced form of the services or goods.For example, if a traveler acquires educationalservices while he is in an economy other than theone in which he is a resident, the transaction isclassified as a travel, rather than an educational,service.

154. Whereas goods and services are outputs of theprocess of production, transactions involving use ofthe factors of production can only be inputs for theproduction process. For this reason, in the nationalaccounts, a fundamental distinction is made between(1) the production of goods and services and (2) theuse of the factors of production (income). Thisdistinction is important in the BOP standardcomponents in which income transactions areseparately identified.

Current Transfers

155. The BOP current account includes currenttransfers as well as transactions in real resources.Transfers are offsetting entries to the provision,without a quid pro quo, of real or financialresources. Transfers are classified as current orcapital. Current transfers offset the provision ofreal or financial resources that are immediatelyconsumed or those that are consumed shortly afterthe transfer is made. For example, a cash grant froma nonresident is used to buy wheat for immediateconsumption. The grant is a current transfer asthe provision of cash and the consumption of wheatare closely related.

156. The relationship between current transfersand consumption is the basis for including them inthe current account. Current transfers, alongwith transactions in real resources, have a direct andimmediate impact on an economy’s opportunities forconsumption in any specific period.

157. Credit entries recorded under currenttransfers reflect offsetting entries to the compilingeconomy’s receipt, without a quid pro quo, of realor financial resources. Debit entries are offsets to thecompiling economy’s provision, without a quid proquo, of real or financial resources. As withtransactions in goods and services and in income,gross credit and debit entries are separately shownfor current transfers in the standard componentsof the balance of payments.

Capital Account

158. The capital account, which is a subdivisionof the capital and financial account, includes aneconomy’s transactions with nonresidents in non-produced, nonfinancial assets (such as patents,copyrights, and licenses) and in capital transfers.These transactions are separated from transactionsrecorded in the current account because capitalaccount transactions are not directly related to theprocesses of production and consumption. Thecapital account of the balance of payments issynonymous with the capital account of the nationalaccounts. Gross credit and gross debit entries shouldbe shown separately for capital account transactions.

159. There is an important distinction between (1) non-produced, nonfinancial assets and (2) services produced from these assets. Theseservices, which are generically called royalties andlicensing fees, are recorded (along with all other

CLASSIFYING BALANCE OF PAYMENTS TRANSACTIONS

28

transactions in services involving residents andnonresidents) in the services component of thecurrent account. For example, the copyright toBeatles songs is a non-produced, nonfinancial asset,and transactions in this asset are recorded in thecapital account. However, royalty payments madeto the owner of the copyright reflect productiveoutput from the use of the asset. In other words, theroyalties are payment for a service provided by theowner of the copyright to the user of the songs.

160. Offsets to transactions in capital transfers canbe recorded in the current account or in the capitalor financial components of the capital andfinancial account. A transfer is classified as capitalif the transfer involves the provision of a capitalasset or if the transfer involves the provision of afinancial asset and that financial asset is linked to theacquisition or disposal of a capital asset. A capitalasset is any nonfinancial asset that can produce astream of services over time. For example, aircraftare capital assets because aircraft can providepassenger services for many years.

Financial Account

161. Transactions in the compiling economy’sfinancial assets and liabilities are recorded in thefinancial account, which is a subdivision of thecapital and financial account. The financialaccount shows how an economy’s BOP transactionsare financed. If an economy’s savings exceed itsinvestment, the surplus must be reflected in netfinancial outflow or net financial investment in therest of the world. This financial outflow finances, inturn, the acquisition of nonfinancial resources byother economies. If an economy’s savings are lessthan its investment, the economy will be a netimporter of nonfinancial assets from the rest of theworld. These net imports must be financed by a netfinancial inflow from the rest of the world.

162. Financial account transactions are classified by(1) functional type of investment (direct investment,portfolio investment, other investment, and reserveassets); (2) assets and liabilities or, in the case of

direct investment, direction of investment; (3) type ofinstrument (for example, equity, debt securities, andloans); and, in some cases, by (4) domestic sectorand (5) original contractual maturity. The similarityof this classification to the one used for theinvestment income component of the currentaccount permits consistency of analysis betweenthese closely related BOP components.

163. Users of BOP statistics are generally interestedin net, rather than gross, financial accounttransactions. For this reason, it is recommended inthe BPM that—for the most part—financial accountitems be shown as net credit (financial inflow) or netdebit (financial outflow) entries.

International Investment Position

164. The classification scheme presented in the BPMfor the IIP statement, which shows an economy’sstock of external financial assets and liabilities at aparticular point in time, is similar to the classificationscheme used for the financial account and theinvestment income portion of the current account.This similarity of classification reflects the closerelationship between the IIP statement and these twocomponents of the balance of payments.

165. It is suggested in the BPM that the IIPstatement be presented in the form of areconciliation between positions existing at twopoints in time. Changes occurring over time in aneconomy’s international investment position can bethe result of (1) transactions that are recorded in thefinancial account of the balance of payments or(2) other changes, such as changes in prices ofassets and liabilities or changes in the exchange rateof the unit of account vis-à-vis the currency in whichthe assets and liabilities are denominated. Unilateralactions (such as the monetization of gold and debtwrite-offs) that create or destroy financial assets areanother cause of non-transaction changes in stocksof financial assets and liabilities. Further informationon the reconciliation between the balance ofpayments and the international investment positioncan be found in paragraphs 690–702 of chapter 13.

CHAPTER III

29

Credit Debit

1. Current AccountA. Goods and services.

a. Goods1. General merchandise2. Goods for processing3. Repairs on goods4. Goods procured in ports by carriers5. Nonmonetary gold

5.1 Held as a store of value5.2 Other

1. A. b. Services1. Transportation

1.1 Sea transport1.1.1 Passenger1.1.2 Freight1.1.3 Other

1.2 Air transport1.2.1 Passenger1.2.2 Freight1.2.3 Other

1.3 Other transport1.3.1 Passenger1.3.2 Freight1.3.3 Other

2. Travel2.1 Business2.2 Personal*

3. Communications services4. Construction services5. Insurance services**6. Financial services7. Computer and information services8. Royalties and license fees9. Other business services

9.1 Merchanting and other trade-related services9.2 Operational leasing services9.3 Miscellaneous business, professional, and technical services*

10. Personal, cultural, and recreational services10.1 Audiovisual and related services10.2 Other personal, cultural, and recreational services

11. Government services n.i.e.

1. B. Income1. Compensation of employees2. Investment income

2.1 Direct investment2.1.1 Income on equity

2.1.1.1 Dividends and distributed branch profits***2.1.1.2 Reinvested earnings and undistributed branch profits***

2.1.2 Income on debt (interest)2.2 Portfolio investment

2.2.1 Income on equity (dividends)2.2.2 Income on debt (interest)

2.2.2.1 Bonds and notes2.2.2.2 Money market instruments and financial derivatives

2.3 Other investment


30

***See Supplementary Information table on page 00 for components.***Memorandum items: 5.1 Gross premiums

5.2 Gross claims

***If distributed branch profits are not identified, all branch profits areconsidered to be distributed.

Standard Components of the Balance of Payments

2. C. Current transfers1. General government2. Other sectors

2.1 Workers’ remittances2.2 Other transfers

2. Capital and Financial AccountA. Capital account

1. Capital transfers1.1 General government

1.1.1 Debt forgiveness1.1.2 Other

1.2 Other sectors1.2.1 Migrants’ transfers1.2.2 Debt forgiveness1.2.3 Other

2. Acquisition/disposal of non-produced, nonfinancial assets

2. B. Financial account1. Direct investment

1.1 Abroad1.1.1 Equity capital

1.1.1.1 Claims on affiliated enterprises1.1.1.2 Liabilities to affiliated enterprises

1.1.2 Reinvested earnings1.1.3 Other capital

1.1.3.1 Claims on affiliated enterprises1.1.3.2 Liabilities to affiliated enterprises

1.2 In reporting economy1.2.1 Equity capital

1.2.1.1 Claims on direct investors1.2.1.2 Liabilities to direct investors

1.2.2 Reinvested earnings1.2.3 Other capital

1.2.3.1 Claims on direct investors1.2.3.2 Liabilities to direct investors

2. Portfolio investment2.1 Assets

2.1.1 Equity securities2.1.1.1 Monetary authorities2.1.1.2 General government2.1.1.3 Banks2.1.1.4 Other sectors

2.1.2 Debt securities2.1.2.1 Bonds and notes

2.1.2.1.1 Monetary authorities2.1.2.1.2 General government2.1.2.1.3 Banks2.1.2.1.4 Other sectors

2.1.2.2 Money market instruments2.1.2.2.1 Monetary authorities2.1.2.2.2 General government2.1.2.2.3 Banks2.1.2.2.4 Other sectors

2.1.2.3 Financial derivatives2.1.2.3.1 Monetary authorities2.1.2.3.2 General government2.1.2.3.3 Banks2.1.2.3.4 Other sectors

CHAPTER III

31

Standard Components of the Balance of Payments (continued)

Credit Debit

2.2 Liabilities2.2.1 Equity securities

2.2.1.1 Banks2.2.1.2 Other sectors

2.2.2 Debt securities2.2.2.1 Bonds and notes

2.2.2.1.1 Monetary authorities2.2.2.1.2 General government2.2.2.1.3 Banks2.2.2.1.4 Other sectors

2.2.2.2 Money market instruments2.2.2.2.1 Monetary authorities2.2.2.2.2 General government2.2.2.2.3 Banks2.2.2.2.4 Other sectors

2.2.2.3 Financial derivatives2.2.2.3.1 Banks2.2.2.3.2 Other sectors

3. Other investment3.1 Assets

3.1.1 Trade credits3.1.1.1 General government

3.1.1.1.1 Long-term3.1.1.1.2 Short-term

3.1.1.2 Other sectors3.1.1.2.1 Long-term3.1.1.2.2 Short-term

3.1.2 Loans3.1.2.1 Monetary authorities


3.1.2.2 General government3.1.2.2.1 Long-term3.1.2.2.2 Short-term

3.1.2.3 Banks3.1.2.3.1 Long-term3.1.2.3.2 Short-term


3.1.3 Currency and deposits3.1.3.1 Monetary authorities3.1.3.2 General government3.1.3.3 Banks3.1.3.4 Other sectors

3.1.4 Other assets3.1.4.1 Monetary authorities






32

Standard Components of the Balance of Payments (continued)

Credit Debit

3.2 Liabilities3.2.1 Trade credits



3.2.2 Loans3.2.2.1 Monetary authorities

3.2.2.1.1 Use of Fund credit and loans from the Fund3.2.2.1.2 Other long-term3.2.2.1.3 Short-term




3.2.3 Currency and deposits3.2.3.1 Monetary authorities3.2.3.2 Banks

3.2.4 Other liabilities3.2.4.1 Monetary authorities





4. Reserve assets4.1 Monetary gold4.3 Reserve position in the Fund4.4 Foreign exchange

4.4.1 Currency and deposits4.4.1.1 With monetary authorities4.4.1.2 With banks

4.4.2 Securities4.4.2.1 Equities4.4.2.2 Bonds and notes4.4.2.3 Money market instruments and financial derivatives

4.5 Other claims

CHAPTER III

33

Standard Components of the Balance of Payments (concluded)

Credit Debit

1. Liabilities constituting foreign authorities’ reserves1.1 Bonds and other securities

1.1.1 Monetary authorities1.1.2 General government1.1.3 Banks1.1.4 Other sectors

1.2 Deposits1.2.1 Monetary authorities1.2.2 Banks

1.3 Other liabilities1.3.1 Monetary authorities1.3.2 General government1.3.3 Banks1.3.4 Other sectors

2. Exceptional financing transactions2.1 Transfers

2.1.1 Debt forgiveness2.1.2 Other intergovernmental grants2.1.3 Grants received from Fund subsidy accounts

2.2 Direct investment2.2.1 Investment associated with debt reduction2.2.2 Other

2.3 Portfolio investment: borrowing by authorities or other sectors on authorities’ behalf—liabilities*2.4 Other investment—liabilities*

2.4.1 Drawings on new loans by authorities or other sectors on authorities’ behalf2.4.2 Rescheduling of existing debt2.4.3 Accumulation of arrears

2.4.3.1 Principal on short-term debt2.4.3.2 Principal on long-term debt2.4.3.3 Original interest2.4.3.4 Penalty interest

2.4.4 Repayments of arrears2.4.4.1 Principal2.4.4.2 Interest

2.4.5 Rescheduling of arrears2.4.5.1 Principal2.4.5.2 Interest

2.4.6 Cancellation of arrears2.4.6.1 Principal2.4.6.2 Interest

3. Other transactions3.1 Portfolio investment income


3.2 Other (than direct investment) income3.2.1 Monetary authorities3.2.2 General government3.2.3 Banks3.2.4 Other sectors

3.3 Other investment (liabilities)3.3.1 Drawings on long-term trade credits3.3.2 Repayments of long-term trade credits3.3.3 Drawings on long-term loans3.3.4 Repayments of long-term loans


34

Selected Supplementary Information

*Specify sector involved and standard component in which the item is included.

4. Services sub-items4.1 Travel (personal)

4.1.1 Health-related4.1.2 Education-related4.1.3 Other

4.2 Miscellaneous business, professional, and technical services4.2.1 Legal, accounting, management consulting, and public relations4.2.2 Advertising, market research, and public opinion polling4.2.3 Research and development4.2.4 Architectural, engineering, and other technical services4.2.5 Agricultural, mining, and on-site processing4.2.6 Other

CHAPTER III

35

Selected Supplementary Information (concluded)

A. Assets1. Direct investment abroad*

1.1 Equity capital and reinvested earnings1.1.1 Claims on affiliated enterprises1.1.2 Liabilities to affiliated enterprises

1.2 Other capital1.2.1 Claims on affiliated enterprises1.2.2 Liabilities to affiliated enterprises

2. Portfolio investment2.1 Equity securities


2.2 Debt securities2.2.1 Bonds and notes

2.2.1.1 Monetary authorities2.2.1.2 General government2.2.1.3 Banks2.2.1.4 Other sectors

2.2.2 Money market instruments2.2.2.1 Monetary authorities2.2.2.2 General government2.2.2.3 Banks2.2.2.4 Other sectors

2.2.3 Financial derivatives2.2.3.1 Monetary authorities2.2.3.2 General government2.2.3.3 Banks2.2.3.4 Other sectors

3. Other investment3.1 Trade credits

3.1.1 General government3.1.1.1 Long-term3.1.1.2 Short-term

3.1.2 Other sectors3.1.2.1 Long-term3.1.2.2 Short-term

3.2 Loans3.2.1 Monetary authorities

3.2.1.1 Long-term3.2.1.2 Short-term


3.2.3 Banks3.2.3.1 Long-term3.2.3.2 Short-term



36

Standard Components of the International Investment Position

Changes in Position Reflecting _______________________________________

Position at Exchange Other PositionBeginning Trans- Price Rate Adjust- at Endof Year actions Changes Changes ments of Year

*Because direct investment is classified primarily on a directional basis—abroad under the heading Assets and in the reporting economy under the headingLiabilities—claim/liability breakdowns are shown for the components of each, although these sub-items do not strictly conform to the asset and liabilityheadings.

3.3 Currency and deposits3.3.1 Monetary authorities3.3.2 General government3.3.3 Banks3.3.4 Other sectors

3.4 Other assets3.4.1 Monetary authorities





4. Reserve assets4.1 Monetary gold4.2 Special drawing rights4.3 Reserve position in the Fund 4.4 Foreign exchange

4.4.1 Currency and deposits4.4.1.1 With monetary authorities4.4.1.2 With banks

4.4.2 Securities4.4.2.1 Equities4.4.2.2 Bonds and notes4.4.2.3 Money market instruments and financial derivatives

4.5 Other claims

B. Liabilities1. Direct investment in reporting economy*

1.1 Equity capital and reinvested earnings1.1.1 Claims on direct investors1.1.2 Liabilities to direct investors

1.2 Other capital1.2.1 Claims on direct investors1.2.2 Liabilities to direct investors

2. Portfolio investment2.1 Equity securities

2.1.1 Banks2.1.2 Other sectors

2.2 Debt securities2.2.1 Bonds and notes

2.2.1.1 Monetary authorities2.2.1.2 General government2.2.1.3 Banks2.2.1.4 Other sectors

CHAPTER III

37

Standard Components of the International Investment Position (continued)



*Because direct investment is classified primarily on a directional basis—abroad under the heading Assets and in the reporting economy under the headingLiabilities—claim/liability breakdowns are shown for the components of each, although these sub-items do not strictly conform to the asset and liabilityheadings.

2.2.2 Money market instruments2.2.2.1 Monetary authorities2.2.2.2 General government2.2.2.3 Banks2.2.2.4 Other sectors

2.2.3 Financial derivatives2.2.3.1 Monetary authorities2.2.3.2 General government2.2.3.3 Banks2.2.3.4 Other sectors

3. Other investment3.1 Trade credits



3.2 Loans3.2.1 Monetary authorities

3.2.1.1 Use of Fund credit and loans from the Fund3.2.1.2 Other long-term3.2.1.3 Short-term




3.3 Currency and deposits3.3.1 Monetary authorities3.3.2 Banks

3.4 Other liabilities3.4.1 Monetary authorities






38

Standard Components of the International Investment Position (concluded)



166. As defined in the BPM, the goods componentof the balance of payments covers generalmerchandise, goods for processing, repairs on goods,goods procured in ports by carriers, andnonmonetary gold. General merchandise (sometimesreferred to as merchandise) is defined for BOPpurposes as covering (with a few specificexceptions) all movable goods for which actual orimputed changes of ownership occur betweenresidents and nonresidents.

167. Certain commodities, although constituting realassets that undergo international changes inownership, are nonetheless excluded from thegoods component and included in other standardcomponents of the balance of payments. Primaryexamples of goods excluded from the goodscomponent and included in other portions of thecurrent account are:

monetary gold, which is classified under reserveassets in the financial account;

goods acquired by travelers and nonresident workersfor their own use and recorded under travel (part ofservices);

goods that are acquired from host countries byembassies, consulates, military missions andagencies, and related nonresident personnel andclassified under government services n.i.e. (part ofservices);

newspapers and periodicals (not in bulk) sent underdirect subscription and included under computer andinformation services (part of services);

goods that are acquired and relinquished within thesame recording period, do not cross the frontier, andare recorded—on a net basis—under themerchanting and other trade-related services portionof other business services (part of services).

168. Assets regarded as evidence of financial claims(even when such assets possess material form andare movable) are included in a BOP financial accountcomponent appropriate to the type of claim.Examples of such assets are paper money and coin in

current circulation and securities that have beenissued. Furthermore, if a change in the ownership ofa real asset results from the acquisition of an existingenterprise by a resident of an economy other thanthe one in which the enterprise is located, the changeof ownership is treated as a financial transaction andnot included in goods. (Exceptions are changes ofownership actually involving physical movement ofgoods across the frontier.) The change of ownershipis treated thus because the enterprise is considered aresident of the economy in which the enterpriseoperates (see paragraph 92), and ownership of theenterprise is considered a financial investment.

169. As the previous paragraph indicates, the goodscomponent does not cover all changes, betweenresidents and nonresidents, in the ownership ofcommodities. Criteria for items to be included orexcluded from goods are not always as clear asthose for the exclusion of goods regarded asevidence of financial claims.

170. An explanation for the existence of exceptionsto coverage, by the goods component of thebalance of payments, of all exchanges in real assetsmay be found in the considerations (discussed inparagraph 143) for determination of BOP standardcomponents. Two of these considerations areparticularly important:

The item should exhibit distinctive behavior thatdemonstrates a unique response to a particulareconomic factor or combination of factors.

It should be possible to obtain statistics for the itemwithout undue difficulty.

171. Therefore, transactions depicting similarbehavioral characteristics are grouped together ifseparate data can be obtained for the group oftransactions selected. For example, forces influencingthe purchase of commodities by a nonresidenttraveler differ sufficiently from those affecting thehost country’s other exports to warrant the exclusionof such purchases from the goods component. Inaddition, it would be difficult to obtain statistics onindividual purchases made by nonresident travelers.

39

IV. Goods

Similar reasoning applies to the other exceptionscited in paragraph 167. For instance, goods that areacquired and relinquished within the same reportingperiod and do not cross the frontier are classifiedunder merchanting and other trade-related services(rather than goods) provided by an economy to therest of the world because the provision ofmerchanting services is generally unrelated to acountry’s consumption of imports and production ofexports.

172. While certain specific transactions are excludedfrom the goods component, other transactions areincluded—even though such transactions may bemore akin to services. For example, an element oftransportation is often included in the value of goodsbecause of the BOP accounting convention requiringgoods to be uniformly valued at the customs frontierof the exporting country. This basis of valuationdiffers from the pure concept of commoditytransactions, which are usually used in constructinginput-output tables for valuing goods at theestablishment of the producer. The rationale forselection of the customs frontier as the point ofvaluation is discussed in paragraphs 220–227.

173. Within the goods component, four specialtypes of transactions are separately distinguishedfrom general merchandise. These are:

(1) goods sent abroad for processing andsubsequently returned to the country of theoriginal exporter (These goods are part of thegoods for processing item.)

(2) goods (and services) used in the repair of othergoods owned by nonresidents (These goods arepart of the repairs on goods item.)

(3) fuels, provisions, stores, and supplies for carriers(Commodities purchased for commercial use inships, aircraft, and other carriers are assigned tothe goods procured in port by carriers item.)

(4) nonmonetary gold, which is subdivided into goldheld as a store of value and other gold.

174. Although the commodities involved are clearlygoods, the transactions are often undertaken forreasons other than the general level of economicactivity within an economy. Also, the inclusion ofsuch transactions in general merchandise couldcreate a misleading impression about the volume ofa country’s merchandise transactions. For example,fuel purchased by carriers for use in operations isnot recorded in the general merchandise category

because purchases of fuel for carriers are moreclosely linked to transportation operations than to aneconomy’s demand for oil. Classification of such fuelpurchases as general merchandise transactions mightbe economically meaningful for the country sellingthe fuel but much less so for the country purchasingit. For similar reasons of symmetry, ships’ suppliesare grouped under goods procured in port bycarriers. Transactions in nonmonetary gold are oftenmotivated by considerations other than the use ofgold as part of the processes of production andconsumption. Including these transactions in generalmerchandise could create a misleading impressionabout an economy’s production (in the case ofexports) or consumption (in the case of imports).Accordingly, under the goods component,transactions in nonmonetary gold are shownseparately from those in general merchandise.Transactions in goods for processing are often verylarge in a gross sense, but the net impact of thesetransactions on an economy is much smaller.Including these transactions in general merchandisecould create a misleading impression about theoverall size of a country’s external trade.

175. In summary, the concept of transactions ingoods excludes certain commodity exchangesbetween economies but includes certain distributiveservices. Furthermore, while most transactions ingoods are classified under general merchandise,some transactions are separately identified. Theseclassifications are the result of analyticalconsiderations and statistical convenience.

Convention for Recording Change ofOwnership

176. Aside from the exceptions noted previously,the content of the goods component is defined withreference to changes in the ownership of allmovable goods subject to exchanges betweenresidents and nonresidents. The change ofownership rule adopted for defining goods ensures,in principle, that the goods component isconsistent—with regard to coverage and timing—with other items (especially financial items) in thebalance of payments. According to the BPM, goodsfor export are generally considered to changeownership when the exporter ceases to carry thegoods on his books as real assets and makes acorresponding change in his financial items. In thisway, consistency is ensured between the goodscomponent and the BOP financial account of the

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40

compiling county. Consistent compilation of thegoods component by exporting and importingcountries is thus ensured as well. The followingexample illustrates the simultaneity, both internaland inter-country, of the pairs of entries.

Exporting ImportingCountry Country

Goods credit debitFinancial account debit credit

177. International standards for trade statistics,which are often used as a source for compiling thegoods component of the balance of payments, arebased—not on change of ownership—but onphysical movements of goods across national (orcustoms) frontiers. Although goods that changeownership internationally are, for the most part, thesame goods that move across frontiers, the changeof ownership and the movement of the goods donot necessarily occur at the same time. Internationaltransactions reporting systems (such as those basedon foreign exchange and similar bank records) areanother possible source of information for thegoods component. In these systems, transactions ingoods are not generally recorded on a change ofownership basis. The nature of these differencesshould become clearer in the context of informationpresented, in subsequent sections of this chapter, ontiming adjustments required to convert source datafor use in the balance of payments.

Exceptions to the Change of Ownership Rule

178. While the scope of the goods component isrestricted to commodities that have undergone achange—between a resident and a nonresident—ofownership, the BPM nevertheless introduces a fewexceptions to the change of ownership principle.Each exception and underlying rationale is discussedin a subsequent paragraph.

Enterprises Operating in More Than One Economy

179. As noted in chapter 2, when a multinationalenterprise has significant operations in more thanone economy, a separate resident enterprise isassumed to exist in each of the economies where themultinational concern is operating. Goods exchangedbetween the constituent units of the multinationalenterprise do not, in fact, change ownership aswould have been the case for goods exchanged by

units of separate legal entities. Transactions betweena parent company and a branch cannot, in the literalsense, bring about a legal change of ownershipbecause both parties are part of the same legalentity. However, it is recommended in the BPM thatany international shipment of commoditiesexchanged between units that are part of amultinational enterprise and constitute a single legalentity be construed as a change in the ownership ofthe goods. The transaction is therefore included inthe balance of payments.

180. In the situation described in the precedingparagraph, a change of ownership is ascribed on thebasis of international shipment. The circumstancesdiffer very little from those in which a commodity isexchanged between a parent company and itssubsidiary (an incorporated enterprise). As the parentcompany and its subsidiary constitute separate legalentities, the change of ownership rule may be strictlyapplied. In this case, the goods component of thebalance of payments would be comprised ofcommodities that had actually undergone a change,between a resident (e.g., the parent company) and anonresident (e.g., its subsidiary), of ownership. Inthe BPM, however, international transactionsbetween affiliated enterprises that are not legallydistinct from one another are treated the same asinternational transactions between enterprises thatare legally distinct. Thus, the BPM recommendationis that all transactions between direct investmententerprises and parent or other related enterprises berecorded as if changes of ownership have occurred.This general instruction does not apply, however, tothe kinds of transactions in goods specified inparagraph 201.

Financial Leases

181. The possession of goods may also, in effect,change between a resident and a nonresident whoare not affiliated and do not record a change ofownership in their accounts. A common means oftransferring the control of goods without a legalchange of ownership is through financial leasing.Such lease arrangements provide for the recovery ofall, or substantially all, of the cost of the goods andfor carrying charges. Furthermore, under a financiallease, most (if not all) of the risks and benefits ofownership are transferred from the lessor to thelessee. In consideration of the essential nature—rather than the legal form—of the transactions, theBPM recommendation is that goods covered by such

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leasing arrangements be recorded in the balance ofpayments as exports and imports when the goodspass from a lessor resident in one economy to alessee resident in another.

182. To distinguish financial leases from other formsof leasing, a suggested rule of thumb is that a leasearrangement expected to cover carrying charges andat least three-fourths of the cost of the goods issufficient evidence of financial leasing and has thesame effect as a change of ownership.7 At theinception of the financial lease, the equivalent of themarket value of the goods (not the cumulative totalof expected lease payments) should be recordedunder goods, and an offsetting entry should bemade in the financial account to record the creditextended to the lessee. (Refer to paragraphs 109–111for more details on the methodology underlying therecording of transactions relating to financial leases.)

Goods for Processing

183. When there is no change of ownership, thetreatment of goods sent abroad for processing andre-export depends upon whether the goods arereturned to the economy of origin or exported to athird country. The BPM recommendation is that,when goods are shipped from one economy toanother for processing and then returned to the firsteconomy, transactions in these goods should berecorded under the goods component—butseparately from general merchandise transactions—as if a change of ownership has occurred. However,when the processed goods are exported to a thirdcountry, no change of ownership is imputed; in thiscase, only legal changes of ownership are recordedin the balance of payments.

184. The rationale for the treatment of goods sentabroad for processing and returned to the originalexporting economy is based upon requirements ofthe national accounts and can best be explained byan example. Cromania produces $100 of crude oiland sends the oil to a refinery in Dromesia forprocessing. A fee of $10 is paid for the processing.The oil is then returned to Cromania in the form ofrefined oil, which is valued at $110. In the “sourcesand uses of resources” approach employed in thenational accounts, an imputed change of ownership

is required to link the produced good (crude oil)with the consumed good (refined oil) in Cromania’snational accounts. Were these imputations not made,Cromania’s national accounts would show the“disappearance” of crude oil. That is, the crude oilwould not be shown as being exported or used forintermediate consumption, and the refined oil wouldinexplicably appear without ever having beenproduced or imported.

185. As no legal change of ownership takes placewhen the crude oil is exported or when the refinedoil is imported, imputed financial account entries arerequired in the balance of payments to preserve thebalance between debit and credit entries. CromanianBOP entries would be:

Credit Debit

Goods for processing 100 110Other investment

AssetsTrade credits 100** 100*

Reserve assets (or other appropriate financial account item) 10**

**Reflects the claim that Cromania has on Dromesia because of the oil thatthe first economy has sent to the second for processing

**Reflects (1) the extinguishment of this claim when the processed oil isreturned to Cromania and (2) the payment for the processing

186. In the case of goods that are sent, without alegal change of ownership, from one economy toanother for processing and then exported to a thirdcountry or ultimately acquired by the processingeconomy, there is no need to show the same link inthe national accounts as production andconsumption take place in different economies. Inthese instances, the BPM recommendation is that thechange of ownership rule be applied and notransactions in goods are recorded in the balance ofpayments until legal changes of ownership actuallytake place. Accordingly, the value added to suchgoods by processing should be regarded as a serviceperformed by a resident of one economy for aresident of another. For example, goods worth 30units are shipped (without a transfer of ownership tothe processing country) from Domestica to Longa forprocessing. After processing, the goods are sold byDomestica (the legal owner) to a third country(Pokolbin) for 80 units. In the balance of payments,there would be no transaction in goods betweenDomestica and Longa or between Longa andPokolbin, although the external trade statistics ofthese countries would include those movements.There would, however, be a transaction in goodsbetween Domestica and Pokolbin as well as aservice transaction between Domestica and Longa.

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42

7Certain leases not satisfying this rule of thumb can be considered financialleases if the leases are accounted for as financial leases in the accountingrecords of the transactors or if, in the compiler’s opinion, most of thebenefits and risks of ownership have passed from the lessor to the lessee.

187. The transactions of the three countries areillustrated in the following diagram. Solid lines showthe movement of unprocessed goods (valued at 30units) from Domestica to Longa and the movementof processed goods from Longa to Pokolbin. Theprocessed goods are valued at 80 units (that is, 30units for the unprocessed goods plus 50 units for thecost of processing). However, transactions to berecorded in the balance of payments consist of (1) the processing service for which Domestica paysa fee of 50 units to Longa and (2) the sale, byDomestica to Pokolbin, of the processed goods for80 units. These two transactions are indicated bybroken lines.

188. BOP entries for the three countries would be:

Domestica Longa Pokolbin

Credit Debit Credit Debit Credit Debit

General merchandise 80 80

Services 50 50Reserve assets

(or other appropriate financialaccount item) 30 50 80

Merchanting

189. Another exception to the change of ownershiprule is made when goods are acquired from oneeconomy and relinquished again to that or someother economy without ever crossing the frontier ofthe economy in which the temporary owner of thegoods is a resident. Unlike the three previouslydiscussed exceptions for which changes ofownership (although there were none in a legalsense) were ascribed, this exception negates the factthat the commodity has changed ownership.According to the BPM, the net amounts of thetransactions are recorded and classified astransactions in services rather than transactions ingoods. The relevant services, which are merchanting(or commodities arbitrage), are classified undermerchanting and other trade-related services.

190. The BOP treatment of merchanting transactionsis in accordance with what may be termed the “realflows principle.” In accordance with this principle,the balance of payments includes, on a gross basis,transactions that are regarded as gross flows of realresources into and out of the domestic economy.However, the balance of payments includes only thevalue added in the domestic economy by othertransactions in goods and services that do not playan important role in relation to economic activity inthe reporting economy. With such transactions, thenet balance is usually small in relation to the grossturnover. This treatment is consistent with that in thenational accounts.

191. If a merchanting transaction is completed withinone accounting period, the value added is thedifference between the purchase price and the saleprice of the goods. For example, a merchant inClintonstan buys a commodity for 100 units from aresident of Bushland and sells the commodity withinthe same reference period to an importer in Algorniafor 110 units. The production attributable to lintonstanis 10 units, which represent services produced by anentity engaged as a middleman in this form ofinternational trade. In the example, ownership of thegoods changes from Bushland to Algornia. BOPentries for the three economies would be:

Clintonstan Bushland Algornia


Goods 100 110Merchanting

and other trade-related services 10

Reserve assets (or other appropriate financial account item) 10 100 110

192. Entries made for the three economies undergoods and merchanting and other trade-relatedservices are asymmetrical. This asymmetry stemsfrom the pragmatic assumption that the importer inAlgornia would seldom, if ever, have information onthe merchanting profit or loss realized by theintermediary in Clintonstan. Furthermore,asymmetries arising from the treatment ofmerchanting transactions are unlikely to have asignificant impact on the comparability ofinternational BOP statistics.

193. The treatment is more complicated if acommodity is purchased abroad in one accounting

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Domestica Longa

Longa

|

|

|

|

|_ _ _ _ _ _ _ _ _ _ ♦Sale of processedgoods (80 units)

||||||||ℜ ______________

Processed goods(80 units)

Unprocessed goods (30 units)____________________________♦ℜ _ __ _ __ _ __ _ _ _ _ _ _ _ _ _

Processing service (50 units)

period and sold abroad in another period. The BPMstates that merchanted goods acquired in onerecording period and relinquished in a subsequentperiod are recorded in the balance of payments ofthe temporary owner’s economy as imports for theperiod in which the merchanted goods are acquiredand that the same amount is deducted from importsin the period in which the merchanted goods arerelinquished. In these cases, changes—from onerecording period to another—in stocks of goodslocated abroad and valued at acquisition cost willconstitute part of the goods component for theeconomy of the owner. Any difference between thevalue of the goods when acquired and whenrelinquished is to be entered under merchantingand other trade-related services. Had themerchanting transaction in the example in paragraph191 taken place during two accounting periods (thatis, if Clintonstan had purchased the goods in period1 and sold them in period 2), the transaction wouldbe recorded as:

Clintonstan’s Balance of Payments

Period 1 Period 2Credit Debit Credit Debit

Goods 100 –100Merchanting and other

trade-related services 10Reserve assets

(or other appropriate financial account item) 100 110

194. The negative debit entry for imports in thesecond period is construed as a withdrawal fromstocks held abroad. This transaction could have beenrecorded as a credit entry (exports) because anegative debit is mathematically equivalent to apositive credit. However, the treatment shown inparagraph 193 is preferred as this treatment ensuresthat, over time, an economy’s transactions in goodsare not “grossed up” unnecessarily.

Physical Movement of Goods and the GoodsComponent

195. What is the relationship between the physicalmovement of goods across customs or nationalfrontiers and coverage of the goods component inthe balance of payments? While there is significantcorrelation between goods that change ownershipinternationally and goods that move across thefrontier, the changes and the movements do notusually occur at exactly the same times. Furthermore,certain goods that do not cross the customs bordermay undergo changes of ownership, whereas other

goods may cross the border without changingownership. These two situations and implications forBOP compilation are discussed in subsequentparagraphs.

Goods Not Crossing the Frontier

196. With the exception of merchanting transactions,international changes in the ownership of goods thatdo not cross the frontier are treated, in the balanceof payments, as transactions in goods. The followinglist contains examples of goods that might not crossthe frontier but are nonetheless treated as goodsbecause ownership has changed:

ships, aircraft, gas and oil drilling rigs, andproduction platforms;

goods consumed on offshore installations such asgas and oil drilling rigs and production platforms;

fish and other marine products caught and soldabroad directly from the compiling economy’s ships;

goods lost or destroyed after the importer hasacquired ownership but before the goods havecrossed a frontier.

197. Ships and aircraft acquired by a reportingeconomy and put into international operation maynever cross the customs frontier of the reportingeconomy but, on delivery, the ships and aircraft passinto the ownership of a resident enterprise and thusbecome part of domestic fixed-capital formation. Theships and aircraft, which are additions to theeconomy’s capital assets, do not result from domesticproduction and therefore originate in imports ofgoods. The same is true of gas and oil drilling rigsand production platforms acquired from abroad by aresident enterprise and used in offshore operations.Such equipment may be acquired under a financiallease or be the property of a direct investmentaffiliate that is designated a resident enterprise. Inboth cases, transactions in goods should berecorded. (Refer to paragraphs 103–106 for adiscussion of the treatment of mobil equipment.)

198. Once the residence of enterprises operatingoffshore installations (such as gas and oil drilling rigsand production platforms) is identified, any goodsacquired from abroad and consumed by suchinstallations are recorded as imports of goods by theeconomy operating the enterprise—even if the goodsdo not cross the actual frontier of that economy.

199. Fish and other marine products caught on thehigh seas and sold abroad directly from the

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compiling economy’s ships are part of the compilingeconomy’s production sold abroad and,economically, are akin to exported goods thatactually cross the border of the compiling economy.

200. As change of ownership is the criterion forestablishing whether a transaction in commoditieshas occurred, the goods component includes goodslost or destroyed after the importer acquiredownership but before the goods crossed theexporting or importing country’s frontier. Forexample, an importer in Coonawarra takes delivery,at the establishment of the seller in Nostaw, ofgoods worth 1,000 units. The goods aresubsequently lost before leaving Nostaw. Becausethe goods are lost, their value is not recorded in thetrade statistics of either the exporting or theimporting economy. Nevertheless, from thestandpoint of both economies, a change in theownership of real assets, which are probablyexchanged for financial assets, occurs. The BOPstatements (shown subsequently) of the twocountries show these transactions as exports andimports of goods, even though physical movementof the goods across national frontiers does not occur.Were entries of 1,000 units (credit for Nostaw anddebit for Coonawarra) not made in the goodscomponent, each country’s statement would be outof balance for this transaction. The financialmovements (assumed, in this case, to be in reserveassets) reflecting payment for the goods are recordedwhether or not the goods are successfully delivered.

Nostaw CoonawarraCredit Debit Credit Debit

Goods 1,000 1,000Reserve assets

(or other appropriate financial account item) 1,000 1,000

Goods Crossing the Frontier WithoutChanging Ownership

201. With some exceptions, goods that cross thefrontier without changing ownership are not coveredunder goods. Exception are goods exchangedbetween a parent and a branch (or between twobranches of the same parent enterprise), goodsobtained under financial lease arrangements, andgoods exported for processing and returned to theoriginal exporting country. The following listenumerates categories of goods that are alwaysexcluded from the goods component—even if thegoods cross the frontier. Therefore, therecommendation that all transactions between direct

investment affiliates be recorded as if changes ofownership have occurred is modified to excludethese categories of goods:

(a) goods sent abroad for processing andsubsequently sold to a third country

(b) goods sent abroad for repair

(c) goods sent abroad for servicing and re-export bythe servicing economy and goods to which somevalue is added without the occurrence of aphysical transformation of the goods (e.g.,storage, sorting, or inspection)

(d) returned exports and imports

(e) goods shipped under operational (i.e.,nonfinancial) lease arrangements

(f) transportation equipment, fishing vessels, gas andoil drilling rigs, and other mobile equipmentowned by nonresident enterprises

(g) direct transit trade

(h) shipments by a specific economy to thateconomy’s military and diplomaticestablishments located outside the territory ofthat economy

(i) goods lost or destroyed after having crossed thefrontier but before having been delivered by theexporter

(j) goods that are temporarily exported andimported but are not for sale (e.g., displayequipment for trade fairs and exhibitions; artexhibits; animals for breeding, show, or racing;and stage and circus equipment)

(k) samples of no commercial value.

Reasons for the exclusion of goods in thesecategories are presented, with corresponding letters,in the following paragraphs.

202. (a) goods sent abroad for processing

The treatment of goods that are exported forprocessing and not returned to the economy of theoriginal exporter is explained in detail in paragraphs186–188. These goods are recorded under the goodscomponent only when actual changes of ownershipoccur and not when such goods cross customsfrontiers.

203. (b) repairs on goods

The recommendation of the BPM is that repairs ongoods be recorded under goods but in an item

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seperate from general merchandise. However, onlythe value of the repairs—not the value of the goodsbefore and after repairs—is recorded in the balanceof payments. For example, the Australian Navy sendsone of its ships to Singapore for a major refit. Thecost of the refit is US$ 1,000,000. The followingentries would be shown (in US$) in Australia’sbalance of payments:

Credit Debit

GoodsRepairs on goods 1,000,000

Reserve assets (or other appropriate financialaccount item) 1,000,000

The rationale for the BOP treatment of repairs ongoods as transactions in goods (instead oftransactions in services) is that the value added fromsuch transactions primarily results from the provisionof materials rather than from other inputs.

204. (c) goods sent abroad for servicing and re-export

The BOP treatment of goods sent abroad forservicing (without physical transformation of thegoods) and re-export excludes these goods from thegoods component. Instead, the services provided inconnection with the goods are recorded under anappropriate item in the services component. Forexample, the servicing of aircraft is recorded underair transport-other, and the servicing of computerequipment is recorded under computer andinformation services. Storage, packing, and similarservices are generally recorded under the othertransport-other item of the services component. Insome cases, however, it may be difficult todistinguish these goods from goods sent abroad forprocessing that involves physical transformation andre-export to the country of original export.

205. (d) returned goods

When a contract for the sale of goods is canceledafter the goods have been shipped out of theexporting economy and the goods are consequentlyreturned to the original owner, no change ofownership has taken place. In such cases,anticipation, at the time the goods originally cross thefrontier, of the future return of the goods is highlyunlikely. The BPM suggestion is that, for the sake ofstatistical convenience, compilers should make anyadjustment necessary to eliminate such transactionsfrom the goods component in the period when thegoods are returned rather than revising entries for the

period when the goods were originally (andincorrectly) recorded as exports or imports.

206. For example, during a particular period, thereporting economy’s trade statistics show 100 unitsin returned goods (imports). These goods wereexported in a prior period, and the nonresidentbuyer (presumably under the terms of the purchasecontract) decided to return the goods to the seller inthe reporting economy. The seller refunds thefinancial assets that he acquired at the time of thesale, so the foreign exchange holdings of thereporting economy are reduced by 100 units. Howshould the contra entry be made under the goodscomponent? In the simplest terms, the return of thegoods is a reversal of the change in ownershipbecause the original seller of the commodity hasrepurchased it from the buyer. The return of thegoods could be recorded as an import of goods,which would be denoted by a debit entry andappear thus in the balance of payments:

Credit Debit

Goods 100Reserve assets (or other appropriate


207. However, it is suggested in the BPM that thecontra entry to the decrease in reserve assets shouldbe a negative entry in exports. BOP entries would be:

Credit Debit

Goods –100Reserve assets (or other appropriate


The negative adjustment to the reporting economy’sflows of goods in the current period is designed toreverse the change of ownership and to eliminate itfrom the balance of payments as if a change ofownership had never occurred.

208. If trade statistics are the source from whichexports and imports are derived, the value of goodspurchased and returned in the same period shouldbe eliminated from total exports and total importsfor that period.

209. (e) operational lease arrangements

Although goods shipped under operational (ratherthan financial) leases may physically move acrossnational frontiers, these goods are excluded fromcoverage under the goods component. The leasepayments due on these goods are recorded as otherbusiness services-operational leasing in the servicescomponent.

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46

210. (f) transportation equipment

Excluded from the goods component—even thoughphysical movement across national frontiers occurs—are transportation equipment, fishing vessels, gasand oil drilling rigs, and other items of mobileequipment that are operated in a host country’sdomestic territory or territorial waters but owned bynonresident enterprises. (Refer to chapter 2 of thisTextbook and chapter 4 of the BPM for discussionson the residence of owners.) However, for BOPpurposes, a change of ownership is said to occurr if(1) a resident enterprise operates mobile equipmentunder a financial lease arrangement or (2) anonresident owner of mobile equipment separatelyaccounts for the long-term operations of theequipment in the host country and the equipment isrecognized by host country authorities as part ofcapital stock. In the first case, ownership is assumedto pass from the lessor to the lessee; in the secondcase, ownership is assumed to pass from the parententerprise to a branch that is resident in the hosteconomy.

211. (g) direct transit trade

Direct transit trade refers to goods that pass througha reporting country lying on a route between originand destination. For instance, goods exported by theUnited States to Switzerland may be shipped toRotterdam in the Netherlands and then sent by bargeon the Rhine to Switzerland. Such goods areregarded as direct transit trade by the Netherlandsand are omitted from the external trade statistics andbalance of payments of that country. In such cases,there are no transactions in goods betweennonresidents and residents of the country of transit.However, any transactions in transportation or anyother services rendered by Netherlands residents inconnection with goods in transit are recorded in theservices component of the balance of payments ofthe Netherlands.

212. (h) shipments to diplomatic and militaryestablishments

Although the goods move across nationalboundaries, shipments from an economy to extra-territorial military and diplomatic establishments ofthat economy are considered transactions betweenresidents and are therefore excluded from thebalance of payments.

213. (i) goods lost or destroyed before change ofownership occurs

Goods lost or destroyed inside the customs frontierof the importing economy will be recorded in theinternational trade statistics (ITS) of both theexporting and importing economies. Adjustmentsshould be made to the statistics of both economiesif the loss or destruction of goods took place beforechange of ownership occurred. Goods lost ordestroyed between the customs frontiers ofexporting and importing economies will berecorded in the exporting economy’s ITS but not inthose of the importing economy. An adjustmentshould be made to the statistics of the exportingeconomy if the loss or destruction of goods tookplace prior to a change of ownership. Goods lost ordestroyed inside the customs frontier of theexporting economy will not be recorded in the ITSof either the exporting or importing economy. Noadjustment to the statistics is required if no changeof ownership occurs.

214. (j) goods temporarily exported and imported

Goods temporarily exported and imported and notintended for sale (for example, display equipmentfor trade fairs and exhibitions, art exhibits, andanimals for breeding) are also excluded from thegoods component on the grounds that no change ofownership occurs between residents of differenteconomies. Although these goods cross nationalfrontiers, there is an expectation that goods shippedfor such purposes will be returned.

Time of Recording

215. The provision and acquisition of goods by aneconomy should be recorded in the balance ofpayments of that economy in the period in whichthe change of ownership takes place. The timeassigned to a change in the ownership of goods isthe time at which the two parties to the transactionrecord it in their books. The change of ownershipcriterion employed for the goods component isdesigned to promote and preserve consistencybetween the recording of goods and other items(particularly financial items) in the balance ofpayments.

216. Neither the physical movement of goods, onwhich customs statistics and similar returns arelargely based, nor payment for goods, which is

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reflected in foreign exchange or banking systemrecords, will necessarily coincide with the time thatownership of the goods changes. Timing adjustmentsnecessary for statistics derived from these twosources are detailed in paragraphs 257–280. Exceptin the case of large, discrete transactions (such asdeliveries of ships or aircraft), the appropriateadjustments are often difficult to make. Informationon the actual time that ownership changes is seldomavailable in a form that can be related to times ofphysical movement or payment for goods. However,if the total value of trade, the regional pattern oftrade, and/or the terms of payment for trade at thebeginning of the recording period changesubstantially by the end of the period, failure tomake adjustments for timing is likely to be a majorsource of error in BOP statements. Timingdifferences in the recording of goods by differentcountries produce asymmetry between totals forworld exports and imports.

217. Consignment goods that are intended for salebut are not actually sold at the time the goods crossthe frontier of the compiling economy should (inprinciple) be included in goods only at the timewhen ownership changes. As a matter ofconvenience and in the expectation that a change ofownership will occur shortly thereafter, such goodsare sometimes recorded at the time that they crossthe frontier. If that treatment is used and theexpected change of ownership does not materialize,the goods are returned to the exporting country.Then the goods must be recorded, by means of theprocedure suggested in paragraphs 205–208, as adeduction from exports and imports. If such anadjustment is made in a period following the periodin which the goods were originally consigned, timingerrors will be introduced into the balance ofpayments. Furthermore, for goods that are actuallysold after having been consigned, there will betiming errors to the extent that sales take place inperiods that differ from the periods in which thegoods were consigned.8

Valuation

218. The value at which goods are recorded in thebalance of payments is the market value of the

goods at the place of uniform valuation, which is thecustoms frontier of the economy from which thegoods are exported. At least two aspects of thisgeneral statement require elaboration.

Market Valuation

219. The concept of market value and the specificapplication of the concept to internationally tradedgoods are discussed in chapters 5 and 10 of theBPM. The United Nations, in connection with itsstandards for related statistics, has dealt at lengthwith the issue of valuing exports and imports. TheCustoms Cooperation Council has also provided an extensive analysis of the standards to be applied for customs valuation of imports. Paragraphs282–286 also pertain to application of the marketvalue concept to goods and to reconciliation of thestandards of the United Nations and the CustomsCooperation Council with those recommended in the BPM.

Point of Valuation

220. Goods are provided or acquired whenownership passes from a resident of one economy to a resident of another; transfer of ownership issynonymous with delivery by an exporter orexporter’s agent to an importer or importer’s agent.The delivery of goods may take place at any timeand any place agreed upon by the exporter andimporter. “Time and place” may vary between thepoint at which the exporter originally produces oracquires the commodity and the point at which theimporter consumes the commodity or provides it toa third party.

221. The value assigned to a transaction in goodsdepends on when and where the transaction isvalued. The simplest point for valuing goods is attime and place of delivery. At any other point,valuation may (1) fail to cover the total value of thegoods and services being provided by residents ofone economy to residents of another economy or (2) fail to exclude from that value additional goodsand services transferred between residents of thesame economy.

222. For example, an exporter in Domesticacontracts to deliver goods to an importer inCromania. The contract requires the exporter todeliver the goods at the establishment of the

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8Timing errors will occur because, in the period in which the goods areconsigned, entries for the initial consignment will not be offset by entriesin the financial account. Instead, the offsetting entries will be recorded in asubsequent period when the goods are actually sold (or returned to theexporter).

importer. The cost of the commodity and associateddistributive costs are:

Value of commodity at place of production in Domestica 2,000

Cost of transportation to the border of Domestica 50Cost of transportation from the border of

Domestica to the border of Cromania 200Transportation cost from border of Cromania

to the establishment of the importer 25

Road transportation in Domestica is provided by aresident carrier of Domestica. Ocean transportation isprovided by a resident carrier of Daniherland. Theinland freight in Cromania is purchased by theexporter from a railroad enterprise in Cromania. Thevalue of the commodity at the place of delivery inCromania is the sum of all the separate cost elements(2,275 units). If any other point of valuation (such asthe establishment of the exporter, the frontier of theexporting economy, or the frontier of the importingeconomy) were selected, the value placed on thegoods would not include all of the services acquiredby Domestica and provided, during the delivery ofthe goods to the Cromanian importer, to Cromania.Valuing the transactions at the point of deliveryresults in the following BOP entries:

Domestica Cromania


Goods 2,275 2,275Freight 225 25Reserve assets


223. Under a different scenario, contract terms couldcall for the importer to take delivery of the goods atthe establishment of the exporter. All costs oftransportation and other related distributive costs aredirect purchases by the importer. The value of thegoods at the time and place of delivery is 2,000 units.Failure to select this valuation point could result inthe inclusion, in the value of the goods, of servicesthat are not actually provided by Domestica toCromania. In this case, the distributive servicesacquired by the importer are provided in part byDomestica, in part by Daniherland, and in part byother residents in Cromania. Valuing the transactionin goods at the point of delivery would result in thefollowing BOP entries:

Domestica CromaniaCredit Debit Credit Debit

Goods 2,000 2,000Freight 50 250Reserve assets


224. While a convention of valuing goods at thepoint of delivery may have merit from the standpointof registering flows (between residents andnonresidents) of goods and services, such aconvention imposes severe problems with regard tothe interpretation, and possibly the availability, ofdata. If goods were valued in accordance with thevarying terms of individual contracts, the goodsmight be recorded free on board (f.o.b.) at someinland point in the exporting country; or f.o.b. at thecustoms frontier of the exporting country; or cost,insurance, and freight (c.i.f.) at the frontier of theimporting country; or c.i.f. at some inland point ofthe importing country. Statistical trends reflectingeconomic developments could be masked by datachanges that were merely the result of changes inthe time or place at which deliveries of most goodswere recorded. The distortion of other statistics(such as data on freight transactions) associated withtransactions in goods would be proportionatelymuch greater. From a practical and analyticalstandpoint, it is desirable to distinguish, on the basisof a uniform principle, between (1) goods and (2) related distributive transactions.

225. A possible approach would be to adopt theuniform physical valuation point utilized forconstruction of input-output tables. In these tables, thevalue assigned to a commodity is the market value ofthat commodity when it is located at the establishmentof the producer. Any other services (such astransportation and distribution) performed in relationto the commodity are viewed as ancillary servicessupplied to the final or intermediate consumer of thecommodity. Such an approach attempts todifferentiate between (1) commodity output and (2)the rendering of services. In the example given inparagraph 222, use of this approach would producethe following BOP entries for Cromania:

Credit Debit

Goods 2,000Freight 250Reserve assets (or other appropriate


226. Use of this approach to distinguish betweengoods per se and related freight services isanalytically appealing but difficult to implementstatistically—especially for series of data produced atfrequent intervals. It is assumed that inter-industryaccounts can be used as a basic statistical frameworkin which flows of goods and services are integrated.With a few exceptions, most countries do notconstruct input-output tables on a quarterly, or even

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an annual, basis. Quarterly BOP estimates arenecessary for appraising current developments, andstatistical sources from which totals of goods arederived must supply data on a quarterly (or at leastannual) basis.

227. As it is desirable to adopt a uniform point ofvaluation for the goods component, some otherapproach must be recommended for producingquarterly or annual data. According to the BPM, thevalue existing at the customs frontier of the economyfrom which goods are exported shall, in principle, bethe value recorded (in the goods component of thebalance of payments) for goods and relateddistributive services. The value includes the costs ofloading goods on board carriers at the frontier. (Thatis, exports and imports of goods are to be valuedf.o.b. at the customs frontier of the exportingcountry.) In the application of this rule, customsbonded warehouses, customs bonded manufacturingplants, and free areas are considered to be within thecustoms frontiers of the economies that control andsupervise them. Customs frontiers need not coincidephysically with national boundaries and may belocated in the interior at places such as airports.

228. Use of the BPM rule on uniform valuation oftransactions in goods involves two theoreticalconcepts: (1) Freight, insurance, and other shipmentcharges incurred for transporting goods to the pointof uniform valuation are always the result oftransactions between a resident (usually the exporter)of the exporting economy and the carrier or insurer.(2) Similar costs incurred for transporting goodsbeyond the point of uniform valuation are alwaysthe result of transactions between the importer andthe carrier or insurer.

229. The example given in paragraph 223 illustratesthe system of entries made if the customs border ofthe exporting economy is designated as the uniformphysical point for valuing goods. The exporter islocated in Domestica; the importer, in Cromania; andthe carrier, in Daniherland. (Valuation of the goodswould be unchanged by different locations forcontractual delivery.)

Domestica Cromania Daniherland


Goods 2,050 2,050Freight 2,200 200Reserve assets

(orother appropriatefinancial account item) 2,050 2,250 200

230. In the example, the importer in Cromania tookpossession of the goods at the establishment of theexporter in Domestica and purchased, from a carrierresident in Domestica, transportation services formoving the goods to the customs border ofDomestica. In reality, these transportation serviceswould have been contracted between the carrier andthe importer. However, use of a uniform physicalpoint for valuation of goods in the balance ofpayments requires that the internal transportationcost of 50 units be attributed to a transactionbetween residents of Domestica—the exporter andthe carrier. In this particular case, the total domesticproduct of Domestica is provided to Cromania in asingle component, goods, rather than as acomposite of goods and transportation. Although itis possible that nonresidents may, in fact, providefreight services inside the valuation boundary, thiscircumstance arises rather infrequently. Such atransaction (illustrated in the following paragraph)would arise if an importer hired, in his or hercountry, a truck to transport goods from a locationin the exporting country.

231. Clinstonstan and Bushland are contiguouscountries. The importer, a resident of Bushland, takesdelivery of goods worth 1,000 units at theestablishment of the exporter in Clintonstan. Theimporter arranges with a trucking company inBushland to transport the goods to her place ofbusiness in that country. Total transportation cost is200 units, of which 100 units are the estimated costof moving the goods from the exporter’sestablishment to the border of Clintonstan. In thiscase, the freight payment is a transaction betweenresidents of the importing country. In accordancewith the convention for distinguishing betweengoods and associated distributive costs in a uniformand consistent manner, the freight cost fortransporting the goods to Clintonstan’s border isincluded in the value of the goods when that value isrecorded in the BOP statements of both countries.Consequently, it is necessary to make offsettingentries in the BOP statements of both countries tocorrect the overstatement of receipts and payments. Afreight debit that cancels the overstatement of exportreceipts is recorded in the balance of payments ofthe exporting country. (The offsetting elementrepresents a transaction between nonresidents.) Inthe importing country’s BOP statement, the offsettingentry is a freight credit representing a transactionbetween residents and canceling the overstatement,on the goods account, of payments to nonresidents.

GOODS

50

232. The second theoretical concept required by theuse of a uniform physical point for valuation ofgoods is closer to fact. The exporter is regarded asan intermediary in arranging for goods to be shippedbeyond the frontiers of his country. If the exporterpays freight charges, he is assumed to do so onbehalf of the nonresident importer, who ultimatelyreimburses the exporter directly or indirectly.

233. For example, a purchaser in Longa agrees topay a seller in Namdarb 6,600 units for a commoditydelivered c.i.f. at the port of entry in Longa. Theseller contracts with a Longan carrier to transport thegoods for 600 units. Longa, however, wishes torecord imports on an f.o.b. basis and thereforeconsiders the 6,000 units to be the price of thecommodity and the 600 units to be payment fortransportation. There is no problem in recording the6,000–unit value of the import; this amount is paidto the exporter in Namdarb, and the transaction iscompleted. The 600 units for transportation,however, are paid to the exporter in Namdarb, whoreturns the 600 units to Longa in the form ofpayment to the carrier. (The route of the 600 units isshown in solid lines in the following diagram.) Froman economic point of view, however, thetransportation service is performed by a resident ofLonga (the carrier) for a resident of Longa (theimporter). There is no economic significance to thepayment being made directly by one resident toanother resident or through some nonresidentintermediary (the exporter) and, on an overall basis,the balance of payments is not affected. (Thesignificant movement of the 600 units is shown inthe diagram, by the broken line and arrow, as atransaction occurring within Longa.)

234. Similar reasoning would apply if the goodswere transported in the ships of a third economy.For example, the exporter in Namdarb pays shippingcharges to a carrier in Central Paradiso and isreimbursed by the Longan importer (as is indicatedin the following diagram). The transportation serviceis viewed as being rendered to the importer ratherthan the exporter, who may be regarded as anintermediary. In accordance with the “real flows”

principle, the significant movement of thetransportation service is from Central Paradiso toLonga. The two offsetting movements in Namdarb’sbalance of payments (payment of 600 units toCentral Paradiso and receipt of the same amountfrom Longa) are, therefore, excluded fromNamdarb’s balance of payments.

235. Freight, insurance, and other distributivepayments made by residents of the exportingcountry to nonresidents for the transport of goodsbeyond the customs frontier of the exporting countryare therefore omitted from the balance of paymentsof the exporting country. Also omitted are the director indirect reimbursements made by nonresidentimporters for such expenditures. While the omissionof these transactions may be regarded as unimportantin the majority of cases, the omission in other casesis a clear departure from the resident/nonresidentprinciple. However, as the amounts omitted from thecredit and debit sides of the balance of payments areequal, the net balance is not affected.

236. Treating the exporter as an intermediary whoarranges for transportation of goods beyond thefrontier of the exporting country seems realisticwhen goods are sold to the nonresident importerbefore being shipped from the exporting country.This treatment is not so realistic when goods aresold while en route or upon arrival in the importingcountry. The treatment is clearly unrealistic whengoods are shipped on consignment and stored (forthe exporter’s account) in the importing countrybefore being sold there.

237. Another example illustrates some of theproblems described in the preceding paragraph. Anexporter in Pokolbin ships goods on consignment toan agent in Coonawarra for sale in that economy.The value of the commodities upon arrival inCoonawarra is 10,000 units, of which 1,000 unitsrepresent the cost of shipping the goods fromPokolbin to Coonawarra. Residents of Cromaniahave provided freight services. If these goods aresold in the same reporting period, the BOPstatements of Pokolbin and Coonawarra will

||| 600 units|_____________________________________♦

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51

Longaimporter

|

|

|

Carrier

Namdarbexporter

600 unitsℜ __________________________

|||||_____________♦

600 units

Longaimporter

Namdarbexporter

600 unitsℜ __________________________

|

|

|

|ℜ _ _ _ _ _ _ _

600 units

600units

CentralParadisocarrier

(measurement problems notwithstanding) includethe following entries:

Pokolbin Coonawarra


Goods 9,000 9,000Freight 1,000Financial assets/

liabilities 9,000 10,000

238. The recording of flows of goods and theattribution of associated distributive costs is based onthe uniform point of valuation recommended in theBPM. Although the direction of the financial flow inits entirety is from Coonawarra to Pokolbin, thedirection of “real flows” is, in part, from Pokolbin toCoonawarra and, in part, from Cromania toCoonawarra. The balance of payments of Pokolbinomits from credit and debit entries the 1,000 units offreight services that the exporter in Pokolbincontracted for with a resident of Cromania. In thiscase, the exporter clearly was not acting as anintermediary for the importer because the goods hadnot been sold at the time the freight services werecontracted.

239. If, the goods in the example in paragraph 237were consigned in one reporting period and sold ina subsequent reporting period, BOP entries for thethree economies would (measurement problems notwithstanding) be:

Period 1 Pokolbin Coonawarra Cromania


GoodsFreight 1,000 1,000Financial assets/


Period 2 Pokolbin Coonawarra Cromania


Goods 9,000 9,000Freight –1,000 1,000 (1,000)

–1,000)Financial assets/


240. The negative entry shown for freight duringperiod 2 denotes an adjustment to the servicesacquired by Pokolbin during period 1. As the BPMspecifies that the shipment of imports beyond theborder of the exporting country represents atransaction between the provider of the service andthe importing economy, these flows should beattributed to Coonawarra and Cromania—regardlessof the fact that the goods were not sold until theperiod following shipment.

241. An appropriate valuation for the goods item inperiod 2 could have been 10,000 units as that is thevalue of production supplied by Pokolbin toCoonawarra. However, the specification, by theBPM, of a place (the customs boundary of theexporting country) for the uniform valuation ofgoods precludes assignment of the 10,000–unit valueto the goods.

242. In summary, it was desirable to designate apoint at which goods should be uniformly valued.Any of several points could have been chosen aseach has comparable analytic advantages. However,statistical problems exist with any valuation pointselected. A principal difficulty is that shippingpractices are not standard. Documents on which theBOP compiler must usually rely to make estimates ofgoods and freight will often cover shipping servicesperformed on both sides of the customs frontier (orany other uniform point), and total shipping costsmay not be broken down or related to the point ofvaluation. For example, goods may be shipped bytruck from door to door, or goods in containers maybe moved between central warehouses that aredistant from customs frontiers. A primaryconsideration in specifying the customs frontier ofthe exporting country (rather than some other place)is the probability that customs officials value exportsat that point. Imports, too, are valued at the customsfrontier in a significant number of countries. As datagenerated by customs are often the basis of BOPentries pertaining to transactions in goods, it isconvenient for both series to refer to this point ofvaluation.

243. Application of the rule for uniform valuationmay result in inclusion, in the goods component, ofsome flows of services occurring betweennonresidents or between residents of the sameeconomy. Specifically, an exporter may delivergoods before the goods reach the customs frontier ofthe exporter’s economy, and the importer may thenemploy a supplier of distributive services who is nota resident of the exporting economy to ship thegoods to the customs frontier. To maintain uniformvaluation for the goods component, an offset tosuch a flow of services occurring betweennonresidents is required in the balance of paymentsof the exporting country. The BPM states that theoffsetting entry is made in the freight item. Similarly,if the supplier of the services is the importer or aresident of the importer’s economy, the flow ofservices occurs between residents of the sameeconomy, and an offset in the freight item is also

GOODS

52

required in the balance of payments of the importingcountry.

244. The f.o.b. valuation of goods at the customsborder of the exporting country includes any costsincurred in loading the goods on board the carrier atthat frontier. However, when the service of loadinggoods on board the carrier at the customs frontier isactually performed, the service is frequentlyperformed by or for the carrier. In these cases,customs statistics are likely to exclude the cost ofsuch services, and data on freight charges will almostcertainly include them. For practical reasons, theBPM does not suggest that attempts be made toreallocate such charges from the freight item to thegoods component. There is explicit recognition that,in practice, most goods are recorded on a freealongside ship (f.a.s.), rather than an f.o.b., basis.

245. Goods delivered to an importer at somelocation within the exporting economy may not beshipped to the customs frontier of that economyduring the same recording period. In such a case,an entry for the value of the goods at the point ofdelivery is made in one period, and another entryfor the cost of freight from that point to the customs frontier is made in a subsequent period.Both of these entries are included in the goodscomponent.

246. There may be practical difficulties in readilydistinguishing the distributive service element inimports that are valued on a c.i.f. basis in the basicdata source. However, users of the balance ofpayments would experience real inconvenience ifthere were no single standard. Lack of comparabilitybetween statements compiled on different bases isperceived as a more serious drawback thandifficulties (or errors) in allocating certain flowsbetween the goods component and freight items.Therefore, the BPM rule for uniform recording ofgoods should be followed—even if adherenceinvolves rough estimates.

247. How should services performed by agents inconnection with transactions in goods be treated? Inprinciple, fees and commissions paid by exporters tononresident brokers and agents reflect servicesrendered to exporters by brokers or agents, andthese fees and commissions are classified as such inthe balance of payments. Thus, for example, feespaid to nonresident agents by exporters are enteredas an integral part of the value of goods (credit) andan offsetting entry (debit) is made in merchantingand other trade-related services. For the importing

country, these entries are reversed if the agent is aresident of the importing country.

248. What about services rendered to an importerby an agent in the exporting country? Are theseservices separately portrayed as service items orincluded in the values of goods? Likewise, how arefees paid by an importer to a resident agent forservices pertaining to imports treated in the balanceof payments? Are these services—although they maybe included in the customs values of imports—construed as transactions between residents? It isrecommended in the BPM that, for practical reasons,fees paid in connection with transactions in goodsby the importer to an agent in the exporting countrybe included in the value assigned to goods at thecustoms frontier of the exporting economy. Thesefees are usually included in the customs values ofimports; the exporting country will probably have toadd these fees to the customs values of exports.Agent fees paid by the importer to an agent in theimporter’s country or to an agent in a third countryare not included in the value of imports. If thesefees are included in customs valuations, the feesshould be deducted. This recommendation is madebecause the exporting country cannot know thevalue of these fees and therefore cannot incorporatethe fees in the customs values of exports. Thetreatment of agent fees is further discussed inchapter 5.

249. In some cases, fees are paid by exporters toconsulates of importing countries. The BPM rule isthat such fees are not included in the valuation ofgoods at the frontier of the exporting country. Aconsular fees is thus treated as a cost incurredbeyond the customs frontier of the exportingcountry; that is, a consular fee is incurred in theimporting country.

Adjustments to Basic Data

Overview

250. Basic data from which statistics on the goodscomponent are derived are seldom available in aform that fits concepts presented in the BPM. Thetwo most common sources are external tradestatistics, which are usually derived from customsrecords, and bank records, such as records offoreign exchange transactions. Statistics obtainedfrom these two sources are, or were, collected forpurposes other than BOP compilation. Tradestatistics based on customs returns are generated as

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a by-product of customs administration, andexchange records are primarily used as a means ofmonitoring and controlling foreign exchange. Tosatisfy BPM requirements for compilation of thegoods component of the balance of payments,compilers must usually make adjustments to sourcedata.

251. Discussed in the following paragraphs areadjustments that must be made to compensate forconceptual differences between the goodscomponent and external trade statistics for whichcoverage, valuation, and timing are defined by theUnited Nations,9 and between the goods componentand foreign exchange and similar bank record datacovering (at the time of settlement) all transactionsin goods paid for through the banking system.

252. However, trade statistics and bank recordsavailable to BOP compilers may not conform entirelyto the definition stated by the United Nations.Compilers should not adjust source data to conformto these definitions and subsequently adjust datafurther for use in the balance of payments.Adjustments described in the Textbook should beapplied only when source data already conform tothe United Nations definition and are, thereby, atvariance with BOP definitions. Other discrepanciesbetween source data and the goods componentshould be eliminated.

253. Adjustments to bring source data intoconformity with standards for compilation of thegoods component of the balance of payments aredescribed under the headings of coverage,classification, timing, and valuation. (For additionalinformation on these adjustments, refer to chapter 11of the Balance of Payments Compilation Guide.)

Adjustment for Coverage

254. Coverage adjustments are required whenstatistics that are the source of BOP goodscomponent entries (a) include certain goods thathave not, in fact, changed ownership and (b) fail toinclude certain other goods that have, in fact,changed ownership internationally. If external tradestatistics are the source of information ontransactions in goods, such statistics usually cover allgoods that cross the border. To adjust external tradestatistics for use in the balance of payments,additions must be made for goods that change

ownership (or are construed as changing ownership)without crossing the border, and deductions must bemade for goods that cross the border withoutchanging ownership. If foreign exchange records arethe source of information on transactions in goods,such data generally cover all goods that are paid forthrough the banking system. Therefore, additions toforeign exchange and similar bank record data mustbe made when payment is not made through thebanking system for goods that change ownership.

Adjustments for Classification

255. In source data, some transactions may beinappropriately—for BOP purposes—classified astransactions in goods. In addition, transactions thatare, for BOP purposes, classified under goods maybe otherwise classified in source data. Adjustmentsare required to correct the improper classifications.

256. One important classification adjustment is thededuction of distributive items from import totalsobtained from external trade statistics. When importsare recorded in external trade statistics at c.i.f.valuations that include international freight,insurance, and other distributive services, suchservices must be eliminated so that goods may berecorded at f.o.b. valuations in the balance ofpayments. If such services have been provided bynonresidents, the values that have been deductedare included in the freight item or the insurance itemor, as appropriate, in other items under services.Certain import transactions may also be valued on ac.i.f. basis (or some basis other than f.o.b.) in bankrecords. Classification adjustments should be madein these statistics as well.

Adjustments for Timing

257. Timing adjustments are required for BOPpurposes when flows of goods are recorded insource data at times that do not coincide withchanges in ownership. Goods are usually recordedin external trade statistics when the goods cross theborder. Goods are recorded in bank records whenpayment for the goods is made through the bankingsystem. The time at which the ownership of goodschanges may differ from the time at which goodsphysically move across a border or the time at whichpayment for the goods is made.

258. For example, an exporter in Essendonia shipsgoods to an importer in Nostaw in December 1991.The importer in Nostaw acquires ownership of the

GOODS

54

9“International Trade Statistics: Concepts and Definitions,” United NationsStatistical Papers, Series M, No. 52, Rev.1 (New York, 1982).

goods in January when she receives documentsforwarded to her bank for collection and accepts, asan account payable, a three-month draft falling duein April 1992. The goods are cleared throughcustoms in Nostaw in March 1992.

Summary of Events

December 1991—exports recorded in customs returns ofEssendonia

January 1992—goods change ownership; importer inNostaw accepts draft as an account payable

March 1992—imports recorded in customs returns ofNostaw

April 1992—draft paid

259. According to the timing principle stated in theBPM, a transaction in goods should be recorded, inthe balance of payments of both Essendonia andNostaw, in January. Simultaneous entries ensurethat the transaction is recorded symmetrically andon a basis consistent with transactions in thefinancial account of each country’s balance ofpayments. In the balance of payments ofEssendonia, the export (credit) is offset by theacquisition of a draft (a debit to trade credits). Inthe balance of payments of Nostaw, the import(debit) is offset by the corresponding increase intrade credits (credit).

260. If external trade statistics in which Essendoniaand Nostaw record this transaction serve as sourcedata for BOP entries, a timing adjustment is requiredonly in Essendonia. (It is assumed that Nostawprepares its BOP statement on a quarterly basis.)The adjustment is made by eliminating the exportfrom 1991 statistics and adding it to 1992 statistics.

As both the change of ownership and the recordingof the transaction by Nostaw customs officials tookplace during the first three months of 1992, notiming adjustment is required in Nostaw unless BOPstatements are prepared monthly, rather thanquarterly, in that country.

261. If bank records in which this transaction isrecorded serve as the source from which BOPentries are derived and if quarterly BOP statementsare prepared, a timing adjustment is required in thebalance of payments of both Essendonia andNostaw. Whereas bank records attribute thetransaction in goods to April (when settlement wasmade through the banking system), the actualchange of ownership took place in January. Theadjustment is made by deducting the amount of thetransaction from April totals and adding the amountto January totals. Thus, the use of timing adjustmentsapplies to source data from external trade statisticsand from bank records.

262. Table 4.1 summarizes timing adjustments thatshould be made when data from external tradestatistics are used as a source for BOP entries in thegoods component.

263. Table 4.1 shows additions and deductions thatmust, for the purpose of compiling imports andexports for the balance of payments, be made toexternal trade statistics in various periods.Adjustments made for a current period may requireoffsetting adjustments in previous or subsequentperiods. As line 1 of table 4.1 indicates, whenexports move across the frontier in the current

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Table 4.1 Timing Adjustments for External Trade Statistics Used as Source Data for BOP GoodsComponent Entries

Period in Which Adjustment Is MadePeriod in Which Goods to Data on Goods

__________________________________________ _____________________________________________

Change Ownership Cross Frontier Previous Current Subsequent

Exports

1 subsequent current none deduction addition2 current previous deduction addition none3 current subsequent none addition deduction4 previous current addition deduction none

Imports

5 current subsequent none addition deduction6 previous current addition deduction none7 subsequent current none deduction addition8 current previous deduction addition none

period and change of ownership occurs in asubsequent period, the amount of the transaction ingoods is subtracted from the external trade statisticsof the current period and added to the statistics forthe period in which the goods are sold. The physicalmovement of goods across the frontier does not alterthe ownership of the goods; goods that do notchange ownership before crossing the frontier areconsidered an addition to the exporting economy’sstocks held abroad.

264. According to the conventions of the 1993 SNAand the BPM, capital formation in the form ofcommodity stocks can take place abroad. If goodsthat are shipped abroad but not sold in the currentperiod relate to current production, the reportingcountry’s domestic product should include anaddition to stocks, rather than an export, asindicated by external trade statistics of the currentperiod. The decline in stocks and the actual exportsare reflected in the period in which the goods aresold (see line 2 of table 4.1).

265. If goods sold in the current period are shippedabroad in a subsequent period (see line 3 of table4.1), the reporting economy should add the amountof the transaction in goods to exports of goods forthe current period. The nonresident importer wouldadd the goods located in the compiling economy tohis stock of goods. These goods should besubtracted from the external trade statistics of thereporting economy for the period in which thegoods are shipped (see line 4 of table 4.1). Thenonresident importer would then have drawn downhis stock of goods held in the reporting economy.

266. Line 5 of table 4.1 illustrates changes, whichcome about through purchases made abroad, in acountry’s stocks held abroad. Goods bought in thecurrent period are shipped to the importing countryin a subsequent period. The amount of thetransaction in goods is added to the external tradestatistics for the current period and deducted fromthe statistics for the period in which the goods crossthe frontier of the importing country. There is areduction in stocks held abroad during the period inwhich the goods physically enter the country (seeline 6 of table 4.1).

267. Some goods do not change ownership untilsometime after they arrive in the reporting country.For BOP purposes, these goods are said to beowned by nonresidents from the time the goodsarrive until the goods are sold. A deduction istherefore made to exclude the amount of such goodsfrom the external trade statistics of the compilingeconomy (see line 7 of table 4.1). An addition to thestatistics is subsequently made for the period inwhich the goods are purchased by residents (seeline 8 of table 4.1). Both of these adjustments arelinked to changes in stocks held by nonresidents inthe compiling economy.

268. Table 4.2 summarizes timing adjustments thatshould be made when data from foreign exchangeand similar bank records are used as a source forBOP entries in the goods component.

269. Table 4.2 shows additions and deductions thatmust, for BOP purposes, be made to bank recordscontaining data on exports and imports as well as

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56

Table 4.2 Timing Adjustments for Bank Records Used as Source Data for BOP GoodsComponent Entries

Adjustment Made to Current Period DataPeriod in Which on Trade Credit

____________________________________________ ____________________________________________

Ownership Changes Payment Is Made Goods Assets Liabilities

Exports

1 subsequent current deduction none addition2 current previous addition none deduction3 current subsequent addition addition none4 previous current deduction deduction none

Imports

5 current subsequent addition none addition6 previous current deduction none deduction7 subsequent current deduction addition none8 current previous addition deduction none

adjustments that must be made to transactions intrade credits. Trade credit adjustments follow fromand serve as offsets to timing adjustments made for exports and imports. As table 4.2 indicates, whenbanking system data such as foreign exchangerecords are used to derive the BOP goodscomponent, timing adjustments are made to tradecredits rather than to changes in stocks. Trade credits may be postpayments (when payment ismade after the change in ownership) orprepayments (when payment precedes the change of ownership).

270. Line 1 of table 4.2 refers to prepaymentsreceived for exports. Prepayments are not classifiedas export receipts but as trade credits received(liabilities). These prepayments are deducted fromtotal exports of goods (as shown in bank records),and a corresponding increase in trade creditliabilities is entered in the balance of payments.Upon delivery of the goods (see line 2), theprepayment amounts are added to the bank recordfigure for current year exports, and a correspondingentry is made in the BOP financial account torecord liquidation of the liabilities.

271. When exported goods change ownershipbefore payment is rendered (see line 3), an additionmust be made to the bank record figure for exportsof goods. The resulting amount is recorded in thebalance of payments as a reduction in real assets(exports), and an offsetting increase in financialassets (trade credits) is also recorded. Line 4 refers to adjustments made in the current period whenpayment is received for exports delivered in aprevious period.

272. A country may acquire ownership of goods inthe current period and pay for the goods in asubsequent period (see line 5). When postpaymentsfor goods are made, the figure (contained in theimporting country’s bank records) for imports ofgoods in the current period must be adjusted by theaddition of an amount representing goods importedbut not yet paid for. A contra entry must be made inthe balance of payments under trade credit liabilities.When goods are paid for through settlement of thetrade credit (see line 6), the import total (shown inbank records) for the period in which payment isreceived must be adjusted to exclude the amount ofthe settlement. The settlement is recorded as afinancial transaction (reduction in trade creditliabilities).

273. When prepayments are made for imports (seeline 7), such prepayments are deducted from theestimates of goods contained in bank records andshown in the balance of payments as the creation ofa financial claim (assets). When the imports arereceived (see line 8), the prepayment amounts areadded to the amount recorded for goods in bankrecords, and a contra entry representing thecorresponding reduction in trade credit assets ismade.

274. If unadjusted statistics from bank records wereused in the balance of payments, a number of errorsand omissions would ensue. A significant number oftransactions in goods would be recorded in thewrong period. Serious omissions would occur in therecording of increases and decreases in internationalindebtedness as total trade credits for an entirecountry can constitute a sizeable amount and changerapidly. Statistics portraying the economicrelationship between output and capital would bedistorted, and an incorrect ratio would be implied.

275. While the principles and the importance oftiming adjustments should be understood andappreciated, in practice, it is not always possible tomake these adjustments. When basic data fortransactions in goods are derived from customsreturns, it is generally assumed that there is a ratherconstant time lag between actual change ofownership and entry of the goods in customsrecords. No timing adjustments would be required if(1) the level of trade and (2) the lag between changeof ownership and recording by customs bothremained constant. If trade were expanding orcontracting, however, timing adjustments wouldprobably be necessary if substantial time lagsexisted—even if such lags were constant. If tradewere constant, changes in time lags might also createthe necessity for major adjustments.

276. There is no clear evidence that changes ofownership normally take place when goods areshipped (in which case a timing adjustment forimports may be required) or when goods arrive attheir destination (in which case a timing adjust forexports may be required). A sample survey could beused to obtain information on actual practices indifferent countries. Timing adjustments could then bemade to correct statistics in categories of goods forwhich changes of ownership and customs entries arerecorded at different times. If BOP statistics do notreflect simultaneous recording of exports and imports,aggregations and comparisons of such BOP data are

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much less meaningful. Discrepancies in times ofrecording are most apt to arise in periods when rapidchanges are occurring in prices, in volumes, or inrelationships between the times that goods changeownership and are recorded in source data.

277. In practice, timing adjustments are made to datagenerated by customs only when it is known that thetime at which goods were recorded in customsdocuments differs from the time at which ownershipof the goods changed. It may be necessary to obtaindirect records of purchases or sales and to substitutesuch records for customs documents. For example,wheat is shipped by Canada to the United States forstorage. Usually, none of the wheat is sold to theUnited States; instead, the wheat is sold overseas andshipped directly from the storage location. Shipmentsof wheat for storage are eliminated from exports inCanada’s balance of payments, and wheat sales fromstorage abroad are added to exports on the basis ofspecial reports obtained from the Canadian WheatBoard. A second example is that of Colombiancoffee. The Colombian Coffee Growers Associationprovides data that enable Colombian BOP compilersto adjust customs returns in respect of coffee stocksheld abroad. In countries where marketing boards orspecial procurement agencies exist, data on actualsales and purchases are often available and can, ifnecessary, be substituted for customs data.

278. Timing adjustments may also be made to datagenerated by customs when a single or discrete bulkcommodity purchase (especially transportationequipment) is made by an official entity or a largecorporation in the reporting country. For example,Australia makes a timing adjustment to the externaltrade statistics to compensate for the time lagbetween the acquisition, by Australian enterprises, ofitems such as aircraft and the recording of theaircraft in the customs returns.

279. The necessity for timing adjustments is muchgreater when foreign exchange or other bank recordsserve as the source of data on transactions in goods.Unadjusted statistics for transactions in goods may bemisleading if substantial changes have occurred inthe terms of payment. For instance, in countries thathave exchange controls, it may be customary tomake advance cash payments for imports.Nonresident exporters may be unwilling to extendcredit to these countries because of uncertaintyregarding the allocation of foreign exchange toimporters for payment of their debts. If—from theperspective of nonresident exporters—the

creditworthiness of such a country improves greatly,or if the market for major categories of goodsimported by that country changes from a seller’s to abuyer’s market, nonresident exporters may decide toextend credit. If changes in credit policy occursuddenly, unadjusted bank records may seriouslyunderstate imports during the period of transition.

280. A bank record can be adjusted for timing ifdata recorded for each transaction include the timeof payment and the time of the transaction. It will, ofcourse, be impossible to ascertain the specific dateon which the legal change of ownership took place,but that information is not required. Timingadjustments may be made on the basis of somesimple rule of thumb. For example, it may beassumed that changes of ownership for both exportsand imports coincide with shipment from theexporting country. In this case, a record of theshipment date (which is usually indicated ondocuments available to the foreign exchange control)will be sufficient as an approximate indication of thetime that ownership changed. (However, in the caseof postpayments, the necessary adjustments can onlybe made retroactively.) Alternatively, data availablefrom an official record of export credits extended orimport credits received could be used to maketiming adjustments to foreign exchange records ontotal transactions in goods. For example, rice—oneof Myanmar’s major export commodities—is soldthrough a state corporation that extends credit onexports. As information on changes in rice creditscan be obtained from the accounts of the statecorporation, this data can be used to adjust receiptsfor rice exports from a payment basis to atransaction basis.

Adjustments for Valuation

281. Valuation adjustments are necessary whengoods are recorded in source data at other thanmarket values. Thus, when customs-generated dataon imports and exports refer to valuations made forthe purpose of levying customs duties on goods,adjustments must be made to account for anydifferences between those values and the marketvalues of the goods.

282. The BPM and the United Nations standards forexternal trade statistics cite market values as the basisfor valuing flows of goods; therefore, adjustments onthis basis are unnecessary. However, fees payable toconsulates of importing countries are treateddifferently by the two systems. Inclusion of consular

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fees in the value of exported goods and in importsrecorded f.o.b. at the frontier of the exportingcountry is recommended in the standards for externaltrade statistics, whereas exclusion of such fees isrecommended in the BPM. Therefore, internationaltrade statistics valuations of goods must be adjustedfor BOP purposes.

283. In some countries, Customs Cooperation Councilstandards for valuation of imports are used to assesad valorem duties. Values assigned for this purpose toimported goods may differ from those recommendedfor the balance of payments, and adjustments shouldbe made for (a) differences between contract-stipulated market prices at which goods have beensold and prices at which import duties have beenassessed and (b) special quantity discounts.

284. For BOP purposes, goods should generally berecorded at contract prices (adjusted for transferpricing, taxes, subsidies, etc.) at which the goodswere sold. As the customs valuation for goods is alsogenerally based on the purchase/sale price of bonafide sales, no adjustment is necessary in most cases.In a period of abnormal price fluctuations or in theevent of an unusually long delay between thepurchase/sale contract date and the payment date forcustoms duty (for example, if goods are stored forsome time in a bonded warehouse), the customsvaluation may be based on the price fetched by thegoods at the time that the duty became payable. Inthese circumstances, the price used for customs dutyvaluation will not be the same as the price requiredfor BOP purposes, and an adjustment will berequired.

285. Occasionally, a single purchase/sale contractmay cover goods destined for import into more thanone country. Under such a contract, the buyer may

receive a quantity discount that would not beavailable if the purchase were made in installments.The Customs Cooperation Council recommends thatcustoms statistics reflect the price that the goodswould fetch if the special quantity discount were notavailable. The BOP item for imports, however,should reflect the discount price as it represents themarket value of these goods. For example, amultinational enterprise resident in Algornia agrees,under the terms of a single contract, to make a bulkpurchase from an enterprise in Coonawarra.Commodities purchased by the multinationalenterprise are shipped to three branches located inCromania, Dromesia, and Essendonia. If threeseparate purchases were made, the market price ofthe commodities would be 100 units per purchase or300 units in total. However, the multinationalenterprise receives a 20 percent discount for buyingin bulk and therefore pays only 240 units. Accordingto the Customs Cooperation Council, Cromania,Dromesia, and Essendonia should value the importsat 100 units each. In accordance with the BPMconcept of market price, however, Cromania,Dromesia, and Essendonia should value the importsat 80 units each. Upward adjustments made bycustoms officials for the purpose of eliminatingspecial quantity discounts received by importersshould not be recorded in the balance of payments.

286. As foreign exchange and other bank recordscovering transactions in goods settled through thebanking system reflect prices actually paid for goods,valuation adjustments generally need not be appliedto data contained in such records. An exception isany adjustment required to convert a transactionprice to a market price for goods such as thosetransferred, at prices significantly distorted frommarket values, between related enterprises.

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287. According to the BPM, the BOP currentaccount is divided into three broad categories:goods and services (which is subdivided into thesame two components), income, and currenttransfers. The goods component is discussed inchapter 4. Chapter 5 deals with issues associatedwith the recording of transactions in services.Definitions and treatments of each of the items inthis component are elaborated upon.

288. Unlike the production of goods, the productionof a service is generally linked to an arrangementbetween a particular producer and a particularconsumer. Thus, international trade in services isclosely linked with international production ofservices as the production process involves aresident and a nonresident. Despite the conceptualdifference between goods and services, theboundary is sometimes blurred in practice;conventions are therefore necessary to assistcompilers in classifying borderline transactions forthe balance of payments.

289. The significance of particular types oftransactions in services varies from country tocountry. Nevertheless, a standard classification fortransactions in services is recommended in the BPMfor a number of reasons. These include theincreasing global importance of numerous types oftransactions in services; the desirability of linkingBOP classifications with those of the Central ProductClassification (CPC); the analytic value, for users, of astandard classification; and the statistical requirementsfor multilateral negotiations on international trade inservices. The classification framework is alsodesigned to encompass transactions expected toassume greater importance in the future.

Transportation Services

Definition

290. In the BPM, transportation is defined ascovering services provided by all modes oftransportation performed by residents of oneeconomy for those of another. Modes of

transportation consist of sea, air, and other—whichincludes land, internal waterway, space, andpipeline. Transportation includes the carriage ofpassengers and the movement of goods (freight), aswell as rentals (charters) of carriers with crew.Related supporting and auxiliary services (such ascargo handling, navigation fees, and maintenanceand cleaning of carriers) are also included intransportation. Excluded from transportation servicesare freight insurance (included in insuranceservices); repairs of transportation equipment(included in goods); repairs of railways, harbors,and airfield facilities (included in constructionservices); and rentals (charters) of carriers withoutcrew (included in other business services).

291. Most transportation services, for bothpassengers and freight, are provided by enterprisesthrough the operation of carriers or similarequipment. Because carriers such as ships or aircraftmay operate in the territory of more than oneeconomy or outside the territory of any economy,determination of the residence of the enterprise thatoperates the carrier—and, consequently, theeconomy to which the services provided by thecarrier should be attributed—is not alwaysstraightforward. (Refer to chapter 4 of the BPM andparagraphs 103–106 of the Textbook for furtherinformation on this issue.)

292. In the BOP standard components,transportation services are classified by type of carrier(sea transport, air transport, and other transport) andby functional category of service (freight, passenger,and other). This section of the Textbook focuses onthe functional classification of transportation servicesbecause assignment of carrier classification is usuallyquite straightforward. Issues associated with rentals oftransport equipment, which can impact on more thanone transportation item, are discussed at the end ofthe section.

Freight

293. The freight item is closely related to the goodscomponent of the balance of payments. Freight, as

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V. Services

defined in the BPM, refers mainly to the carriage ortransport of goods. The definition excludes shippingservice for baggage that accompanies passengers oninternational journeys; the cost of this service isusually included indistinguishably in statistics forpassenger services. Freight services are almostalways performed in connection with an economy’sexports and imports of goods, and any borderline inthe balance of payments between goods and freightis, in a sense, artificial. Nevertheless, the distinctionbetween goods and freight is important as thedistinction permits comparison of the goodscomponent for economies that provide few freightservices with the goods component of economiesthat provide many such services internationally.

Freight on Imports and Exports of Goods

294. Freight services provided to or acquired fromabroad by the reporting economy will mostly, but notalways, relate predominantly to that economy’sexports and imports of goods. Goods may be ownedby the exporter at the time of shipment abroad, orthe importer may have accepted delivery of thegoods prior to implementation of internationalshipment. In the case of the reporting economy’sexports and imports of goods, the BOP compiler isusually not able to ascertain (from information it isfeasible to collect on goods or freight services) whoowned the goods when shipment took place. Thisinformation is required to determine whethertransactions between residents and nonresidents havetaken place as freight services are performed for, oron behalf of, the legal owners of goods. Anynecessity for relating changes of ownership to freightservices can be obviated by the use of a conventionfor limiting entries for freight services on imports andexports of goods to the carriage of the compilingcountry’s goods beyond the customs frontier of theexporting country. Under a convention of this kind,certain categories of transactions that take place—in astrictly legal sense—between residents are entered asmutually offsetting credits and debits, and certainoffsetting transactions between residents andnonresidents may be excluded from the balance ofpayments. The use of such a convention is, ofcourse, at variance with the general rule for includingin the balance of payments only gross flows ofservices between residents and nonresidents. Theproblems of data collection are minimized, however,because entries made on the basis of this conventionrepresent identifiable types of services performed(whether or not the relevant goods are, at the time,

owned by a resident or a nonresident) by residentsor nonresidents.

Freight Services Provided by the Compiling Economy

295. Freight services performed in connection withexports can be performed on behalf of the exporteror the importer. Strictly speaking, export-relatedfreight services performed by resident operators onbehalf of exporters are transactions betweenresidents. For example, the cost of freight service ongoods transported from the border of an exportingcountry to the point of sale in an importing countryis estimated to be 100 units. The goods are sold foran all-inclusive price of 1,000 units. From thestandpoint of flows between residents andnonresidents, the value of the transaction in goodsamounts to 1,000 units. However, as the BPMconvention is to record the value of goods at thecustoms border of the exporting country, the totalvalue of 1,000 units is split between goods (valuedat 900 units) and freight services (valued at 100units). The flow of services proceeds from (1) theproducer of the service to (2) the exporter to (3) theimporter, rather than directly from residententerprises furnishing the freight services to theimporter. The service flows occur in this waybecause goods may be sold in one reporting periodbut freight services may have been rendered by theproducer to the exporter in a preceding period.

296. When freight services are performed byresident transport operators on behalf of anonresident importer, there is no ambiguity ininterpreting a flow of services from resident tononresident inasmuch as the importer is the ownerof the goods. The direction of the service flow isfrom the producer (a resident enterprise) to theimporter (a nonresident enterprise).

297. Freight services related to the compilingcountry’s imports may be performed, on behalf of thenonresident exporter, by resident enterprises. Thenonresident exporter may sell the commodities onlyupon arrival of the commodities in the compilingcountry. Until that time, the exporter is the owner ofthe commodities. For example, if the cost of freightservices is 200 units and the all-inclusive sales priceof commodities is 1,200 units, the flow (from thestandpoint of the compiling country) betweenresident and nonresident consists of an export ofservices (200–unit credit) and an import of goods(1,200–unit debit). However, as goods are—according

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to the BPM convention—valued at the customsborder of the exporting country (that is, at 1,000units), the additional value of 200 units becomes aservice element provided by a resident producer to aresident consumer (the importer). Hence, in thisinstance, the service flow is:

producer ♦ exporter ♦ importer(resident) (nonresident) (resident)

When freight services related to the compilingcountry’s imports are rendered—on behalf of theimporter—by resident carriers, these servicesunambiguously represent a transaction between tworesidents and are therefore excluded from the scopeof BOP statistics.

Freight Services Acquired by the Compiling Economy

298. What are the freight services that a reportingeconomy acquires from abroad in respect of exportsand imports of goods? Services are performed inconnection with exports when the exporter consignsgoods abroad for subsequent sale. When goods areprovided to a nonresident, the shipping serviceperformed in connection with these goods is clearlyan international transaction. Because valuationuniformly takes place at the customs border, valueadded through shipping of the goods is construed,ultimately, as a service flow from the exporter to thenonresident importer. The direction of the serviceflow is:

producer ♦ exporter ♦ importer(nonresident) (resident) (nonresident)

299. Freight services that are purchased from abroadand relate to the compiling country’s imports consistof services performed (a) on behalf of the exporterand (b) on behalf of the importer. Services performedon behalf of the nonresident exporter are clearlytransactions between nonresidents. However, becauseof the uniform valuation of goods, these services areshown in the balance of payments as service flowsfrom nonresident exporters to importers rather thanas integral parts of the value of goods. In these cases,the direction of the service flow is:

producer ♦ exporter ♦ importer(nonresident) (nonresident) (resident)

When freight services are acquired from abroad andperformed on behalf of a resident importer, it is clearthat such services are international transactions. Thedirection of the service flow is from the producer(nonresident enterprise) to the resident importer.

Conventions for Recording

300. How do freight service flows between residentsand nonresidents compare with BOP entries madeaccording to the method recommended in the BPMfor recording the transactions? The BPM method, ineffect, is to treat freight services that are performed(a) in connection with the compiling country’s goodsand (b) beyond the customs frontier of the exportingcountry as though such services were performed forresidents of the importing country. The treatment isthe same whether the freight services are providedby residents of that country or by residents of anyother country. The procedure is for the compilingcountry to (a) enter as credits all export-relatedservices performed by resident carriers after theexports have been loaded on board the carriers atthe customs border and (b) enter as debits allimport-related services performed by nonresidentsafter the imports have been loaded on board thecarriers at the customs borders of the countries fromwhich the commodities are being exported.

301. For example, an exporter in Longa sells twocommodities to an importer in Pokolbin. Accordingto the terms of the sale contract, the exporter is todeliver the goods to the importer at a port of entryin Pokolbin. The exporter hires, for 200 units, theservices of a resident carrier to ship one of thecommodities. To ship the second commodity, theexporter hires, for 300 units, the services of a carrierbelonging to Central Paradiso. In accordance withthe method recommended in the BPM, transportationservices performed beyond the customs border ofthe exporting country are construed as transactionsbetween the carrier and the importing country.Therefore, 200 units of the freight cost incurred bythe exporter represent the provision of a service bya resident (the transportation enterprise) of Longa toa resident of Pokolbin (the importer). The other 300units of freight cost represent the value of shippingservices supplied by a resident carrier of CentralParadiso to the importer in Pokolbin. BOP entries forthe freight item for Longa, Pokolbin, and CentralParadiso would be:

Longa Pokolbin Central ParadisoCredit Debit Credit Debit Credit Debit

Freight 200 500 300

302. The disadvantage with the approachrecommended in the BPM is that such an approachmay bring about the exclusion of offsetting flowsbetween residents and nonresidents. If therecommendation for recording freight is followed,

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entries are not recorded in the balance of paymentsas offsetting credit and debit entries. When thetransactions occur in different periods, the entryrecorded in the second period should reverse theentry recorded in the first period rather thanrecording an additional service flow. However,exclusions of offsetting entries accord with theeconomic reality that, in the final analysis, the costof freight is borne by the importing economy—whatever arrangements may have been made forshipping the goods.

303. The primary purpose of the BPM convention isto establish a method of recording freight (and otherdistributive services) performed in relation to goodson a basis that is (1) consistent with uniform f.o.b.valuation for the goods component and (2) easier tofollow in practice than the regular procedure forrecording, in the current account, gross resident-to-nonresident transactions. Use of this conventionadmittedly does not obviate all the statistical problemsthat may arise in compiling the items for goods andfreight. When these two items are derived from tradereturns based on c.i.f. valuations of imports at thefrontier of the importing country, a separate estimatemust be made of the amount spent on distributiveservices performed beyond the customs frontier of thecountry from which the goods were exported. Thisdisaggregation simply reallocates, between goods andservices, the distributive services element in the c.i.f.valuation of imports; therefore, any error in estimationwill not affect the two items in combination.Furthermore, if the compiling country performs any ofthe distributive services in connection with its ownimports, the amount of such services must beestimated separately from a total that includes similarservices performed by the compiling country inconnection with exports or other goods owned bynonresidents. While disaggregated data may beconsiderably more difficult to obtain than data ontotal earnings, any error in estimating disaggregateddata will produce equal over- or understatement ofthe credit and debit sides of components for freightand other distributive services and will not affect thenet amount of the item.

304. For example, the total value of imports assessedon a c.i.f. basis is 15,000 units. A sample shows thatthe ratio of imports valued f.o.b. to imports valuedc.i.f. is 0.9—that is, 10 percent of the value of importsassessed on a c.i.f. basis constitutes the cost of freight.The difference between the c.i.f. and f.o.b. valuationsis attributable to freight services that were providedby nonresident enterprises. In this case, the value of

freight services acquired from nonresidents would beestimated at 1,500 units, and the value of goodsassessed on an f.o.b. basis would be 13,500 units.BOP entries for the current account would be:

Credit Debit

Goods 13,500Freight 1,500

Alternatively, if the transportation componentrepresents 11 percent of the total value of importsassessed on a c.i.f. basis, the value of freight servicesand imports of goods valued f.o.b. would be 1,650units and 13,350 units, respectively. From the stand-point of the reporting country, the total value ofdebits (in respect of the sum of goods and freight)in the current account remains the same in bothcases, although the allocation between the two itemsis different.

305. Some freight services performed in respect ofthe reporting country’s imports may be provided byresident enterprises. To determine the value of freightservices provided by nonresidents, the cost ofdistributive services supplied by resident enterprisesmust be deducted from the total cost of transportingimports of goods beyond the customs border of theexporting country. Resident transport enterprises arenormally able to provide data for total earnings onthe international movement of goods and may beable to provide a disaggregation of these earningsinto earnings on imports, earnings on exports, andother earnings from abroad. For example, such datacould indicate that total earnings of domesticenterprises engaged in international transportationservices amounted to 400 units, 150 units of whichwere attributable to earnings on imports. On thebasis of this information and the assumption that thevalue of goods assessed on a c.i.f. basis was 15,000units, 10 percent of which represented internationalfreight, the following BOP entries can be constructed:

Credit Debit

Goods 13,500Freight 250 1,350Reserve assets (or other

appropriate financial account item) 14,600

306. If the accounting systems of resident transportenterprises do not contain information on earningsfrom the shipment of imports, the BOP compilermay have to resort to indirect methods of estimation,such as sample inquiries. The compiler may err indisaggregating total freight services between residentand nonresident suppliers of these services.

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However, any over- or understatement of creditentries is balanced by the probability that debitentries are equally over- or understated. Forexample, if the estimated 150–unit value of freightservices performed by domestic enterprises inconnection with imports was actually 200 units, thenthe value of freight services performed in connectionwith the country’s exports (credit) would beoverstated by 50 units. However, the value of freightservices attributable to nonresidents, which is aderived figure, would also be overstated by the sameamount. That is, instead of being 1,300 units, thenonresident freight services would be calculated as1,350 units. The net amount of the freightcomponent would not be affected.

307. According to the BPM rule for uniformvaluation, the performance of distributive services inconnection with goods always begins at the customsfrontier of the exporting economy. To achievesymmetry between partner country recording ofseparate credit and debit entries for freight, anotherrule stipulates the place at which the performance ofgoods-related freight and other distributive servicesceases—whether at the frontier of the importingcountry or at an interior point in that country. A ruleis necessary because the recommended method forrecording distributive services performed inconnection with the compiling country’s goods canyield entries that are partly net, while the methodused for recording other distributive services alwaysshows gross transactions between residents andnonresidents. The rule states that distributive servicesare regarded as being part of those performed inconnection with goods if such services are(a) performed within the territory of the importingcountry and (b) covered in a single contract (forexample, a “through bill of lading”) that also pertainsto the freight charged on goods up to the frontier ofthe importing country. Stated conversely, the rulestipulates that services performed within the territoryof the importing country (for example, freightforwarding from the frontier to an interior point) andarranged under a separate contract are considered tobe part of freight on goods other than imports orexports and are recorded on a full gross basis. Thisrule is intended to simplify the compilation of thefigures by conforming to underlying data most likelyto be available.

Other Freight Services

308. Only those services performed in connectionwith distribution of goods beyond the customs

frontier of the country from which the goods wereexported are recorded under the conventiondesigned to ensure uniform valuation. For otherdistributive services, the usual recording practice foritems in the current account must be followed.That is, the gross service flows between residentsand nonresidents must be recorded. For example,ownership of a commodity may change from theeconomy of Namdarb to the economy ofHughesavia. Distributive services performed inshipping the commodity beyond the customs borderof Namdarb to the point of destination inHughesavia are provided by a resident ofClintonstan. From the standpoint of Hughesavia, thetransaction represents the purchase of freightservices relating to the import of goods; from theperspective of Clintonstan, the transaction representsthe provision of distributive services for moving non-domestic goods. Freight may also include shipmentof goods that are not exports or imports of anycountry (such as goods transported within a countryby coastal shipping or some other means); shipmentof goods to or from entities located outside theterritories of which the entities are residents (such asgoods sent from a country to its agencies andagency personnel located abroad); and shipment ofgoods lost or destroyed after crossing the frontier butbefore being delivered to the importer.

309. As the physical point for uniform valuation ofgoods is defined in the BPM as the border of theexporting country, any distributive servicesperformed up to that point constitute an integral partof the value of goods assessed on an f.o.b. basis.Consequently, offsets are made in freight to certainresident-nonresident flows that may be included inthe goods component when goods are valueduniformly at the customs frontier of the exportingcountry. Specifically, freight service debits arerecorded by the exporting country and freight servicecredits are included by the importing country forfreight services that the importing economy provideswithin the exporting country’s customs frontiers.

310. For example, the economies of Algornia andCoonawarra are contiguous. An importer inCoonawarra takes delivery of a commodity at theseller’s establishment, which is located at an inlandpoint in Algornia. At the establishment of theAlgornian exporter, the value of the goods is 100units. The importer hires a trucking firm fromCoonawarra to transport the goods to his place ofbusiness, and the cost of transporting the goodsfrom the establishment of the seller to the border of

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Algornia is 20 units. In the BOP statements of botheconomies, the value of the goods would be shown as 120 units. To offset the overstatement,which is caused by the uniform point of valuation,of the goods export figure (credit) for Algornia, acontra entry (debit) is made under freight.Conversely, to offset the overstatement of the goods import figure for Coonawarra, a contra entry(credit) is also made in the freight component. Theentries reflect the distributive services rendered byresidents of Coonawarra in moving the goods froman inland point to the border of Algornia. BOPentries in respect of the goods and freightcomponents are:

Algornia Coonawarra


Goods 120 120Freight 20 20

Treatment of Loading (Stevedoring) Charges

311. Freight refers mainly to the carriage of goods.However, as used in the BPM, the term also includesany ancillary services provided by a carrier inconjunction with the service of transport. Inparticular, freight includes the services of loadinggoods on board a carrier and unloading goods froma carrier if the contract between the owner of thegoods and the enterprise operating the carrierrequires the latter to provide that service. If such aservice is performed at the customs frontier of thecountry from which goods are exported and if theservice is provided by or on behalf of the carrier, the loading charge is included as part of freight.Otherwise, the loading charge is included in thevalue of goods. For example, an importer inCromania takes delivery of goods at the border of the exporting country. The goods are worth 1,000 units. The importer contracts with a carrierbelonging to Dromesia to transport the goods to hisplace of business, and the freight cost is 100 units.Furthermore, the carrier is to arrange for thestevedoring services, which cost 5 units and areprovided by a resident of Dromesia. In this case, the freight charge would include the 5 units inrespect of loading costs. BOP entries for Cromaniawould be:

Credit Debit

Goods 1,000Freight 100Reserve assets (or other appropriate


312. If the freighter were instead operated by aCromanian enterprise, the balance of payments ofCromania would contain the following entries:

Credit DebitGoods 1,000Transportation-other 5Reserve assets (or other appropriate


313. Alternatively, if the importer arranges forstevedoring services, these should be included in thevalue of the goods. In this case (if the operator ofthe carrier is a not a resident of Cromania), the BOPentries would be:

Credit DebitGoods 1,005Freight 95Reserve assets (or other appropriate


314. This treatment is used because the statisticscollected on freight usually cover indistinguishablyall services performed by or on behalf of carriers,whereas statistics collected on goods are unlikely toinclude loading charges if loading is provided by oron behalf of the carrier. (Refer to paragraphs321–324 for further discussion on the recording ofstevedoring transactions in the balance of payments.)

Passenger Services

315. Passenger services are described in the BPM asservices provided by carriers for the transport ofpassengers between countries and services provided,within a specific country, to residents by a carrieroperated by a nonresident enterprise. Theseexamples illustrate the definition.

Example 1 Clintonstan Air, which is operated by anenterprise resident in Clintonstan, transportsresidents of Bushland between airports inClintonstan and Bushland. Clintonstan Air’s receiptsfrom these passenger fares are 100 units.

Example 2 Clintonstan Air transports residents ofBushland from airport A1 to airport A2 in Clintonstan.The tickets for the trips are purchased by Bushlandresidents inside the borders of Clintonstan. The tripsdo not constitute a continuation of an internationaljourney. Clintonstan Air’s receipts from passengerfares are 50 units.

Example 3 Clintonstan Air transports residents ofBushland from airport B1 to airport B2 in Bushland.The trips do not constitute a continuation of aninternational journey. Clintonstan Air’s receipts frompassenger fares are 25 units.

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The balance of payments of Clintonstan shouldreflect the following entries:

Credit Debit

Passenger services 100 (example 1)25 (example 2)

Travel 50 (example 2)Reserve assets (or other

appropriate financialaccount item) 175

316. In examples 1 and 3, the transportation ofnonresident passengers by a domestic carrier istreated as part of passenger services; in example 2,the transaction is treated as part of travel. There aretwo primary reasons for this treatment.

317. The first reason is that, in practice, it is verydifficult to collect data on carrier services provided tononresidents and performed within the economies inwhich the carriers reside. When selling tickets topassengers, carriers normally do not obtaininformation on the residence of passengers.Compilers of BOP statistics often assume that faressold by domestic carriers in the domestic market aresold to residents and, therefore, represent transactionsthat should be excluded from the balance ofpayments. Likewise, fares sold abroad by domesticcarriers are assumed to be sold to nonresidents andto represent passenger services that should berecorded under other transport. In example 2, thefares to nonresidents are sold domestically from theviewpoint of Clintonstan. Identification of passengerservices rendered to nonresidents is probably notpossible because Clintonstan Air does not requestinformation on the residence of passengers.Furthermore, it is likely that expenses incurred byBushland residents in Clintonstan for passengerservices provided by Clintonstan Air will—regardlessof whether foreign exchange records or samplesurveys of nonresident travelers are used to estimatetravel—be included in overall estimates of travelexpenses of nonresident visitors.

318. The second reason is that all goods andservices (including passenger services) acquired bynonresidents in a particular country must berecorded in the BOP statement under travel (if thegoods and services are acquired by travelers or bynonresident workers) or under government servicesn.i.e. (if the goods and services are acquired byforeign official personnel stationed in that country).Such classification is dictated by both analytical andpractical considerations.

319. According to the BPM, passenger servicesinclude actual fares paid to carriers and all incidental expenditures that passengers incur inconnection with carrier transportation or for whichthey pay fees to carriers. Thus, on-boardexpenditures of passengers for food, gifts, souvenirs,etc. and any charges for excess baggage or personaleffects (such as automobiles) accompanyingpassengers on their journeys constitute part ofpassenger services.

Other Transportation Services

320. The services-transportation-other categorycomprises distributive services that are performedduring the course of shipment but are incidental toshipment. Such services include storage andwarehousing; loading and unloading (stevedoring)services not classified under goods or freight;packing and repacking; binding and packaging;cartage, drayage, and haulage; forwarding, handling, and transferring; airport and harbor dues;towing, pilotage, and other navigational aid forcarriers; maintenance and cleaning of transportequipment; and salvage operations. Included as well are commissions and agent fees associated with passenger and freight transportation.

321. The recording of most transactions relating tothe services-transportation-other category isgenerally straightforward. However, the treatment ofstevedoring services warrants further discussion.Paragraphs 311–314 present information about therecording of transactions relating to stevedoringwhen the stevedoring is provided in the exportingeconomy. Two other cases of stevedoringtransactions—stevedoring services provided in theimporting economy and stevedoring servicesprovided in connection with goods other thanexports or imports of the country of the stevedoringenterprise— are discussed in subsequent paragraphs.

322. It is recommended that stevedoring transactionstaking place in the importing economy be recordedon a strict resident/nonresident basis. Thus, whenstevedoring services are arranged by an enterprisethat is not a resident of the importing economy andprovided by a resident stevedoring enterprise, anentry should be made in services-transportation-other. The offset to this entry will be, in all cases,part of the freight item. For example, if a Cromanianimporter pays an Essendonian exporter 1,000 units

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for arranging freight services and 10 units forarranging stevedoring in Cromania, the followingentries would (if it is assumed that the good aretransported by a carrier that is not a resident ofCromania) be made in Cromania’s balance ofpayments:

Credit Debit

Freight 1,010Transportation-other 10Reserve assets (or other


If, on the other hand, the goods are transported by aCromanian resident carrier, the debit entry for freightwould be 10 units, and the net transaction in reserveassets would be nil.

323. Recording transactions in this way classifiesstevedoring services performed in the importingeconomy as part of freight services rather than asservices ultimately attributed to the importer in theway that international freight services are. Thereason for this treatment is that stevedoring services performed in the importing economy and provided to nonresidents will generally be an indistinguishable part of overall freight services.

324. Stevedoring services provided in connectionwith goods that are not exports or imports of thecountry providing the stevedoring services shouldalso be treated, on a strict resident/nonresident basis, as other transportation services. For example,if a Hughesavian importer purchases goods fromDomestica and the goods are unloaded and loaded in Nostaw en route, the stevedoring should be shown, in the balance of payments ofNostaw, as a credit under services-transportation-other and as a debit under the same item in thebalance of payments of the country of the enterprisethat arranged the stevedoring service. The countrycould be that of the importer, or the exporter, or theoperator of the carrier.

Rental of Transportation Equipment

325. A transportation service often performed byone economy for another is the rental (charter) orlease of mobile equipment such as ships, aircraft,trucks, and railroad cars. A rental or lease should bereflected in the balance of payments when anenterprise resident in one economy retains legalownership of equipment but hires or leases theequipment to an enterprise resident in another

economy. According to the BPM, however,equipment (including transportation equipment)obtained under financial leases should not be treatedas charters in the balance of payments. Instead,these goods should be added to the capital stock ofthe economy of the lessee, and an imputed changein the ownership of these goods should be recordedin the balance of payments. A full discussion of thetreatment of these cases is provided in chapter 2.

326. For rentals of transportation equipment that arenot financial lease arrangements, a distinction shouldbe made between equipment rented with and withoutcrew. When transportation equipment is rented withcrew for a limited period, a transportation service isprovided, and the value of this service is equivalent tothe rental payment. If equipment is rented withoutcrew, the rental should be recorded under operationalleasing in the other business services item. In thesecases, it is the lessee—rather than the lessor—that isproducing the transportation services, and the rentalof equipment without crew is treated the same as therental of any other equipment.

327. For example, an enterprise in Central Paradiso charters an aircraft with crew from anenterprise resident in Domestica for a period of twoweeks. In this and similar cases, the BPMrecommendation is that the charter should,depending on the use of the aircraft, be treated as afreight or passenger service. By providing the crew,the Domestican owner of the aircraft continues tooperate the aircraft.

Travel

Definition

328. The travel component should cover all goodsand services acquired for personal use by travelersduring their visits in host countries. A traveler isdefined in the BPM as an individual who stays forless than one year in a country where he or she isnot a resident. The following types of persons arenot regarded as travelers:

(a) official diplomatic and consular representatives;members of the armed forces; other governmentpersonnel of a foreign economy; and thedependents, who are stationed in the foreigneconomy, of these individuals

(b) diplomatic and military personnel who arestationed on a military base or in an embassyand nonresident experts employed by a foreign

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government (These personnel are not, from theviewpoint of the countries where theseindividuals are stationed, considered travelers.Therefore, the expenditures of these individualsin the foreign economy should be included ingovernment services n.i.e. rather than in travel.)

(c) persons who are temporarily engaged in aproductive activity in another economy and whoare paid for their work by an entity of thateconomy. (However, any expenditures, on goodsand services in the economy in which they workshould be recorded under travel.)

329. The one-year rule does not apply to studentsand medical patients who remain residents of theireconomies of origin even if the length of stay inother economies is more than one year. Therefore,host economies should—regardless of the length ofstay—consider students and medical patients astravelers. All goods and services, including educationand medical services, acquired by students andmedical patients while in host economies areregarded as travel expenditures and not recordedunder any other items in the goods or servicescomponents.

330. Services pertaining to the international carriageof passengers—that is the carriage of travelersbetween countries—are not recorded under thetravel item. Such services are recorded in thepassenger services category. For example, if aresident of Hughesavia travels to Essendonia anddecides there to undertake a trip by bus fromEssendonia to neighboring Cromania, the passengerservice provided to the resident of Hughesavia bythe carrier of Essendonia should be excluded fromtravel and included in the passenger servicescategory. However, in practice, it may be difficult toobtain the relevant data from a carrier in Essendoniabecause carriers normally do not collect informationon the residence of passengers to whom they selltickets.

331. The scope of the travel item, as described inthe BPM, is similar to the definition and coverage ofvisitors in World Travel Organization (WTO)recommendations relating to statistics oninternational tourism. However, there is an importantdifference between the BPM and WTO definitions.The former includes the expenditures of seasonaland border workers, but the latter excludes theseexpenditures.

Types of Travel

332. Two types of travel, business and personal, aredescribed in the BPM and reflected in the BOPstandard components. For analytical purposes,further disaggregation, such as the separateidentification of education- and health-relatedexpenditures, may be useful under the personalcategory of the travel item.

Business Travel

333. Business travelers are commercial travelerswho visit an economy for sales campaigns, marketexploration, or commercial negotiations on behalf ofthe nonresident enterprise that employs them.Government employees who are traveling on officialbusiness and are not stationed in the economiesthey visit and employees of internationalorganizations on official missions are businesstravelers. Employees installing machinery orequipment (if the enterprise that employs them isnot a resident of the economy where the installationtakes place) and crew members of carriers stoppingoff or lying over are classified as business travelers.Excursionists traveling for the purpose of business,such as attendance at meetings, should also beregarded as business travelers. Personalexpenditures on goods and services by seasonal,border, and other nonresident workers in theeconomies in which they are employed are alsorecorded under travel-business.

Personal Travel

334. This category covers travelers going abroad forpurposes other than business (for example, holidaysfor pleasure; participation in sports; visits to relativesand friends; and religious, educational, and healthpurposes). Also included in this category aregovernment employees on leave in economies otherthan those in which they are resident or those inwhich they are stationed. For example, U.S. militarypersonnel who are stationed in Germany andholiday in Switzerland should be treated as travelerswhile they are in Switzerland.

Goods and Services Covered

335. Included as part of the travel item are allgoods and services acquired by travelers. It does notmatter—as long as the goods and services areacquired by the traveler for personal, rather than

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commercial, use—whether the goods and servicesare consumed immediately or later, or whether thegoods and services are finally consumed by thetraveler himself or by a third person. For example,an automobile purchased by a traveler during herstay in a host country and shipped to her homecountry for personal use should be included as partof the travel item. Goods that are obtained and latergiven away by the traveler should also be includedin the travel item.

336. The travel item should also cover goods andservices acquired by travelers whether the goods andservices are paid for by the traveler or provided tohim without a quid pro quo. In practice, informationon goods received free of charge (such as free roomand board received by official visitors or freeinstruction received by students) will be difficult toobtain. If information is available, offsetting entriesshould be made in travel and current transfers.

337. The most common goods and services thatnonresident travelers acquire when staying in a hostcountry are meals, lodging, entertainment,sightseeing excursions, gifts, and souvenirs. It is alsorecommended that fees such as airport taxes ortickets for traffic violations be recorded undertravel—although such fees are, strictly speaking,transfers. This recommendation is predicated ongrounds of practicality, and these transactions areunlikely to be internationally significant.

338. For example, a resident of Coonawarra travelsin Daniherland for six months to attend a trainingcourse. During this time, the traveler spends 850units on goods and services, 500 units of which arespent on an automobile that the traveler subsequentlytakes back with him to Coonawarra and 30 units ofwhich are spent on gifts for relatives in Daniherland.The traveler stays in accommodations provided bythe Daniherland government. The accommodationsare provided free of charge but valued at 125 units.The following entries should be recorded inDaniherland’s balance of payments:

Credit DebitGoods 30Travel 975Current transfers

General government 125Other 30

Reserve assets (or other appropriate financial account item) 850_____ _____

1,005 1,005

The travel item includes the accommodation servicesreceived by the traveler without a quid pro quo, aswell as the purchase of the automobile. The gifts

provided to the traveler’s relatives are shown asimports of goods and are offset by a transfer.

Other Services

339. Transactions in international services notcovered under transportation or travel items arecovered under other services. In the BOP standardcomponents, other services comprise nine broadcategories: communications services; constructionservices; insurance services; financial services;computer and information services; royalties andlicense fees; other business services; personal,cultural, and recreational services; and governmentservices not included elsewhere (n.i.e.). Chapter 13 ofthe BPM provides a detailed description of the typesof transactions covered by each of these categories.The discussion in this Textbook is limited toparticular transactions for which the recording issomewhat complicated.

Construction Services

340. Construction services cover work onconstruction and installation projects performed byconstruction enterprises that are residents ofeconomies other than those in which the work istaking place. The BOP compiler often facesproblems in determining the residence of enterprisesengaged in construction activity. However, the rules(which are discussed in chapter 3 of the BPM andchapter 2 of the Textbook) used to determine theresidence of enterprises should be applied toconstruction enterprises as well. The initialdetermination is the economy to which productionshould be attributed. If production is deemed to beundertaken by the country in which the constructionenterprise is resident, the host country should recordconstruction service imports. Correspondingly, thecountry in which the construction enterprise isresident should record construction services. Thevalue of these construction services should equal thefull value of the construction project and not anotheramount such as net profit or net foreign exchangereceived by the construction enterprise. If productionis deemed to be undertaken by the host economy, adirect investment enterprise that is resident in thehost country is created, and no construction servicesare recorded in the balance of payments. Thefollowing two examples illustrate the treatment ofenterprises engaged in construction activity abroad.

341. An enterprise in Daniherland is awarded aconstruction contract worth 8,000 units for a project

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located in Pokolbin. The contract is implementedduring a six-month period. The enterprise incursthese expenditures:

Materials purchased in Pokolbin 3,000Materials purchased in Daniherland 1,000Wages paid to residents of Pokolbin 1,000Taxes paid to government of Daniherland 1,000

Because the duration of the project is less than oneyear, production should be attributed to theenterprise resident in Daniherland, which is deemedto be providing a construction service to Pokolbin.Accordingly, these entries would be required inDaniherland’s balance of payments:

Credit Debit

Construction services 8,000Other business services 3,000Compensation of employees 1,000Reserve assets (or other appropriate


The materials purchased in Daniherland and taxespaid to the government of Daniherland are resident-resident transactions and, therefore, not recorded inthe balance of payments.

342. An enterprise from Namdarb is awarded aconstruction contract worth 60,000 units for a projectlocated in Jaymaranda. The contract is implementedduring a two-year period. Because of the long-termnature of the project, the enterprise sets up a siteoffice in Jaymaranda and maintains a complete set ofaccounts for operations in that economy. Toundertake the project, machinery worth 12,000 unitsis sent from Namdarb to Jaymaranda. At the end ofthe first year, the value of the work in progress is25,000 units. This amount is paid by the client inJaymaranda. After the expenses incurred inJaymaranda are paid, the balance is remitted toNamdarb. At the end of the second year, theremaining 35,000 units are paid by the client. Theseexpenditures are incurred on the project.

Year 1 Year 2

Materials purchased in Jaymaranda 6,000 12,000Wages paid to residents

of Jaymaranda 7,000 4,000Wages paid to residents of Namdarb* 2,000 2,000Depreciation on machinery 1,000 1,000Taxes paid to government

of Jaymaranda 3,000 5,000______ _____

Total expenses 19,000 24,000Net profit 6,000 11,000______ ______

25,000 35,000

*Wages paid to Namdarb residents who work on the project for short (lessthan one year) periods of time

In this example, the criteria for attributingproduction to a resident of Jaymaranda have beensatisfied; therefore, a direct investment enterprise,which undertakes the construction, is established.The following BOP entries would be made inNamdarb’s balance of payments:

Year 1 Credit Debit

Goods (machinery) 12,000Compensation of employees 2,000Direct investment income 6,000Direct investment-provision

of machinery 12,000Direct investment-depreciation 1,000Reserve assets (or other


Year 2 Credit Debit

Goods (machinery) 10,000Compensation of employees 2,000Direct investment income 11,000Direct investment-return

of machinery 10,000Direct investment-depreciation 1,000Reserve assets (or other


As the direct investment enterprise is a resident ofJaymaranda, transactions between this enterprise andother Jaymarandian residents are obviously notrecorded in Namdarb’s balance of payments.

Insurance Services

343. Insurance services cover the provision ofvarious types of insurance to nonresidents byresident insurance enterprises and vice versa. Thisitem covers many types of insurance, includinginsurance on freight, accident insurance, marineinsurance, fire insurance, reinsurance, life insurance,and commercially provided pension and annuityservices. To classify insurance services correctly inthe balance of payments, a distinction should bemade between nonlife (casualty) insurance and lifeinsurance, which includes commercially providedpension and annuity services.

Nonlife Insurance

344. Conceptually, the “normal” service charge thatan insurer takes into account in setting premiumsduring a specific period may not be the same as thenet premiums (premiums minus claims) payableduring that period. Losses may be greater or lesserthan those expected in the longer run; claims maynot yet be payable on losses that have alreadyoccurred; and premiums may have been paid in

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advance on risks to which the insurer has not yetbeen exposed. Therefore, in principle, net premiumsmay reflect not only a service charge but also capitalgains/losses and pre- or postpayments. Furthermore,insurers will invest their unearned premiums(premiums paid in advance of periods in which anyclaims that may result from these premiums areincurred), and the income earned from theseinvestments will also be taken into account by theinsurer in determining the “normal” service charge.Because of the practical difficulties in sorting outthese various elements, net premiums are customarilyconsidered—for BOP purposes—the measure ofinsurance services from the point of view of theinsurer. This method is therefore recommended inthe BPM for determining exports of all types ofinsurance services and imports of reinsuranceservices.

345. However, if each individual insurancetransaction (or a subset of an insurance enterprise’stransactions) is considered, net premiums become avery poor proxy of the measure of insuranceservices. When a premium of 10,000 units is paid ona policy, the service charge represents only afraction of this amount. The remainder representsmoney transferred to the insurance enterprise to payfuture claims in respect of this or other policies.Likewise, a claim of 50,000 units does not representa “negative service” provided by the insuranceenterprise. The claim simply reflects a transfer offunds from the insurance enterprise to the claimant.For these reasons, the BPM recommendation is that,for imports of insurance services, the serviceprovided should be calculated—in the case ofinsurance on goods—by applying to gross premiumspaid to nonresident insurers the ratio of insuranceservices to gross premiums for exports of insuranceservices or—in the case of other direct insurance—by applying to gross premiums paid to nonresidentinsurers the ratio of estimated service charges to totalpremiums for resident insurers. Other flows ofmoney between the resident insured and thenonresident insurer—that is, premiums payableminus the estimated service charge and claimsreceivable—are regarded as transfers.

346. The following example illustrates therecording of insurance services in the balance ofpayments. An insurance company resident inAlgornia insures residents of Coonawarra,Cromania, Dromesia, and Essendonia against therisk of damage from hurricanes. Premiums of 4,000units are received from each country. During the

accounting period, a claim of 10,000 units is madeas a result of storm damage suffered inCoonawarra. In accordance with recommendationsin the BPM, the insurance services provided by theinsurer are equal to the premiums received minusany claims paid. Thus, the following BOP entrieswould be made for Algornia:

Credit Debit

Insurance services 6,000Current transfers 10,000 10,000Reserve assets (or other


The transfer items represent, for debits, claimspayable and, for credits, premiums receivable minusthe insurance service charge. While these entries arenet across all transactions, such will not be the caseat the regional level.

347. On the basis of information contained inparagraph 346, the insurance service charge per unitof premium for this type of insurance may becalculated as 6,000 units (net premiums) divided by 16,000 units (gross premiums), or 0.375. Therefore,the insurance service received by Coonawarra,Cromania, Dromesia, and Essendonia is 0.375 timesthe premium paid (4,000 units), or 1,500 units each.This result makes sense, as each country receivedexactly the same insurance coverage from Algornia.

348. BOP entries for Coonawarra, Cromania,Dromesia, and Essendonia may now be constructed.Entries for Cromania, Dromesia, and Essendonia areidentical.

Credit Debit

Insurance services 1,500Current transfers* 2,500*Reserve assets (or other


*The transfer debit entries represent premiums paid minus the servicecharge.

For Coonawarra, the following BOP entries arerequired:

Credit Debit

Insurance services 1,500Current transfers* 10,000 2,500*

Reserve assets (or other appropriate financial account item) 6,000

*The transfer debit entry is equal to premiums paid minus the servicecharge. The transfer credit entry is equal to Coonawarra’s claims receivable.

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349. As the statistician has the necessary information,it is possible to allocate, for domestic transactionsand exports of insurance services, insurance servicecharges to classes of policyholders in proportion topremiums paid. However, it is difficult to do thesame for imports of insurance services as theimporters are generally not in a position to determinethe proportion of service charges attributable tothem. (Therefore, the BPM recommendation is to useratios derived from the domestic insurance industry.)For imports of insurance services, other proxies mustbe used to estimate insurance service charges. If thisprocedure is not feasible (for example, if the type ofinsurance services under consideration are notexported or if there is no domestic insurance industryfor a particular type of insurance), the long-termrelationship between premiums paid to nonresidentsand claims received from nonresidents could be usedto determine approximate service charges.Alternatively, BOP compilers in the exporting countrycould be contacted for information regarding servicecharges.

350. Before the discussion of nonlife insuranceservices is concluded, it may be useful to considermeasures to be taken if claims exceed premiums forexported insurance services or for imports ofreinsurance services. Use of the difference betweenpremiums and claims would result in a “negative”service charge, which is a concept that makes noeconomic sense. Therefore, it is recommended thatthe compiler use the “normal” service charge perunit of premium, which is calculated by using thelong-term relationship between premiums andclaims, to determine the service charge for theperiod under consideration. This recalculatedinsurance service charge would then be used in thecalculation of items for insurance services andrelated transfers.

Life Insurance

351. Two main features distinguish life insurancefrom nonlife insurance. There is often a substantial lagbetween the payment of life insurance premiums andthe payment of claims arising from these premiums.For example, a 20–year-old person takes out a lifeinsurance policy that matures when she turns 60. Thepayout value is based upon total payments madeduring the life of the policy. Forty years will elapsebetween initial payments and actual payout of thepolicy. The income earned on these premiums, whichconceptually should be considered in the calculationof the insurance service charge, is often significant.

The second distinguishing feature of life insurance isthe certainty that a claim will occur. (Insurancepolicies that pay claims only in the event of deathbefore a particular age are not considered lifeinsurance for BOP purposes.) Because of thiscertainty, payment of premiums may be viewed bythe insured as savings, and claims may be viewed aswithdrawal of these savings. Furthermore, with manylife insurance policies, the policyholder has a“surrender option”; that is, he or she can cash in hisor her policy before maturity. On the basis of theseattributes, the life insurance policyholder is consideredto have a claim on the life insurance enterprise.

352. It is recommended in the BPM that the serviceelement in life insurance be calculated on the samebasis as the service element associated with nonlifeinsurance. However, this practice could producemisleading results in the balance of payments—particularly if international transactions in lifeinsurance are significant.10 If this is the case, analternative and more meaningful way of calculatingthe service charge associated with life insurancewould be to divide the sum of the operating costsand profits of life insurance enterprises into totalpremiums payable. As with nonlife insurance, theservice charge is more easily calculated for exports ofinsurance services than for imports. Similar ratios,which could be obtained from the domestic lifeinsurance industry or from BOP compilers in othercountries, could be used for imports. As life insurancetransactions between residents and nonresidents tendto be relatively insignificant and service charges tendto be a relatively small percentage of premiums, analternative is to ignore entirely the service element oflife insurance transactions.

353. Because of the investment nature of lifeinsurance premiums and claims, life insurancepremiums (minus any service charge calculated) arerecorded as increases in the policyholder’s claim onthe life insurance enterprise (or mutual pool, in thecase of mutual funds); claims (and surrenders ofpolicies) are recorded as decreases in this investment.Investment in life insurance is recorded, in thefinancial account and the international investmentposition, under the other investment-otherassets/liabilities items. The subject is not addressed inthe BPM, but the compiler may wish to record

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10Subtracting claims from premiums to determine a proxy for the insuranceservices item is more likely to result in the calculation of a “negative” servicecharge for life insurance than for nonlife insurance—even if the calculationis made with average premiums and claims from a number of years.

“bonuses” on life insurance policies. (Bonuses arisefrom the investment, by insurance enterprises, ofpolicyholder funds.) Such bonuses could be recordedas income payable from insurance enterprises topolicyholders and offset by an increase inpolicyholder claims on insurance enterprises.

354. An example may clarify the treatment of lifeinsurance in the balance of payments. Residents ofPokolbin pay 12,000 units in premiums to anonresident life insurance enterprise and receive22,000 units in claims. Furthermore, analysis ofPokolbin’s domestic life insurance industry showsthat the ratio of operating costs and profits topremiums receivable is 0.05. The following entrieswould be recorded:

Pokolbin’s Balance of Payments:

Credit Debit

Insurance services 600Financial account

Other investment-other assets* 22,000 11,400Reserve assets (or other appropriate


*In BOP presentations, these entries would be shown on a net basis(10,600–unit credit). Gross entries are shown for illustrative purposes only.

The insurance services item was calculated bymultiplying the 12,000 units of premiums by 0.05.The increase in investment (debit entry) wascalculated as the difference between premiums andthe estimated service charge.

Financial Services

355. Financial services cover a number oftransactions in services related to the financialindustry. A full description of this item can be foundin chapter 13 of the BPM. One type of transaction—foreign exchange trading—that gives rise to financialservices is considered in the Textbook. According tothe BPM, transactions denominated in foreigncurrency should be converted to the unit of accountby using the midpoint between the buy and sell rateapplicable at the time of the transaction. As themidpoint rate is unlikely to be the rate actually usedin the transaction, how should transactions involvingthe exchange of one currency for another berecorded in the balance of payments? The midpointrule should still be applied. The difference betweenthe value of the part of a transaction involvingforeign exchange converted to the unit of accountby using a midpoint rate and the value of the partof the transaction involving the unit of account

represents an implicit service normally provided by a financial intermediary (such as a bank or other foreign exchange dealer) to a customer (suchas a corporate client). This service should beclassified under financial services in the balance of payments.

356. For example, an Australian bank usesAustralian dollars (A$) to buy United States dollars(US$) at the rate of A$1.39 to US$1 and sells USdollars at the rate of US$1 to A$1.41. The midpointrate is US$1 to A$1.40. An American resident wishesto exchange US dollars for A$10,000, which will bedeposited with the Australian bank. At theAustralian bank’s buy rate, the American residentwill pay US$7,194. Entries in Australia’s balance ofpayments show that the Australian bank increasesits holdings of US dollars by US$7,194. Converted atthe midpoint rate, this amount is shown inAustralia’s balance of payments as a debit ofA$10,072. The bank’s liabilities (in the form ofdeposits) increase (a credit entry) by A$10,000. TheA$72 credit required to balance the entriesrepresents a financial service provided by the bankto a nonresident.

Australia’s Balance of Payments

Credit Debit

Financial services 72Other investment-assets 10,072Other investment-liabilities 10,000

357. Consumers are unlikely to know the value ofservices that they have implicitly purchased and, inmany cases, the producer will be unable to provideinformation on services provided to nonresidents.Proxies for service charges could be calculated bydetermining the average spread (difference)between buy and sell rates and then multiplyingforeign exchange transactions with nonresidents byhalf of this spread.11 However, care must beexercised in determining which party is theconsumer and which party is the producer of theservice—particularly with regard to transactionsbetween foreign exchange dealers located indifferent economies. The same dealer can be aprice-taker (consumer) in one transaction and aprice-maker (producer) in another transaction.(Additional information on this topic can be foundin paragraphs 562–568 of the Balance of PaymentsCompilation Guide.)

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11Similar adjustments will be required for financial account entries if theentries have been recorded at buy or sell rates rather than at midpoint rates.

Merchanting and Other Trade-RelatedServices

358. Two aspects of this item warrant considerationin the Textbook: (1) commissions and similar fees onexports or imports of goods and (2) merchanting.

Commissions and Similar Fees on Exports andImports of Goods

359. According to the BPM, agent fees on exportsand imports are regarded as part of the value ofgoods if such fees are paid by the exporter (regardlessof whether the agent is a resident of the exportingcountry or some other country) or if such fees arepaid by the importer to an agent resident in theexporter’s country. When agent fees are paid by theexporter to a nonresident agent or paid by animporter to an agent in countries other than theimporting or exporting economy, entries should bemade in the balance of payments in the merchantingand other trade-related services item. No entries arerequired in this item for agent fees paid by theimporter to agents in the exporting country. Whilesuch transactions involve residents in different econ-omies, the fees constitute part of the value of trans-actions in goods to which the agent fees are related.

360. The following example illustrates the materialin paragraph 359. These transactions take placebetween Domestica and Nostaw in a particular year.

aValue (excluding agent fees) of goods exported from Domestica to Nostaw 200

bFees charged on Domestica’s exports (seea) by an agent in Nostaw and paid by the importer 10

cFees charged on Domestica’s exports (seea) by an agent in Domestica and paid by the importer in Nostaw 20

dValue of goods imported by Domestica from Nostaw 300eFees charged on Domestica’s imports (seed) by

an agent in Cromania and paid by the importer 40

In this case, the balance of payments of Domesticashould show the following entries:

Credit Debit

GoodsExports f.o.b. 220Imports f.o.b. 300

Merchanting and other trade-related services 40

Reserve assets (or other appropriatefinancial account item) 120

Thus, entries under exports include agent fees thatwere paid in connection with transactions in goodsby the Nostawan importer to an agent resident in

Domestica. Fees paid by the Nostawan importer tothe agent in Nostaw are not reflected in the value ofexports as the transaction is strictly between twononresidents.12 The debit entry recorded formerchanting and other trade-related services relatesto agent fees paid by the importer in Domestica to aresident of a third economy, Cromania. Had thesefees been paid to a resident of Nostaw, the feeswould have been included in the value of goodsrecorded in the balance of payments rather thanbeing shown as a separate transaction undermerchanting and other trade-related services.

Merchanting

361. The acquisition and subsequent sale of goodsthat do not cross the frontier of the economy inwhich the temporary owner of these goods is aresident is called merchanting. These transactionsare not recorded as imports and subsequent re-exports of goods. The BPM recommendation is thatany difference in the value of the goods be regardedas a fee for a service rendered to nonresidents andthat this fee be included in merchanting and other-trade related services. Speculative gains or lossesrealized from transactions in commodity arbitrage arealso recorded under this item. However, speculativegains or losses occurring in connection with financialitems constitute part of the value of these items and,when realized, such gains or losses are reflected inthe financial account. Paragraphs 189–194 of theTextbook provide additional details on the treatmentof merchanting.

362. An enterprise in Bushland purchases coffeefrom a resident of Central Paradiso for 300 units andsells the coffee to a resident of Jaymaranda for 330units. The goods are shipped directly from CentralParadiso to Jaymaranda, and the goods do not crossthe border of Bushland. In another transaction, theenterprise in Bushland speculates in oil stocks heldabroad and loses 10 units in the transaction.

The balance of payments of Bushland should showthe following entries:

Credit DebitMerchanting and other

trade-related services 30–10

Reserve assets (or other appropriate financial account item) 20

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12Furthermore, BOP compilers in Domestica would generally not haveaccess to this information. However, customs authorities in Nostaw mayinclude these fees in their valuation of Nostaw’s imports, in which case thefees should be deducted by Nostaw’s BOP compilers.

Thus, the credit entry for merchanting represents themerchanting gain of 30 units, which is calculated asthe difference between acquisition and sale prices ofthe coffee, and the debit entry for that item reflectsthe loss from oil trading.

Government Services n.i.e.

363. Government services n.i.e. include (1) transactions between the compiling country’sgovernment and other governments (or internationalorganizations); (2) transactions between thecompiling country’s government andnongovernment nonresident entities; (3) transactionsbetween foreign governments (includinginternational organizations) and the compilingcountry’s nongovernment units; and (4) personalexpenditures by foreign diplomatic, military, andother personnel of official entities in the economyin which the entities are located. However, not allof the transactions satisfying this criterion should berecorded as government services n.i.e. Transactionsthat can be classified under other BOP items shouldbe recorded accordingly. Subsequent paragraphsdescribe in detail some of the principal transactionsclassified as government services n.i.e.

Embassies, Consulates, and Other Official Entities

364. Transactions of embassies, consulates and otherofficial entities of foreign governments (such asmilitary units, aid missions, tourist and informationoffices, libraries, and offices to encourageimmigration) with residents of countries where theentities are located should be recorded in the balanceof payments of both the host countries and thecountries represented by the entities. According tothe BPM, these entities are residents of the countriesrepresented rather than the countries where theentities are located. Goods and services acquiredfrom host economies by these entities should beregarded as transactions in the government servicesn.i.e. item in the balance of payments of bothcountries. On the other hand, cash remittances,shipments of goods, and any other transactionsbetween these official entities and their homecountries should be excluded from the balance ofpayments of host countries because thesetransactions represent transactions betweennonresidents.

365. Transactions of the nonresident personnel offoreign official entities (such as embassies) withresidents of the economies in which the entities arelocated should also be recorded in the balance ofpayments. The residence of personnel fromembassies, consulates, and other government officesis not defined by the usual one-year rule of residencebut by center of interest. On the basis of the centerof interest concept, persons posted from their homecountries to work in official entities located in othercountries maintain centers of interest in their homecountries—regardless of whether the employeesreside in host countries for less or more than oneyear. Therefore, such personnel are always treated asnonresidents of host countries, and transactions ofthese personnel with residents of host countriesshould be included in the balance of payments.

366. The following summary represents the principaltypes of transactions engaged in by embassies,consulates, other official entities, and relatedpersonnel and classified as government services n.i.e.:

expenditures in host countries by embassies,consulates, etc. for goods and services such as officesupplies and furniture, fuel and utilities, rent orpurchases and sales of embassy buildings, officialcars and the operation and maintenance thereof, andofficial entertainment;

personal expenditures in host countries bydiplomatic, military, and other personnel of foreignofficial entities.

367. Several examples show how transactions relatingto embassies and other official entities located abroadshould be recorded in the balance of payments. Inthe first example, the Cromanian embassy inHughesavia buys, for embassy use, an office buildinglocated in Hughesavia. The embassy pays 500 unitsfor the building. The balance of payments ofCromania should show the following entries:

Credit Debit

Government services n.i.e. 500Reserve assets (or other

appropriate financial account item) 500

However, purchases and sales of land by foreignembassies should not be recorded as governmentservices n.i.e. Rather, these transactions should berecorded under the acquisition or disposal of non-produced, nonfinancial assets in the capitalaccount.

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SERVICES

76

368. In the second example, during a particular year, Cromania’s embassy in Hughesavia collects the following receipts and makes the followingpayments through commercial banks in Hughesavia:

ReceiptsaCash received from government in Cromania 1,000bInterest on bank deposits in Hughesavia 50

PaymentscWages paid to Hughesavian staff 200dWages paid to Cromanian staff 500eExpenditure for office supplies in Hughesavia 50fRent for embassy building 150

These transactions should be recorded in the balanceof payments of Hughesavia in the following manner:

Credit Debit

Government services n.i.e. 50e

150f

Compensation of employees 200c

Investment income 50b

Other investment-assets-currency and deposits-banks 1000a

Other investment-liabilities-currency and deposits-banks* 1000a 200c

50b 50e

150f

*In BOP presentations, this item would be shown on a net basis (650–unitcredit). Gross entries are shown for illustrative purposes only.

369. In the third example, a resident of Cromania isstationed for three years with the embassy of hiscountry in Hughesavia. The Cromanian residentcollects the following receipts and makes thefollowing payments through commercial banks inHughesavia:

ReceiptsaSalary paid by embassy into local bank account 500bInterest on bank account in Hughesavia 10cDividends (on shares from an enterprise

in Cromania) paid into local bank account 50

Payments

dExpenditures for food and clothing in Hughesavia 100

eRent for apartment in Hughesavia 150fPurchase of a car in Cromania 1,000**The funds were transferred from the diplomat’s bank account in Hughe-savia to Cromania prior to the purchase.

The balance of payments statement of Hughesaviashould reflect the following entries:

Credit Debit

Government services n.i.e. 100d

150e

Investment income-interest 10b

Other investment-assets-currency and deposits-banks* 1000f 500a

50c

Other investment-liabilities-currency and deposits-banks* 500a 100d

10b 150e

50c 1000f

*Entries are shown on a gross basis for illustrative purposes.

In practice, it often may be difficult to obtain dataon the expenditure by nonresident staff ofembassies, consulates, military units, etc. Therefore, an estimate of their expenditures may bebased on information received from those entities on wages and salaries paid to nonresident personnel.

370. In addition to transactions between foreigngovernment entities located in a country and theresidents of that country, receipts and contributionsmade under joint military arrangements constituteanother group of transactions recorded in thecategory of government services n.i.e. Also recorded under this item are general administrativeexpenditures associated with aid.

Definition

371. Income, in economic accounts such as thebalance of payments, consists of earnings arisingfrom the provision of the factors of production: land,labor and capital. Ownership of land, according toBOP concepts, is always attributed to residents.Consequently, income receivable (such as rent) forthe use of land will generally be a transactionbetween residents and, therefore, outside the scopeof the balance of payments.13 Accordingly, theincome component of the balance of payments isrestricted to income earned from the other twofactors of production: labor and capital. Incomeearned from the former is called compensation ofemployees, while income earned from the latter iscalled investment income.

372. In principle, any earnings derived from theprovision of nonfinancial assets is not consideredincome for BOP purposes. The most common types of earnings from the provision of nonfinancialassets are royalties and licenses, earnings from filmrentals, and earnings from rentals or charters ofequipment. Royalties and license fees comprise anitem in the services component of the currentaccount. Rentals and charters of transportationequipment with crew are recorded undertransportation-other in the services component.Rentals of other equipment are recorded in otherbusiness services-operational leasing in the services component. Earnings from film rentals and other distribution rights are recorded inpersonal, cultural and recreational services-audiovisual and related services in the servicescomponent.

Compensation of Employees

373. Compensation of employees includes wages,salaries, and other compensations (whether paid incash or in kind) earned by nonresident individualsfor work performed for residents of the economy in which the work is performed. (The definition of a nonresident worker can be ascertained byreferring to chapter 4 of the BPM and chapter 2 ofthe Textbook.) Included as part of compensation of employees are contributions paid by employers to social security schemes or similar privateinsurance or pension funds. However, interest and other income received by nonresident workers from financial investments made in host economies are classified as investment income.

374. In editions previous to the fifth, the treatmentrecommended in the BPM for expenditures ofnonresident workers in host economies was torecord these expenditures under the same item—labor income—as nonresident worker salaries, etc.However, this treatment of workers’ expendituresresulted in disharmonization with the nationalaccounts. The BOP entries contained amountsrelating to both income and consumption, which are two distinct concepts within the nationalaccounting framework. Consequently, the treatmentof workers’ expenditures, which are now part oftravel, was changed to harmonize with the nationalaccounts. However, in practice, information availableto many countries on compensation of workers isnet of the expenditures of these workers.(Paragraphs 580–588 of the Balance of PaymentsCompilation Guide describe the data sources thatcould be used to measure compensation ofemployees.)

375. An example illustrates the recording, in the balance of payments, of transactions relating to nonresident workers. A worker fromNamdarb is employed for three months by anenterprise located in Cromania. In Cromania, theworker receives certain amounts and makes certainpayments.

77

VI. Income

13In rare circumstances, a nonresident may rent land from a resident. Forexample, a traveler could rent land while traveling in an economy otherthan his or her own or an enterprise operating temporarily in anothereconomy could rent land as part of the temporary operation. In thesecases, the rental would be recorded in the balance of payments as part ofthe services component; the rent from the traveler would be recordedunder travel; and the rent from the enterprise would be recorded undermiscellaneous business, professional, and technical services.

ReceiptsSalary from enterprise in Cromania 500Interest on bank deposit in Cromania 50Rent from an apartment owned by

the worker in Cromania 200

PaymentsFood consumed in Cromania 110Clothing purchased in Cromania 100Property tax paid to government in Cromania 40Income tax paid to government in Cromania 50

The balance of payments of Namdarb should reflectthese entries:

Credit Debit

Services-travel 210Income

Compensation of employees 500Direct investment income 160Other investment income 50

Current transfers-general government 50Reserve assets (or other appropriate


376. The salary received by the nonresident workerin Cromania is shown on a gross basis undercompensation of employees, while the rent received (net of property taxes) from investment inan apartment and interest on bank deposits areclassified, respectively, as income under directinvestment and other investment. The nonresidentworker’s expenditures on goods and services inCromania are recorded under travel, while theincome tax paid is shown as a current transfer.

377. Individuals who derive labor income fromemployment in countries where they are notresidents can be either border or seasonal workers.Border workers are individuals whose abodes arenot located in the economies in which they work.Seasonal workers are individuals who live and workin economies for less than one year. Labor incomepaid by resident entities to nonresident border andseasonal workers is recorded as compensation ofemployees.

378. The following example clarifies materialcontained in paragraph 377. A Belgian national (A)lives in Belgium but near the border with France andworks for an enterprise in France. Two other Belgiannationals (B and C) work for the same enterprise inFrance but have homes in France. B has a contract forsix months; C’s contract is open-ended. In one year,the Belgian nationals receive the following salaries:

A 200B 300C 350

The balance of payments of Belgium should showthese entries:

Credit Debit

Income-compensation of employees 500


Only the salaries paid to A and B are recorded inthe balance of payments of Belgium. From theviewpoint of that country, A is a border worker andB is a seasonal worker, and both are receivingsalaries from a nonresident employer. C, however,must be regarded, from the viewpoint of Belgium, asa nonresident, and the income he receives in Franceshould not be recorded in the balance of paymentsof Belgium.

379. The Belgian nationals spent the followingamounts for consumption in Belgium and France:

Belgium France

A 150 50B 100 200C 60 300

The balance of payments of Belgium should recordthese expenditures:

Credit Debit

Services-travel 60 250Reserve assets (or other


The entry under travel credits represents theexpenditures, which must be treated as travelreceipts, made by the nonresident national (C) inBelgium. The entry under travel debits reflects thepersonal expenditures made in France by A and B,who are employed with private enterprises in thatcountry. The expenditures made in Belgium by Aand B are not recorded because these expendituresare related to transactions between residents. Theexpenditures made by C in France representtransactions between nonresidents and are alsoexcluded from the statement of Belgium. It isacknowledged in the BPM that it is often verydifficult for the compiler to distinguish betweenforeign nationals who work and live in a country forless than one year and those who work and live in acountry for one year or longer. The BPM suggestionis that an effort should nonetheless be made toobserve the distinction between foreign workers whoshould be treated as nonresidents and workers who

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are residents. Lack of uniformity in the statisticaltreatment of the same individuals by the two relevantcompiling economies could create significantproblems of asymmetry between the BOP statements.

Investment Income

Definition

380. Investment income is defined in the BPM asthe income accruing to an investor from theownership of financial assets. The most commontypes of financial assets are bank deposits, loansextended, bonds, bills, shares in the equity capital ofan enterprise, and head office claims on branches.Investment income derived from these assetscomprises mainly interest, dividends, remittance ofbranch profits, and direct investor shares of theretained earnings of direct investment enterprises.

381. Interest represents income that is normallypaid in accordance with a binding agreementbetween a creditor and a debtor. Included are allcommitment charges in lieu of interest anddiscounts covered by such agreements. Net interestflows arising from interest rate swaps and similarinstruments are also included. Dividends are paid,in contrast, by virtue of discretionary decisions ofincorporated enterprises. Dividends representincome payable without a binding agreementbetween creditor and debtor. Dividends may bepaid in cash or in stock.

382. Apart from dividends payable on shares ofequity capital in incorporated enterprises, investmentincome may also result from the ownership or co-ownership of branches and other unincorporatedenterprises operating abroad. These enterprises areaccorded resident status in the economies in whichthe enterprises operate. Any income remitted fromenterprise operations to nonresident owners isrecorded in the balance of payments underinvestment income-direct investment.

383. Another type of investment income recorded inthe balance of payments is direct investor shares ofthe retained earnings or net losses of anincorporated enterprise and the retained earnings orlosses of branches and other unincorporatedenterprises. Retained earnings increase the value ofan investor’s financial investment in an enterprise,and losses lessen the value of the financialinvestment. Therefore, retained earnings represent,from the viewpoint of the direct investor, the

counterpart to an increase in the value ofinvestment; losses represent the counterpart to adecrease in the value of investment. In accordancewith BPM conventions, portfolio investor shares ofthe retained earnings and losses of an enterprise areexcluded from the BOP statement.

384. Two examples are presented to illustratepreceding concepts. An investor in Dromesia holds50 percent of the shares of an enterprise located inLonga. The profits or net earnings are 500 units. Theenterprise decides to pay 300 units in cash dividendsto shareholders and to retain 200 units to increaseenterprise reserves. In this case, the BOP statementof Dromesia should record (1) the direct investor’sshare of cash dividends, which amounts to 150, asan investment income inflow and (2) 50 percent,which amounts to 100 units, of the retainedearnings. Total investment income is therefore 250units. The investor’s 50 percent participation in theequity capital of the enterprise should entitle her toan effective voice in the management of thatenterprise; therefore, she is a direct investor. Thus,the decision to retain a part of enterprise earningsmust have been made with her concurrence. It canbe assumed that, had the direct investor wished,those earnings would have been distributed.Accordingly, the direct investor made a consciousdecision to forgo the distribution of income and toreinvest the earnings in the direct investmententerprise. Therefore, offsetting entries are madeunder investment income-direct investment-reinvested earnings in the current account andunder direct investment-reinvested earnings in thefinancial account. (For further elaboration of theconcept of direct investment, see chapter 18 of theBPM and chapter 9 of the Textbook.)

385. An investor residing in Domestica holds sharesof a large international corporation located inEssendonia. The investor’s shares represent only lpercent of the equity capital of that enterprise. Theprofit of the corporation is 1000 units. One-half ofthat amount is paid in dividends to shareholders andthe other half is retained by the enterprise. In thiscase, the investment income flow recorded in thebalance of payments of Domestica is 5 units, whichrepresent only the investor’s share of the distributedearnings. The retained earnings are not investmentincome because the investor’s minor (1 percent)participation in the enterprise makes it unlikely thathe has an effective voice in the management of thecorporation. His investment therefore representsportfolio investment rather than direct investment. As

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the decision to retain a portion of the corporation’searnings would be made without muchconsideration of the portfolio investor’s views,reinvested earnings are not shown as income in thebalance of payments in this case.

386. Under certain circumstances, investmentincome may also result from the operation of mobileequipment in an economy other than the economyin which the operator is actually resident. (Seeparagraph 106 of chapter 2.) According to BPMconventions on residency, a change of ownership isimputed for mobile equipment that is operatedabroad for a period of one year, accounted forseparately by the operator, and recognized by theauthorities of the host economy as part of thateconomy’s capital stock. Therefore, a resident ofCoonawarra who operates an aircraft in Hughesaviais regarded as having a direct investment in anotional enterprise in Hughesavia if the precedingcriteria are satisfied. Earnings from the aircrafttherefore represent part of the gross earnings of thenotional enterprise in Hughesavia. After depreciationcosts are deducted, the net earnings are recordedunder direct investment as income of the enterprisein Coonawarra. These earnings are construed asresulting from the financial investment in thenotional enterprise in Hughesavia. An example ofthis type of transaction is provided in paragraphs552–554 of chapter 9.

387. If goods are leased under a financial leasearrangement, a change of ownership from the lessorto the lessee is imputed. The portion of the leasefees representing interest on the loan that isconstrued as being extended in connection with thechange of ownership of the equipment is recordedunder investment income. (See paragraphs 109–111of chapter 2 for elaboration of the treatment offinancial leases.)

388. Another case in which investment income isderived from a type of lease arrangement is thelease or rental of land. For example, a resident ofNostaw owns land in Daniherland and leases theland to a resident of Daniherland for a fee of 100units. According to the BPM convention, land—except when owned by extraterritorial bodies suchas foreign embassies—is always owned by aresident of the economy in which the land islocated. Therefore, it is necessary to create anotional enterprise to which ownership of the landin Daniherland can be attributed. The lease paymentis now considered a domestic transaction. In Nostaw

where the legal owner resides, the imputedwithdrawal of entrepreneurial income from thenotional enterprise is shown in the balance ofpayments as:

Credit Debit

Direct investmentIncome on equityDividends and distributed

branch profits 100Reserve assets (or other


389. Capital gains and losses are excluded frominvestment income. Capital gains and losses do notrepresent income at all but are part of the value ofthe financial assets. When realized, capital gains andlosses are recorded in the financial account.14 Allunrealized valuation changes are excluded from theBOP statement. Valuation changes are, however,reflected in stock positions shown in the IIPstatement and in changes in the values of thesepositions over time.

390. If, however, debt securities (such as bonds,notes, and bills) are issued by the debtor at valuesthat differ from amounts paid to the holders whenthe securities mature, the premiums or discounts arenot regarded as capital losses or gains but asportions of the interest paid on those securities. Thepremiums and discounts on securities are thereforeclassified in the investment income category.

Classification

391. For the purpose of BOP recording, investmentincome is divided into income from directinvestment, portfolio investment, and otherinvestment.

Income from Direct Investment

392. Income from direct investment is income thataccrues to a direct investor from ownership of direct investment capital. A direct investor is aninvestor who makes a long-term investment in anenterprise with the intention of having an effectivevoice in the management of that enterprise.Accoding to the BPM, ownership of 10 percent ormore of the shares of an enterprise is considered a

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14Realized valuation changes are reflected as part of the financialtransactions giving rise to the realization of gains or losses, but suchvaluation changes remain excluded from income.

direct investment. Direct investment capital isprimarily comprised of:

the share of the direct investor in the equity capitalof an enterprise;

the share of the direct investor in accumulatedprofits not remitted by the enterprise;

other net claims of the direct investor on the directinvestment enterprise.

Direct investment enterprises can be incorporatedenterprises (privately or publicly owned), branches,unincorporated enterprises, or notional enterprisesdelineated in accordance with the principles ofresidence presented in the BPM.

393. The BPM divides income from direct investmentinto (1) income on equity (which includes dividends,distributed branch profits, and reinvested earnings)and (2) income on debt (interest). The followingexample illustrates this classification scheme.Enterprise X in Clintonstan holds 50 percent of theequity of enterprise Y in Bushland. Thesetransactions take place in the reporting period. Theprofits of Y are 200 units, of which 100 units are paidin dividends to shareholders and 100 units arereinvested in the enterprise. Enterprise X extends along-term loan of 500 units to enterprise Y, and theinterest rate on this loan is 10 percent. Concurrently,enterprise Y has a claim of 100 units on enterprise Xin the form of a short-term trade credit on which theinterest rate is 15 percent. Enterprise X issues bondsat an interest rate of 8 percent, and enterprise Yacquires 100 of these bonds.

The balance of payments of Clintonstan shouldreflect these entries:

Credit Debit

Direct investment incomeIncome on equity

Dividends 50Reinvested earnings 50

Income on debt (interest) 27Direct investment-abroad (Bushland)

Reinvested earnings 50Reserve assets (or other appropriate


The credit entries under direct investment income-income on equity reflect the share of enterprise X indistributed and undistributed earnings of enterpriseY. The entry for direct investment income-income ondebt reflects the interest (50 units) received on theloan extended to enterprise Y minus the interest(15+8=23 units) payable by X to Y. The interest

payable by X to Y is recorded, in accordance withrecommendations contained in the BPM, as negativedirect investment income. Any income derived byenterprise X from investments in enterprise Y isnetted against income paid by X to Y. If enterprise Yheld a small number of shares in enterprise X, thisinvestment would represent negative directinvestment rather than portfolio investment.Dividends payable by enterprise X to enterprise Yon such shares would be netted against dividendspayable by direct investment enterprise Y to directinvestor X.15 The rationale for these negative directinvestment flows is explained in paragraph 529 ofchapter 9.

Income from Portfolio Investment and OtherInvestment

394. Income from portfolio investment and fromother investment is income accruing to an investorfrom investment (other than direct investment) infinancial assets. The most typical forms of incomefrom portfolio investment are interest earned on debtsecurities and dividends earned on equity securities(shares) issued by companies in which the investorhas no effective voice in the management. Paymentsmade under interest rate swaps and similararrangements also represent income from portfolioinvestment. The BPM shows that income fromportfolio investment is divided into two categories:(1) income on equity and (2) income on debt.Income on debt is further divided into (1) incomeearned from bonds and notes and (2) income earnedfrom money market instruments and financialderivatives (such as interest rate swaps).

395. The most common forms of income from otherinvestment are interest earned from deposits, loans,and trade credits. Lease fees from financial leasearrangements represent, in part, interest on loansconstrued to be extended in connection withimputed changes of ownership for the goods. Thisinterest also constitutes income from otherinvestment.

396. The following example illustrates theclassification scheme for investment income. In aspecific period, residents of Urangastan derivecertain income from their financial investmentsabroad.

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15An exception to the netting of income flows between a direct investorand a direct investment enterprise occurs when each enterprise isconsidered a direct investor in the other. In these cases, income flowsbetween the two enterprises should be recorded on a full gross basis.

Central Bank of Urangastan

(1) Interest of 70 units on bank deposits(2) Interest of 80 units on securities issued by a foreign

public enterprise(3) Interest of 30 units on a loan extended to a foreign

central bank

Government of Urangastan

(4) Dividends of 40 units on a 50 percent share in theequity of enterprise X located in Central Paradiso

(5) Share of 50 units in the undistributed earnings ofenterprise X located in Central Paradiso

(6) Dividends of 20 units on a 5 percent share inenterprise Y located in Central Paradiso

National Airline of Urangastan

(7) Interest of 10 units from bank deposits abroad(8) The airline receives a charter fee of 25 units for an

aircraft chartered for two years to Central Paradiso foroperations in Central Paradiso. The aircraft is separatelyaccounted for by the airline and is recognized by theauthorities of Central Paradiso as part of that country’scapital stock. The charter fee includes depreciationcosts of 10 units and the remainder of the fee (15units) represents direct investment income.

(9) The airline receives a lease fee of 35 units for equip-ment (other than mobile equipment), which is leasedfor six years to Jaymaranda. As the cumulative leasepayments will cover 80 percent of the value of theequipment and the carrying charges, the lease is afinancial one. The compilers estimate that the lease feecovers depreciation costs of 20 units and interestpayments of 15 units.

Car Manufacturer in Urangastan

(10) Interest of 15 units on debt securities issued by aforeign government

(11) Interest of 55 units on trade credits extended to adealer in Central Paradiso

(12) Net receipts of 12 units from an interest swap contractwith a bank in Central Paradiso

(For simplicity, it is assumed that all foreign currencyreceipts were sold to the central bank for local currency.)

In the BOP statement of Urangastan, thesetransactions should be classified thus:

Credit Debit Transaction No.

Investment incomeDirect investment

Income on equityDividends and

distributed branch profits 55 (4)+ part (8)

Reinvested earnings 50 (5)Portfolio investment

Income on equity 20 (6)Income on debt

Bonds and notes 95 (2)+(10)Financial derivatives 12 (12)

Other investment 180 (1)+(3)+(7)+ part(9)+(11)

Credit Debit Transaction No.Direct investment-abroad

(Central Paradiso)Equity capital 10 part (8)Reinvested earnings 50 (5)

Other investment-assetsLoans

Other sectors-long-term 20 part (9)

Reserve assets (or other appropriate financial account item) 392 (1)+(2)+(3)+

(4)+(6)+(7)+(8)+(9)+(10)+(11)+(12)

Time of Recording

397. In principle, all investment income flows arerecorded at the time of accrual. If interest paymentsrelate to a period of time equal to, or shorter than,the period covered by the BOP statement, interest isalso recorded when due rather than when actuallypaid. On the other hand, if interest payments relate toa period longer than that for which the BOPstatement is prepared, the interest is apportioned toeach of the relevant BOP accounting periods. Forexample, if a country that compiles annual BOPstatements issues a discounted bond that matures inthree years, the discount, which represents interest, isapportioned into three amounts representing incomefor each of the years for which BOP statistics areprepared. (In addition to the examples providedsubsequently, further information on recordinginterest on an accrual basis may be found inparagraphs 614–624 of the Balance of PaymentsCompilation Guide.) Dividends are recorded whendeclared payable and not when actually paid.Remitted profits of unincorporated enterprises arerecorded at the time of remittance. Reinvestedearnings are recorded in the period in which therelated profits are earned.

398. Recording income on a full accrual basisrequires an entry in the financial account to offsetany income (which is recorded in the currentaccount) that is earned but not paid during theaccounting period. These financial account entries areextinguished when the interest in actually paid. (In thecase of securities issued at discount, such entries areextinguished when the securities are redeemed or sold.)

Interest

399. The following examples illustrate time ofrecording for interest income. According to the

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binding agreement between the creditor and thedebtor, interest due on a long-term loan extended bythe government of Clintonstan to the government ofBushland amounts to 100 units at the end of 1990and 120 units at the end of 1991. Bushland compilesBOP statistics on an annual basis. As the frequencywith which interest payments are due is the same asthe periodicity of Bushland’s BOP statements, thestatement should reflect interest payments due ineach year—whether or not the interest is actuallypaid. If the debtor is not able to pay the interest onthe loan at the end of 1990 but makes up for thepayment in the following year, these entries wouldbe shown:

Bushland Balance of Payments Statement for 1990

Credit Debit

Investment income-other investment 100Other investment-liabilities

General government-short-term* 100

Bushland Balance of Payments Statement for 1991

Credit Debit

Investment income-other investment 120Other investment-liabilities

General government short-term* 100Reserve assets (or other appropriate


*In analytical presentations of the balance of payments, these entries wouldbe recorded below the line as transactions involving arrears.

Thus interest is recorded for 1990 although it wasnot actually paid. The contra entry to this debit isshown as an increase in short-term liabilities. In1991, when the interest due in 1990 is paid, the BOPstatement shows a decrease in short-term liabilities.

400. The next example illustrates the recording ofinterest income when interest payments are due lessfrequently than BOP statistics are prepared.Madornia issues a 20-year, zero coupon bond with aface value of 10,000 units to a resident of Pokolbin.(A zero coupon bond is one that has no discreteinterest payments. Instead, at the time ofredemption, the holder of the bond receives theinterest in the form of the difference between thebond’s redemption, or face, value and issue oracquisition price. Zero coupon bonds are issued atdiscounts that reflect underlying interest rates;otherwise no investor would purchase such bonds.)The interest rate is 10 percent when the bond isissued. Therefore, the value of the zero couponbond at the time it is issued can be determined bydiscounting 10,000 units by 10 percent each year for20 years. This value is 1,486 units.

401. One year after issue, the accrued interest on thebond is 10 percent of 1,486 units (149 units). At thistime, if there are no changes in interest rates, thebond is valued at issue value plus accrued interest(1,635 units). In the second year, the accrued intereston the bond is 10 percent of the bond’s value at theend of the first year (164 units). The value of thebond at the end of the second year, if there are nochanges in interest rates, is equal to its value at theend of the first year plus the interest accrued in thesecond year (1,799 units). This process continues for18 years until the bond matures. At maturity, thevalue of the bond is 10,000 units, and the sum ofaccrued interest for all periods equals the differencebetween the redemption value and issue price (8,514units). The accrual of interest is therefore reflected in“reinvestment” of the interest in the bond. Madornia’sBOP statement reflects, for years 1, 2, and 20, thefollowing entries in respect of the zero coupon bond:

Year 1 Credit Debit

Investment income-portfolio investmentIncome on debt-bonds 149

Portfolio investment-liabilitiesDebt securities-bonds 1,486

149Reserve assets (or other


Year 2 Credit Debit


Portfolio investment-liabilitiesDebt securities-bonds 164

Year 20 Credit Debit


Portfolio investment-liabilitiesDebt securities-bonds 909 10,000


In this example, it was assumed that interest ratesremained unaltered during the life of the bond. Inmany instances, this would be an unrealisticassumption. How should the accrual of interest onsecurities be calculated when interest rates changeduring the life of the security?

402. A possible approach would be to ignorechanges in interest rates and calculate the accrual of

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interest for all periods by using the interest rateprevailing at the time the security was issued. Such amethod of recording would probably be consistentwith the way the issuing enterprise accrues interestin its accounts. However, there are twodisadvantages with this method. The first is that, ifthe security is traded, the new holder of the securityis unlikely to know, or care, what the interest ratewas at the time the security was issued. Thepurchaser’s concerns will relate to the prevailinginterest rate and the effect of that rate on the returnthat he or she will receive on his or her investment.The second disadvantage with using the interest rateprevailing at time of issue to accrue interest over thelife of the security is that this method does notreconcile well with the use of market values formeasuring levels of investment. The change in themarket value of a security in a particular periodreflects (among other things) the prevailing rate ofinterest and not the rate of interest prevailing whenthe security was issued. If the latter rate were usedin the calculation of accrued interest, there would bedistortions between levels of investment andfinancial transactions and in the apparent rates ofreturn on the securities.

403. To overcome these difficulties, the BPMrecommendation is that, if securities are traded,prevailing rates should be used to determine accruedinterest. This method will not always be consistentwith those used by issuers of securities to accrueinterest. However, unless there are significantmovements in interest rates over time, anydifferences are unlikely to be significant.

404. The next example illustrates the calculation of interest accrued but not paid on securities that are issued at discounts and that have couponpayments of interest as well. In these cases, interestaccrued but not paid is equal to interest that wouldbe accrued if the security were a zero couponsecurity minus the coupon interest. For example, if the market value of a security at the beginning ofa period is 90 units, the prevailing interest rate is 10 percent, and the coupon return is 7 units, the interest accrued but not paid would be [(0.1 ˘ 90) – 7] or 2 units. In this example, thesecurity must be trading at a discount from facevalue as the prevailing interest rate is higher than the rate implied by the coupon payment (7/90 or7.77 percent). If the security were trading at apremium, the calculated interest accrued but notpaid would be negative. In this case, there would bea downward adjustment to the coupon payment to

calculate the overall interest to be recorded on thesecurity.

405. The treatment of interest on index-linkedsecurities, the principal amounts of which are basedon indexes derived from—for example—commodityprices or exchange rates, also warrants attention.Like securities issued at discounts, the value of anindex-linked security at maturity generally differsfrom the value of the security at the time of issue.The difference represents investment income accrued during the life of the security. The accruedinterest in each period is calculated by applying thepercentage movement in the index underlying thesecurity to the market value of the security. Forexample, a resident of Dromesia issues a security,the principal of which is based on the consumerprice index (CPI) of Dromesia. The security ispurchased by a nonresident for 50 units of domestic currency. Dromesia’s CPI is 100 at the timeof purchase. At the end of the first period,Dromesia’s CPI has increased by 10 percent to 110.The accrued interest income is therefore 10 percentof 50 units or 5 units. In parallel with the increase in the underlying index, the value of thesecurity has increased to 55 units at the end of theperiod.

These entries would be shown in Dromesia’sbalance of payments in the first period:

Credit Debit


Portfolio investment-liabilitiesDebt securities-bonds

Issue of security 50Accrual of interest 5

Other investment-assetsCurrency and deposits 50

Income on Equity

406. It is suggested in the BPM that remittedearnings of branches and other unincorporatedenterprises be recorded at times of remittance. Thistreatment is recommended because these paymentsare the result of discretionary decisions that canoccur at any time and because no agreementbetween legally independent partners is involved indetermining when the investment income is paid.The BPM recommendation for reinvested earnings isthat such earnings be recorded in the periods inwhich the underlying profits are earned. Dividends

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84

should be recorded in the periods in which thedividends are declared payable.

407. This example illustrates principles for the timeof recording of equity income from directinvestment. A legally independent, wholly ownedsubsidiary of an enterprise resident in Longa isoperating in Urangastan and earns profits of 1,000units in 1989. The direct investment enterprise inUrangastan pays 600 units to shareholders andretains 400 units to strengthen reserves. The decisionabout distribution of dividends is made in 1990 afterthe usual accounting and auditing procedures havebeen completed. The dividends are actually paid inJanuary 1991.

The following entries would be shown:

Longa’s Balance of Payments Statement for 1989

Credit Debit

Investment income-direct investmentIncome on equity

Reinvested earnings 1,000Direct investment-abroad (Urangastan)

Reinvested earnings 1,000


Credit DebitInvestment income-direct investment

Income on equityDividends –600Reinvested earnings –600

Direct investment-abroad (Urangastan)Reinvested earnings –600Other capital 600


Credit DebitDirect investment-abroad (Urangastan)

Other capital 600Reserve assets (or other


Thus, total earnings attributable to the direct investorare recorded as reinvested earnings in the statementfor 1989. Dividends declared in 1990 are recorded inthat year. This entry is offset by an increase in directinvestment-other capital; the increase reflects Longa’sclaim on Urangastan for the amount outstanding.Actual remittance of the dividends in 1991 reducesthis short-term claim; the reduction is recorded inthe financial account under direct investment-othercapital. In the case of portfolio investments,dividends declared but not paid in a period arerecorded as an increase in other investment-otherassets/liabilities.

Measurement of Earnings

408. Previous paragraphs have referred to earningsfrom direct investment. In the context of the balanceof payments and the SNA, earnings are the netincome—positive or negative—resulting fromproduction and property (including ownership ofother enterprises) of an enterprise. Net income iscalculated by deducting from gross income (sales,interest, dividends, and current transfer receipts) allcosts incurred by the enterprise in connection withoperations. Deductions include taxes owed by theenterprise and due for payment, other currenttransfer payments, and depreciation costs for fixedcapital assets. Depreciation costs are recorded atcurrent replacement values, although data ondepreciation costs are often available only on ahistorical cost basis.

409. Capital gains and losses do not constituteincome and therefore are not included in thecalculation of enterprise earnings. Examples of capitalgains are the sudden discovery of natural resources;the revaluation of fixed assets; and increases, whichare due to changes in exchange rates or to higherstock exchange quotations for these assets, in themarket values of financial assets. Examples of capitallosses are losses occurring as a result of catastrophes,the unforeseen obsolescence of equipment, and thedepletion of natural resources. Bad debt write-offsand expropriations without compensation that are theresult of confiscation or nationalization also representcapital losses.

410. A wholly owned subsidiary of a nonresidententerprise provides, for a year, the followinginformation on income and expenses:

Sales of goods 1,000minus operating expenses

purchase of raw materials 200wages 500depreciation 200____

Operating profit 100

plusdividends receivable on shares in

resident enterprises 120interest receivable on domestic

bank deposits 50interest receivable on trade credits

extended to resident enterprises 30minus

interest payable on loans received from residents 20 ____

Net earnings before tax 280minus tax due for payment 100____

Net earnings after tax 180

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The company decides to pay 120 units in dividendsto nonresident shareholders and to retain 60 units toincrease reserves. The company must pay, on behalfof the nonresident shareholders, withholding taxesof 50 units for the remitted earnings. The BOPstatement of the economy in which the enterpriseoperates would show the following entries:

Credit Debit

Investment income-direct investmentIncome on equity

Dividends 120Reinvested earnings 60

Current transfers-general government 50

Direct investment-in reporting economyReinvested earnings 60


The remitted earnings (dividends) are recorded on agross basis as if accrued in full to nonresidentshareholders. Withholding taxes are recorded as acurrent transfer made by nonresident shareholders totax authorities of the economy in which theenterprise operates.

411. The reinvested earnings of an enterprise maybe formally stated as:

Operating profit (operating revenue minus operatingexpenses)

pluscurrent transfers receivableinterest receivabledividends receivableenterprise’s share of reinvested earnings of any

subsidiary or associated enterprisesminus

taxes due for paymentother current transfers payableinterest payabledividends payable

equals reinvested earnings.

A direct investor’s share of the reinvested earnings ofan enterprise is determined by the proportion oftotal voting equity held by the direct investor in theenterprise.

412. Losses other than capital losses areoccasionally incurred by enterprises. These lossesmust be recorded in the balance of payments asnegative investment income if nonresidents are directinvestors in the enterprise. For example, company Xin Hughesavia holds 50 percent of the shares ofenterprise Y in Nostaw, and company Z in

Hughesavia holds 5 percent of the shares ofenterprise Y. Enterprise Y has losses of 200 units in1991. In this case, the BOP statement of Hughesaviawould reflect the following entries:

Credit Debit

Investment incomeDirect investment-income on equity

Reinvested earnings –100Direct investment-abroad (Nostaw)

Reinvested earnings 100

The entries of 100 units for direct investment incomeand capital reflect company X’s share of the losses ofenterprise Y. Company Z’s share of the losses isexcluded from the statement because the investmentis classified as portfolio investment rather than directinvestment.

Stock Dividends and Bonus Shares

413. Stock dividends are paid in shares (stock)rather than in cash. Stock dividends should berecorded in the balance of payments the same waythat other dividends are if such dividends arereceived by nonresident direct or portfolio investors.Bonus shares reflect the transformation of reserves(which usually consist of accumulated, unremittedearnings) into voting equity capital. As bonus sharesare simply a reclassification of equity from one formto another, bonus shares should not be recorded inthe balance of payments.

414. This example illustrates the recording of stockdividends. Two Algornian investors, X and Z, haverespective interests of 50 percent and 5 percent inenterprise Y in Coonawarra. Enterprise Y reportsearnings of 1,000 units for the year. Of the earnings,200 units are retained; 200 units are paid in cashdividends; and 600 units are paid in stock dividends.

The BOP statement of Algornia would reflect theseentries:

Credit DebitInvestment income-direct investment

Income on equityDividends 400Reinvested earnings 100

Investment income-portfolio investmentIncome on equity 40

Direct investment-abroad (Coonawarra)Equity capital 300Reinvested earnings 100

Portfolio investmentAssets

Equities 30Reserve assets (or other appropriate


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86

The credit of 100 units shown under investmentincome-direct investment-income on equity-reinvested earnings reflects the direct investor’s 50 percent share in the 200 units of retainedearnings of enterprise Y. A contra entry is made inthe financial account under direct investment-reinvested earnings. Credit entries shown underinvestment income-direct investment-income onequity-dividends and investment income-portfolio

investment-income on equity account for the direct and portfolio investors’ shares in cash andstock dividends. Entries to offset the income entries are made under direct investment-abroad-equity capital (direct investor’s stock dividends);portfolio investment-assets-equities (portfolioinvestor’s stock dividends); and reserve assets orother appropriate financial account item (dividendspaid in cash).

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415. Chapters 4, 5, and 6 have dealt with threecomponents of the current account: goods,services, and income. Chapter 7 focuses ontransactions recorded under current transfers,which constitute the remaining component of thecurrent account. Components of the capitalaccount (part of the capital and financialaccount) are also examined. Recorded in thecapital account are capital transfers, which areclosely related in concept to current transfers, andtransactions concerning the acquisition or disposal ofnon-produced, nonfinancial assets (such as patentsand copyrights). However, before these items arediscussed in detail, consideration will be given totopics relevant to the recording, in the balance ofpayments, of both current and capital transfers.

General Information on Transfers

Definition

416. Transfers are defined in the BPM as offsettingentries for real resources or financial items provided,without a quid pro quo, by one economy to another.Whenever an economy does not receive or supplyrecompense—in the form of real resources orfinancial items—for goods, services, income, orfinancial items supplied to or received from anothereconomy, a transfer is recorded in the BOPstatement. For example, if Domestica provides, as agift, goods valued at 100 units to Longa, the BOPstatements of the two countries should reflect thefollowing transactions:

Domestica Longa


Goods 100 100Current transfers 100 100

417. In addition to reflecting transfers for economicvalues provided by one economy to another withouta quid pro quo, the BOP statement also reflectsincreases or decreases that occur in a country’s realand financial resources as a result of migration.

418. If a country’s real resources or financial assetsand liabilities increase or decrease because of a

change in economic territory, the increases ordecreases are not recorded in the BOP statement.For example, if Bushland cedes some territory toClintonstan, the transfer of real resources andfinancial items owned by the inhabitants of theceded territory are not recorded as BOP transactionsbetween the two countries. This convention is basedon the recognition that changes in the territories ofcountries occur infrequently and that attendantchanges represent coverage changes for thereporting economies rather than transactions.

419. For purposes of BOP recording, it is importantto determine whether a transfer is current or capital.Current transfers are recorded in the currentaccount; capital transfers are recorded in thecapital account, which is a component of thecapital and financial account. This distinction,which was first presented in the fifth edition of theBPM (see paragraph 294), is necessary to harmonizethe balance of payments with the national accounts.(Previous editions of the BPM made no suchdistinction.) A capital transfer is transference of theownership of a fixed asset or the forgiveness of aliability. A cash transfer (for example, an investmentgrant) is a capital transfer when the cash transfer islinked to, or conditional upon, the acquisition ordisposal of a fixed asset by one or both parties tothe transaction. According to BOP convention,migrants’ transfers are also capital transfers. Whilecapital transfers are generally large and irregular,such transfers cannot always be defined in terms ofsize or frequency. All transfers not considered to becapital are current.

420. Some cash transfers may be regarded as capitalby one party to the transaction and as current by theother. To prevent different treatments of the sametransaction by the donor and the recipient, the BPMrecommendation is that cash transfers be classified ascapital by both parties even if a transfer is linked tothe acquisition or disposal of a fixed asset by onlyone party. If serious doubt exists as to whether atransaction should be classified as capital or current,the BPM recommendation is that the transfer beclassified as current.

88

VII. Current Transfers and the Capital Account

Valuation

421. Transfers are offsetting entries for realresources or financial items provided without a quidquo pro. The values recorded in the transfer entriesare the same as those of the real and financialresources to which the transfers are offsets. Realresources involved in transfers are valued byreference to the prevailing market price for theresource being transferred. In the absence of aprevailing market price, real resources beingtransferred are valued according to the donor’s costof production or acquisition. For example, thegovernment of Cromania purchases, for 90 units per ton, 100 tons of surplus wheat from Cromanianfarmers. The prevailing world market price of wheat is 100 units per ton. The surplus wheat isdonated to drought-stricken Madornia. The transferwould be valued—in the BOP statements of bothCromania and Madornia—at 10,000, rather than9,000, units.

Time of Recording

422. In principle, transfers are recorded when theresources to which the transfers are offsets changeownership. Taxes, fines, and other currenttransfers imposed by one party on another arerecorded upon the occurrence of underlyingtransactions or other events that give rise to theliabilities. A deferred tax payment is recorded on the basis noted in the preceding sentence ratherthan on the actual payment date, and an offsettingentry is made in the financial account. Forexample, in 1989, a resident of Urangastan mustpay, to the government of Coonawarra, a tax of 50 units on income earned in that year. The residentof Urangastan defers the payment until 1990. TheBOP statement of Urangastan would show theseentries:

1989 Credit Debit

Current transfers 50Other investment-liabilities-other

liabilities 50

1990 Credit Debit

Other investment-liabilities-otherliabilities 50


Thus, the actual payment, in 1990, of the tax relatedto 1989 is treated as a repayment of the liability tothe Coonawarra government.

Current Transfers

423. In the standard components of the balance ofpayments, current transfers are divided into twosub-components: general government and othersectors. The current transfers of other sectors arefurther divided into workers’ remittances and othertransfers.

General Government

424. The general government sub-componentconsists of current transfers made between thegovernment sector (as defined in paragraphs127–140 of chapter 2) of the compiling country andnonresidents. This item includes current transfersbetween the government of the compiling countryand foreign governments and current transfersbetween the resident government sector andnonresident, nongovernment entities. Thiscomponent does not, however, include, currenttransfers between resident nongovernment entities ofthe compiling economy and foreign governments.Such transfers are classified as current transfers-other sectors-other transfers.

425. The current transfers-general governmentitem includes subsidies or grants to current budgets(except for subsidies or grants relating to additionsto the capital stock of the recipient country); gifts offood, clothing, medicine, etc.; gifts of militaryequipment that has no civilian uses; technicalassistance; indemnities imposed under peace treaties (reparations); casualty insurance premiumsminus service charges and casualty insurance claims;and government contributions to the administrativebudgets of international organizations. However,capital subscriptions to organizations such as theWorld Bank are not treated as transfers but asincreases in financial assets that are recorded in thefinancial account. Also classified as currenttransfers-general government are—on the credit side—taxes other than those (such asinheritance taxes) on the transfer of assets,contributions to social security schemes, fines,licenses to fish, and fees for carrier registration,and—on the debit side—scholarships and similargrants given to nonresident individuals for on-the-jobtraining or to finance education or training in thedonor’s country or abroad, refunds on taxes,membership fees paid to nongovernmentalorganizations, grants to nongovernmental entities, and noncontractual pensions and other

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benefits. Taxes and subsidies implicit under amultiple official exchange rate scheme are alsorecorded, when it is appropriate, as currenttransfers-general government. (See paragraph 37 ofchapter 1.)

426. Grants exchanged, in a specific period,between the government sectors of two economiesare recorded on a gross, rather than a net, basis.

427. Taxes levied by the government of acompiling economy on property located in thecompiling economy and owned by a nonresidentare not transfers and are not recorded in thebalance of payments. Such taxes are payable by thenotional resident enterprise construed to be theowner of the property in the compiling economy.These taxes represent resident-resident transactions,although the taxes do have an impact on the directinvestment income attributable to the nonresidentowner of the notional enterprise. The taxes mostcommonly recorded as current transfers are those on income. Taxes on income can consist oftaxes on labor income or taxes (such aswithholding taxes) on investment income (such asdividends).

428. The total cost, including costs incurred in thedonor country, of technical assistance is recorded asa current transfer. (This method of valuation is, ofcourse, consistent with the general principle ofvaluing transfers in the balance of payments.) Someelaboration is necessary for the treatment oftransactions that are offset by technical assistancetransfers. In the BPM, production associated withtechnical assistance is attributed to the recipienteconomy, not the donor economy. Therefore,resources consumed in the provision of technicalassistance are treated as resources acquired by therecipient economy; the acquisition of these resourcesis financed by the donor economy.

429. The following example illustrates the BOPtreatment of technical assistance. Keatinglandprovides Nostaw’s government with technicalassistance, which is valued at 1,000 units, during asix-month period. Costs associated with theprovision of this technical assistance are:

Salaries paid to residents of Nostaw 150Salaries paid to residents of Keatingland

who are working in Nostaw 700Goods and services purchased in Nostaw

as part of the technical assistance project 50Administrative costs incurred in Keatingland 100____

1,000

These entries would be made in Nostaw’s balance ofpayments:

Credit Debit

Government services n.i.e. 100Income

Compensation of employees 700Current transfers-general

government 1,000Reserve assets (or other appropriate


The entry for government services n.i.e. reflectsadministrative costs incurred in the donor country.Keatingland residents working in Nostaw areworking for the government of Nostaw, which isconsidered the producer of output from theprovision of technical assistance. The salaries ofthese staff members, who are not residents ofNostaw, reflect the provision of labor to the Nostawgovernment and thus are shown in the balance ofpayments, even though these salaries are actuallypaid by Keatingland. The labor provided by Nostawresidents and the acquisition of goods and servicesin Nostaw constitute transactions, which are notincluded in the balance of payments, between theNostaw government and Nostaw residents. However,the financing for these transactions is provided byKeatingland, and the impact of this financing isshown as an increase in Nostaw’s holdings offoreign exchange.

Other Sectors

Workers’ Remittances

430. Workers’ remittances consist of goods orfinancial instruments transferred by migrants livingand working in new economies to residents of theeconomies in which the migrants formerly resided.However, money remitted by a migrant for thepurpose of making a deposit in his or her ownaccount with a bank located abroad represents afinancial investment, which is recorded in thefinancial account, rather than a transfer.

431. Workers’ remittances include only thosetransfers made by workers who stay in foreigneconomies for at least one year (that is, migrants). Ifworkers remain in foreign economies less than oneyear, they are not regarded as residents of thoseeconomies and remittances to their home countriesrepresent distributions of labor income earned fromnonresident employers.

432. Workers’ remittances are transfers made bymigrants who are employed by entities of economies

CURRENT TRANSFERS AND THE CAPITAL ACCOUNT

90

in which the workers are considered residents. If amigrant operates her or his own business in the newcountry—that is, if she or he is self-employed—heror his transfers abroad are not classified as workers’remittances but as current transfers-other sectors-other transfers. This distinction is made becauseworkers’ remittances, according to the BOPconvention, arise from labor and not fromentrepreneurial income.

433. The following example illustrates the BOPtreatment of transactions associated with foreignworkers. U.S. citizen A migrates to Canada andworks for an enterprise in Canada. Citizen A has acontract for three years. His salary is 300 units. U.S.citizen B works for the same enterprise in Canadabut retains his abode in the United States. Citizen B’ssalary is 250 units. Citizens A and B make andreceive these payments in Canadian dollars.

Migrant ADeposit in a bank in Canada 120Deposit in a bank in the United States 20Expenditure for food and clothing in Canada 120Cash gift sent to a relative in the United States 10Income tax paid to Canadian government 30

Border worker BDeposit in a bank in the United States 180Deposit in a bank in Canada 35Consumer loan received from a bank in Canada 40Expenditure for food and clothing in Canada 50Income tax paid to Canadian government 25

The balance of payments of the United States wouldshow the following entries:

Credit Debit

Travel 50Compensation of employees 250Current transfers-other sectors

Workers’ remittances 10Other transfers 25

Other investmentAssets-currency and deposits

Banks 210Other sectors 35

LiabilitiesCurrency and deposits-banks 20Loans-other sectors 40

From the viewpoint of the United States, citizen A isa nonresident and citizen B is a resident.Expenditures for food and clothing made by citizenA in Canada, taxes paid by citizen A to the Canadiangovernment, and the deposit made by citizen A in aCanadian bank represent transactions betweennonresidents and are not recorded in the BOPstatement of the United States. The entry for

compensation of employees reflects the salaryreceived in Canada by citizen B; his personalexpenditure in Canada is recorded under travel. Theentry for workers’ remittances covers the cash giftsent to the United States by citizen A. The entry forother transfers covers the tax payment made bycitizen B to the Canadian government. The entry forbank liabilities reflects the deposit made by citizen Ain the United States. The entry under assets-currencyand deposits-other sectors reflects the deposit madeby citizen B in Canada. The entry under liabilities-loans-other sectors covers the loan liability incurredby citizen B in Canada. There is no entry for thedeposit made by citizen B in a U.S. bank becausethe transaction occurs between U.S. residents.

Other Transfers

434. Current transfers, other than workers’remittances, may be made (1) between resident,nongovernment entities and foreign governmentsand (2) between resident, nongovernment entitiesand nonresident, nongovernment entities. Suchtransfers include gifts; alimony and other supportremittances; lottery ticket sales and prizes won fromlotteries; noncontractual pensions fromnongovernmental agencies; casualty (nonlife)insurance premiums minus service charges andcasualty (nonlife) insurance claims; grants made forpurposes other than investment; contributions toreligious, scientific, cultural, and charitableorganizations; and membership fees paid tononprofit associations. Also included, on the creditside, are scholarships and similar grants receivedfrom foreign governments to finance on-the-jobtraining or education in the donor’s country orabroad, tax refunds, and noncontractual pensionsand other benefits received from foreigngovernments. Also included, on the debit side, aretaxes, fines, contributions to social security schemes,licenses to fish, and fees payable to foreigngovernments for carrier registration.

435. Remittances (such as those sent by parents tochildren who are studying in other countries) sentabroad by residents of an economy for the purposeof financing other residents who are staying abroadfor less than one year are excluded from the BOPstatements of the donor economies because theparties to these transactions are residents of thesame economies. Expenditures incurred abroad byresidents staying for less than one year in foreigncountries are recorded as travel expenses.

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436. The following example illustrates the treatmentof transactions related to the current transfers-other sectors-other transfers item. A resident ofHughesavia makes these payments and receivesthese receipts.

Payments

Contribution to a charitable organization in Longa 50

Cash remittance to a relative staying for six months in Longa 30

Payment of house insurance premium to an enterprise in Longa* 10

Payment of life insurance premiums toan enterprise in Longa* 20

Cash gift to a relative living and working for two years in Longa 40

Receipts

Prize won from a government lottery in Longa 5Cash remittance from a relative living and

working in Longa for three years 25Claim received from insurance enterprise

in Longa for bush fire damage to a home 100*The insurance service charge is considered to represent 10 percent of grosspremiums for both life and nonlife insurance.

The BOP statement for Hughesavia would show thefollowing entries:

Credit Debit

Travel 30Insurance services 3Current transfers-other sectors

Workers’ remittances 25Other transfers 105 99

Other investment-assetsOther assets-other sectors

Equity in life insurance policies 18Reserve assets (or other appropriate


The entry for travel reflects cash sent to the relativestaying abroad for six months; it is assumed that thismoney is spent on goods and services acquired bythe traveler in Longa. The entry for insuranceservices represents 10 percent (the service charge) ofpremiums. The entry for workers’ remittances reflectscash received from the relative living abroad forthree years. The credit entry for other transfersconsists of the insurance claim (100 units) plus thelottery prize (5 units). The debit entry for this itemconsists of nonlife insurance premiums minus theservice charge (9 units) plus the contribution (50 units) to the charitable organization in Longaplus the cash gift to the relative living abroad fortwo years. The life insurance premiums minus the

service charge are recorded, in the financialaccount, as an increase in assets.

Capital Transfers

437. Like current transfers, capital transfers aredivided into two sub-components—generalgovernment and other sectors—in the BOP standardcomponents. Capital transfers of general governmentare further disaggregated into debt forgiveness andother; capital transfers of other sectors are dis-aggregated into migrants’ transfers, debt forgiveness,and other. Criteria for determining whether a capitaltransfer should be classified under generalgovernment or other sectors are similar to criteria for distinguishing current transfers-generalgovernment from current transfers-other sectors.Therefore, in subsequent paragraphs, capitaltransfers are discussed in terms of type rather thansector.

Debt Forgiveness

438. Unless the cancellation of a debt occurs bymutual agreement of debtor and creditor, thecancellation is not a capital transfer; the write-off ofdebt reflects a capital loss, which is not recorded inthe balance of payments. For example, in 1988, thegovernment of Clintonstan extended a long-termloan of 100 units to the government of Algornia anda long-term loan of 200 units to an enterprise inBushland. In 1989, the Clintonstan governmentagreed to the request of the Algornian governmentfor forgiveness of one-half of the loan. In Bushland,the deteriorating economic situation led to thebankruptcy of the enterprise that had borrowedfrom Clintonstan’s government. The Clintonstangovernment subsequently recorded repayment ofone-half of the loan made to Algornia and wroteoff, as a bad debt, the loan made to Bushland.Clintonstand’s BOP statements for 1988 and 1989would show these entries:

1988 Credit Debit

Other investment Assets-loans-general government 300


1988 Credit Debit

Capital transfersGeneral government

Debt forgiveness 50Other investment

Assets-loans-general government 50


92

The forgiveness of one-half of the 100-unit loan in1989 is shown as a partial repayment of that loan,and an offsetting entry is shown under capitaltransfers. The write-off of the 200-unit loanrepresents a capital loss that should not be recordedin the BOP statement. However, the capital losswould be reflected in the market value of the stockof loan assets shown in the IIP statement preparedas of December 31, 1989.

Migrants’ Transfers

439. In the BPM, migrants are defined asindividuals (other than students; medical patients; ordiplomatic, military, or similar personnel) who moveto new countries and are expected to remain in thenew countries for at least one year. The termmigrants’ transfers refers to the household andpersonal effects and the financial claims andliabilities transferred by migrants from former tonew countries. In the strictest sense, these are nottransfers between two parties but contra entries toflows of goods between economies and changes,which arise from migration, in the financial items ofeconomies. These contra entries are equal to the networth of migrants.

440. The value of the household and personaleffects of migrants and the movable capital goodsthat they actually transfer to new countries arerecorded as transactions in goods, and offsettingentries are made under migrants’ transfers. Migrants’financial claims on or liabilities to (for example,bank deposits, shares, bonds, and loans extended orreceived) countries of former residence are recordedunder various components of the financialaccount; offsetting entries are made under migrants’transfers. Land and structures owned by migrantsand located in former countries of residence andmovable capital goods not transferred by migrantsto their new countries are treated, according toconventions presented in the BPM, as financialinvestments made by migrants in notionalenterprises that own these assets. In the BOPstatements of the countries to which the migrantshave migrated, these financial investments arerecorded as increases in direct investment-abroad,and offsetting entries are made under migrants’transfers. A migrant’s claims on or liabilities toresidents of the country to which he or she hasmoved are treated, in the balance of payments ofthat country, as if the external claims (liabilities)have been extinguished.

441. A resident of Domestica is migrating toEssendonia. At the time of migration, he has theseassets and liabilities.

Assets

Household effects 200Automobile 100Jewelry 50Bank deposit in Domestica 30Bank deposit in Essendonia 60Bonds issued by the government of Domestica 110Real estate in Domestica 300Real estate in Essendonia 1505 percent of the shares of an enterprise

in Daniherland 70_____Total assets 1070

LiabilitiesConsumer loan owed to bank in Domestica 40_____Net worth 1030

The BOP statement of Domestica* would reflect thefollowing entries:

Credit Debit

Goods 350Capital transfers-other sectors

Migrants’ transfers 1,030Direct investment

Abroad (Essendonia)-equity capital 150

In reporting economy (Domestica)-equity capital 300

Portfolio investmentAssets-equity securities-

other sectors 70Liabilities-debt securities

Bonds-general government 110Other investment

Assets-currency and deposits-other sectors 60

Assets-loans-banks 40Liabilities-currency and deposits-banks 30

*Essendonia’s BOP statement would show reversed entries.

The goods entry represents the value of themigrant’s personal effects. The net worth (assetsminus liabilities equals 1,030 units) of the migrant isshown under migrants’ transfers. The financialaccount entry under direct investment-abroadshows a decrease in Domestica’s direct investmentcapital abroad and reflects the fact that theEssendonian real estate is now owned by a residentof Essendonia rather than Domestica. The entryunder direct investment in Domestica shows aninflow of direct investment capital because theDomestican real estate is now owned by a residentof Essendonia rather than Domestica. The equitysecurities entry under portfolio investment shows a

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decrease in external assets consisting of shares inthe enterprise in Daniherland. The entry for bondliabilities of the general government indicates thatbonds issued by the Domestican government arenow owned by a nonresident and thereforerepresent liabilities of Domestica to Essendonia. Theentry under other investment for the deposit assetsof other sectors reflects a decrease in Domestica’sdeposits with nonresident banks because thesedeposits are now owned by a nonresident. Theentry for the loan assets of banks shows an increasein external assets and reflects the fact that a loanformerly owed by a resident is now owed by anonresident. The entry for the deposit liabilities ofbanks shows an increase in the external liabilities ofbanks.

Other Capital Transfers

442. Other capital transfers relate mainly toinvestment grants. Investment grants are used foradding to or financing the gross fixed capitalformation of the recipient economy. Such grants canbe provided in kind or in cash. For example, aninvestment grant could comprise financing providedthrough a foreign aid program for the constructionof a dam. Although grants for large capital projectsmay be paid in installments over extended timeperiods, each installment is recorded as a capitaltransfer. General grants made to foreigngovernments and used for purposes other thanfinancing capital investments are recorded as current,rather than capital, transfers. Inheritance taxes, gifttaxes, other taxes on the transfer of assets, andcompensation payments (other than those resultingfrom insurance claims) are also recorded as othercapital transfers. Transfers of military equipment that

also has civilian uses are recorded as other capitaltransfers.

Transactions in Non-Produced,Nonfinancial Assets

443. Non-produced, nonfinancial assets are acomponent of the capital account. Under this item,are recorded purchases (debit) and sales (credit) ofassets such as copyrights, licenses, patents, etc. Theessential characteristics of these assets are that (1) such assets are not produced, and (2) such assetsdo not satisfy the definition of financial assets. Bycomparison, transactions in produced assets arerecorded in the current account, and transactionsin financial assets (which are generally evidenced bya claim that one party has on another) are recordedin the financial account. Transactions in the fees,royalties, etc. associated with patents, copyrights, etc.must be recorded separately (in the royalties andlicense fees item under services) from transactionsin the underlying assets, which are recorded in thecapital account.

444. Land satisfies the criteria for non-produced,nonfinancial assets. According to conventionspresented in both the BPM and the SNA, land mustbe owned by a resident of the economy in whichthe land is located. Most transactions in land takeplace between two parties who are consideredresidents of the economy in which the land islocated; therefore, such transactions are not recordedin the balance of payments. However, acquisitions ordisposals of extraterritorial land associated withembassies or with other government activities inforeign countries are BOP transactions and, as such,are recorded under acquisition/disposal of non-produced, nonfinancial assets.

445. Previous chapters of the Textbook havecovered transactions recorded in the BOP currentaccount and in the capital account portion of thecapital and financial account. This chapter isconcerned with concepts pertaining to the financialaccount. Topics such as the definition of financialaccount transactions, coverage, time of recording,valuation, and classification are examined. Insubsequent chapters, individual components of thefinancial account are discussed in greater detail.

Definition and Coverage

446. In the BPM, the financial account is definedas comprising all transactions (actual and imputed)in the external financial assets and liabilities of aneconomy. In this chapter, use of the termtransactions is restricted to exchanges involvingchanges of ownership, including the creation andliquidation of claims. For convenience, the BPMpractice of referring to external financial assets andliabilities as “external assets” or “assets,” and“external liabilities” or “liabilities” is continued in thisand subsequent Textbook chapters.

447. Three criteria must be met for a transaction tobe included in the financial account. These criteriaare:

A transaction involves a change of ownership,including the creation or liquidation of an asset orliability. The pledging, authorization, commitment,or setting aside of funds for the purchase of an assetor repayment of an obligation does not alter theownership of an asset or liquidate a claim.

An asset or liability must represent actual claims thatare legally in existence. Therefore, the authorizationof a loan or the incurrence of a contingent liability isnot sufficient to establish, respectively, a claim orliability.

A transaction involves an external financial asset orliability. The external financial assets of an economyare comprised of holdings of monetary gold, specialdrawing rights (SDRs), and claims on nonresidents.The external liabilities of an economy are comprised

of indebtedness to nonresidents. Therefore, with theexception of SDRs and monetary gold, each externalfinancial asset of one economy is matched by anexternal liability of another economy, and vice versa.The important determinants for classifying financialitems (assets or liabilities) as external are theidentities of the creditor and debtor. The creditorand debtor must be residents of two differenteconomies. The denomination of a financial item—whether in national currency, foreign currency, orany other unit of account (such as the SDR)—is notrelevant for classification of the item as an externalasset or liability. For example, a resident bankpurchases a security that is denominated in nationalcurrency and issued by a nonresident. The securityconstitutes a claim on a nonresident, and thepurchase of the security is therefore included in theBOP statement as a financial transaction.

448. Transactions are not the only cause of changesin the values of financial items. Changes that do notresult from transactions are excluded from thebalance of payments, although such changes may bereflected in the IIP statement. These exclusions arediscussed in more detail in paragraphs 464–470.

449. Assets can take the form of financial items(such as securities, loans, and trade credits) ornonfinancial assets (such as stocks of grain ormachinery held abroad by resident enterprises andreal estate consisting of vacation homes locatedabroad and owned by individual residents) orintangible assets (such as patents and copyrights).Financial assets may be imputed to somenonfinancial assets, such as land, by means of aconvention described in the BPM. Land, byconvention, must be owned by a resident entity.Therefore, if a nonresident legally owns land, thenonresident has a financial claim on a resident entitythat owns the land. For example, if a resident ofPokolbin owns land in Cromania, ownership of thisland is—for BOP purposes—attributed to an entityresident in Cromania. The resident of Pokolbin has afinancial claim equal to his or her equity in the landon the entity resident in Cromania. All receipts andpayments attributable to the land are allocated to the

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VIII. Introduction to the Financial Account

resident entity in Cromania; all profits are remitted tothe legal owner residing in Pokolbin or reinvested toincrease the value of the financial claim of Pokolbinon Cromania. (See paragraphs 550–551 of chapter 9for an illustration of the treatment for land owned bynonresidents.)

450. The treatment outlined in the precedingparagraph applies to land owned by nonresident,nongovernment entities. When land located abroadis held abroad by governments for embassies orsimilar purposes, such land is considered part of theterritory of the government holding the land and not part of the territory of the host economy.Therefore, there is no need to attribute ownership of such land to an entity resident in the hosteconomy. Transactions in government land heldabroad are recorded in the capital account underacquisition/disposal of non-produced, nonfinancialassets; only the financing associated with thesetransactions is shown in the financial account.

451. According to the BPM, the following types ofnonfinancial external assets require the imputation offinancial assets:

immovable assets such as land and structures (exceptwhen such assets are owned by foreign governmententities)

mobile equipment such as ships, aircraft, highwayvehicles, rolling stock, fishing vessels, and drillingrigs that operate within an economy for at least oneyear, have separate records kept in respect ofoperation, and are recognized by tax and licensingauthorities as part of the host economy’s capitalstock (These assets are considered to be owned byan entity residing in the economy in which theassets are located.)

nonfinancial, as well as financial assets, of anunincorporated enterprise operating in an economyother than the one in which the owner resides (Theseassets are considered to be the assets of anunincorporated entity residing in the host economyrather than assets of the economy of the entity’sowner.)

goods transferred under a financial leasingarrangement and presumed to have undergone achange of ownership (imputation of a financial assetfor the lessor and a liability for the lessee)

goods sent abroad for processing and subsequentlyreturned to the original country. Such goods arerecorded in the balance of payments as if ownership

has changed—both when the goods were originallyexported and again when the goods are re-imported. Offsetting the first imputed change of ownership is the creation of an imputed financial claim that is recorded in the financialaccount. This claim is extinguished as an offset to the second imputed change of ownership.

452. Up to this point, an asset has been describedas a resident claim with a counterpart nonresidentliability. Certain assets do not have this characteristicbut are nevertheless treated, in the BPM, as externalfinancial assets. These assets are monetary gold andspecial drawing rights (SDRs) in the IMF. Theseassets are treated as external financial assets becausesuch assets are widely accepted as a means ofinternational payment.

Transactions in Financial Assets

Kinds of Transactions

453. Transactions in financial assets can be classifiedas:

exchanges of real resources for financial items One side of the transaction is recorded in the currentaccount; the other is recorded in the financialaccount.

exchanges of non-produced, nonfinancial assets forfinancial items such as copyrights and patentsOne side of the transaction is recorded in thecapital account; the other is recorded in thefinancial account.

exchanges of financial items for other financial itemsBoth sides of the transaction are recorded in thefinancial account.

exchanges of financial items without a quid pro quoIn such transactions, cash or other financial itemsare provided by one party to another party but no economic value is provided in return.Offsetting the financial transactions are transfersclassified as current or capital transfers and entered in either the current account or thecapital account component of the capital andfinancial account.

Parties to Transactions

454. Information on the identity of both parties to afinancial transaction may not be available to BOPcompilers. For example, a compiler may not know

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whether a resident who purchased a transferablesecurity issued by a nonresident conducted thistransaction with another resident or with anonresident. Similarly, a compiler may not knowwhether a nonresident who withdrew funds from adomestic bank account used the funds to settle atransaction with another nonresident or with aresident. The BPM recommendation for dealing withthis problem is that the balance of payments coverall transactions in external assets and liabilities.Coverage includes (1) transactions that take placebetween two residents of the reporting economy andinvolve that economy’s external assets and (2) transactions that take place between twononresidents of the reporting economy and involvethe external liabilities of that economy.

455. BOP coverage of all transactions in externalassets and liabilities is also relevant to economicanalysis. For example, if the household ornonfinancial corporate sector sells an externalfinancial asset to the banking sector, the sale has animpact on the money supply of the economy. Anyanalysis that relates BOP developments to those inmoney supply must take account of suchtransactions.

456. According to the BPM, credit and debit entriesfor each component of the financial account aregenerally netted in a BOP statement. As a result,most transactions between residents and nearly alltransactions between nonresidents will cancel;therefore, such transactions do not appear as entriesin the statement. However, transactions that involveassets and take place between resident creditors withdifferent sector classifications will be net only athigher level balances and not at balances forparticular items. For transactions involving liabilities,the identity of the nonresident creditor is used indifferentiating between direct investment and othertypes of investment, between liabilities constitutingforeign authorities’ reserves and other transactions(supplementary financial account classifications), andbetween liabilities owed to different countries inregional BOP presentations. When transactions in thefinancial liabilities of an economy involve twononresidents who are classified in differentnonresident creditor categories, the transactions willnot be net for each individual item in the financialaccount.

457. For example, a resident nonbank enterprise ofMadornia uses foreign exchange to purchase short-term commercial paper issued by a resident of

Nostaw. This transaction is recorded in the BOPstatement of Madornia (1) as a debit entryrepresenting an increase in the portfolio debt assetsof other sectors and (2) as a credit entry representinga decrease in reserve assets-foreign exchange. Thecommercial paper is then sold by the residententerprise of Madornia to another resident enterpriseof Madornia. If the sector classification for these twotransactors is the same, the BOP entries are net, andno entry appears in Madornia’s BOP statement forthe resident-resident transaction. However, if thecommercial paper is sold by the resident nonbankenterprise to a resident bank, the transaction isreflected in the BOP statement (1) as a credit entryrepresenting a reduction in the portfolio debt assetsof other sectors and (2) as a debit entry representingan increase in portfolio debt assets of banks.

Reinvested Earnings

458. One type of asset or liability shown in thefinancial account is reinvested direct investmentincome. Related transactions are discussed inchapters 6 and 7. If the reinvested earnings of adirect investment enterprise accrue to a nonresidentdirect investor, these earnings are treated as a BOPtransaction. The reinvested earnings are viewed asincome paid to the nonresident direct investor bythe direct investment enterprise and simultaneouslyreinvested by the investor.

Migrants’ Financial Transfers

459. Migrants’ financial assets and liabilities arerecorded in the financial account of the balance ofpayments when migrants change their countries ofresidence. For example, land owned by migrants intheir former countries, enterprises owned bymigrants and located in the former countries, andmigrants’ deposits with banks in their formercountries become, at the time of migration, financialassets of the countries to which the migrants aremoving. Migrants’ liabilities to their new countriesbecome, at the time of migration, claims betweenresidents of the same country. From the point ofview of the new country, the recording of migrants’financial transfers is achieved by creating orextinguishing assets and liabilities. The offset to achange, which results from the migration, in aneconomy’s financial items is entered as a capitaltransfer in the capital account. Chapter 7 containsadditional information on the treatment of migrants’transfers.

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Borderline Cases

460. Changes in maturities or terms of contracts forexisting assets or liabilities may or may not constitutetransactions that should be recorded in the balanceof payments. The BPM states that changes in theoriginal terms of a contract normally require formalagreement between the parties involved in thecontract. The agreement reflecting the changesconstitutes a transaction that is recorded in thebalance of payments. For example, a resident privateenterprise borrows 200 units from a nonresidentbank. In the period in which the loan becomes duefor repayment, the resident enterprise negotiateswith the bank to extend the loan for another sixmonths. As the contractual terms of the loan arealtered, the following transaction would be recordedin the balance of payments:

Credit Debit

Other investment-liabilities-loans-other sectors-long-term 200

Other investment-liabilities-loans-other sectors-short-term 200

However, if a loan contract originally provides theborrower with an option to extend the loan, theextension does not represent a change in thecontractual agreement between the creditor anddebtor. In such cases, the extension is not recordedas a transaction in the balance of payments.

461. Changes that occur in contractual terms whenthe government negotiates to take over liabilitiesincurred by the private sector may or may notconstitute transactions that should be recorded in thebalance of payments. For example, the central bankof Hughesavia encourages resident companies toborrow funds, on a short-term basis, fromnonresident banks. The resident companies arescheduled to pay interest and repay principal innational currency, which is not convertible, but thecentral bank has agreed to transfer to nonresidentcreditors the equivalent amount in foreign exchange.However, the country subsequently experiences BOPproblems and the central bank does not allocate thenecessary foreign exchange for these payments. Theoutstanding principal (before scheduled repayments)is 700 units. Scheduled repayments of principal andinterest due amount to 100 units and 18 units,respectively. After lengthy negotiation with thecreditors, the outstanding balances on these short-term loans are converted to seven-year loans, andthe central bank replaces the resident companies as

the debtor. The following entries would be recordedin the BOP statement of Hughesavia:

Before loan conversion agreement

Credit Debit

Interest 18Short-term loan repayment

by other sectors 100Payments arrears of other sectors 118

After loan conversion agreement

Credit Debit

Payment arrears of other sectors 118Short-term loan repayment-

other sectors 600Long-term loan drawing-resident

monetary authorities 718

If, however, the monetary authorities simply assumeresponsibility for the arrears and do not renegotiatethe contract, no BOP transactions are recorded. Insuch cases, the changed sector of the liability wouldbe reflected only in the IIP statement.

462. Another type of borderline case occurs when atransactor intends to dispose of a certain asset atvirtually the same moment that ownership of theasset is nominally acquired. The most commonexamples of such closely linked pairs of transactionsare arbitrage and certain other dealings, such asforward contracts, in foreign exchange. Arbitrageseeks to exploit price differentials that may exist indifferent markets; forward contracts are concluded toexploit price differentials that exist over time in thesame markets. It is recommended in the BPM thattwo changes of ownership be recorded—no matterhow briefly an asset is owned—when pairs oftransactions are closely linked. The rationale for thisrecommendation is the recognition that a profit orloss in an arbitrage transaction or a forward contractreflects the realization of a capital gain or loss thatshould be entered in the financial account.

463. Yet another kind of borderline case occurs withthe redefinition, at a later period, of a country’stransactions with the International Monetary Fund.For example, if a member country makes a reservetranche drawing from the IMF, the country’s reserveposition in the IMF decreases (credit) by the sameamount that its reserve of foreign exchange assetsincreases (debit). At a later period, the IMF maydetermine, on the basis of more up-to-dateinformation, that the member country qualified foruse of Fund credit for compensatory financing ofexport fluctuations at the time of its reserve tranche


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drawing. In such instances, it is recommended thatentries showing an increase in the use of Fund credit(credit) and an increase of an equal amount in thereserve position in the Fund (debit) be recorded inthe period in which the redefinition took place. Forexample, a country makes a reserve tranchepurchase of 200 units from the Fund. This purchaseis subsequently redefined as the use of Fund credit.The following entries would be recorded in thecountry’s balance of payments:

Period 1 Credit Debit

Reserve position in the Fund 200Reserve assets (or other



Reserve position in the Fund 200Use of Fund credit 200

This treatment, which relates to transactions thatrarely occur in practice, is recommended in order toalign BOP entries with statistics published by theIMF on its own activities. Because the exchange ofinstruments imposes different obligations on the debtor, the transaction is more akin to therenegotiation of a loan than to a reclassification.

Financial Item Changes to Be Excludedfrom the Balance of Payments

Allocation or Cancellation of SDRs

464. The holding of special drawing rights (SDRs) isdiscussed in detail in chapter 12, althoughallocations and cancellations of SDRs are no longerrecorded in the balance of payments. In the fourthedition of the BPM, such changes were regarded astransactions offset by counterpart entries to theallocations or cancellations. The impact of allocationsor cancellations of SDRs on a country’s reserves canbe determined from an analysis of the reserve assetscomponent of the IIP statement rather than from thebalance of payments.

Monetization or Demonetization of Gold

465. The same stock of gold held by monetaryauthorities may, at different times, be classified as acommodity (nonmonetary gold) or as a financialasset (monetary gold). Changes, which result fromreclassification of gold stocks, in holdings ofmonetary gold are not recorded in the balance ofpayments. Instead, the impact of these changes isreflected in the reserve assets component of the IIP

statement. The treatment of monetization ordemonetization of gold recommended in the fifthedition of the BPM is different from thatrecommended in the previous edition.

Valuation Changes

466. The BPM recommendation is to omit from thebalance of payments all unrealized valuationchanges in the external financial assets and liabilitiesof an economy. Valuation changes can occur for anumber of reasons. One is a change in the price ofthe unit in which an asset is denominated. Forexample, a resident of Namdarb purchases, inClintonstan currency, a security issued byClintonstan at a price of 500 units. The exchangerate at the time of the purchase is l unit of Namdarbcurrency for 5 units of Clintonstan currency, so theresident of Namdarb pays 100 units to purchase thissecurity. When the value of the securitysubsequently increases to 550 units in Clintonstancurrency, the price—expressed in Namdarbcurrency—is 110 units. The increase of 10 units—inNamdarb currency—in the value of the securityrepresents one type of valuation change.

467. Another type of valuation change occurs whenthe monetary unit in which an asset is denominatedchanges in terms of the unit of account used forrecording BOP statistics. For example, Clintonstancurrency depreciates (in terms of Namdarb currency)from an exchange rate of l unit of Namdarb currencyfor 5 units of Clintonstan currency to a rate of l unitof Namdarb currency for 6 units of Clintonstancurrency. The value, in terms of Namdarb currency,of a security worth 500 units of Clintonstan currencydecreases from 100 units to 83.3 units.

468. Valuation changes like those described in theforegoing paragraphs are omitted from the balanceof payments as such changes do not representtransactions. (However, transactions may take placefor which valuation changes are realized. Resultingcapital gains or losses are reflected implicitly in thebalance of payments as part of the value of thetransactions that gave rise to realization of the capital gains or losses.) In the previous edition ofthe BPM, valuation changes in reserves—as well ascounterpart entries to these valuation changes—werereflected in the balance of payments. However, asthe IIP statement provides a framework for analyzingchanges, there is no longer a need to show the totalchange in the level of reserves in the balance ofpayments.

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Write-offs

469. A valuation change occurs as a result of awrite-off if a debtor is unable or unwilling to makepartial or full repayment of a claim. In such cases,the creditor may choose to regard a part or the full amount of the claim as canceled. As opposed tothe contractual rescheduling of debts discussedpreviously, write-offs do not involve contractualagreements and thus are unrealized capital lossesthat should not be recorded in the balance ofpayments. However, forgiveness by a creditor of allor part of the debt owed by the debtor doesconstitute a transaction that should be recorded inthe balance of payments. In such cases, thereduction in debt recorded in the financial accountis offset by an entry in the debt forgiveness item inthe capital transfers component of the capitalaccount.

Classification Changes

470. Classification changes in an economy’s externalassets or liabilities are not recorded in the balance ofpayments. Classification changes arising fromterritorial changes (other than those associated withgovernment purchases of foreign land for embassyand similar uses); reclassifications between portfolioinvestment and direct investment; and reclassifi-cations related to assumption or relinquishment ofcontrol, by monetary authorities, of the foreignexchange assets of banks are examples ofreclassification changes that are not shown in thebalance of payments.

Net Recording

471. In general, financial movements are recordedon a net basis. That is, each item in the financialaccount is presented—depending on whether total debits exceed total credits or vice versa—as anet debit or net credit entry. The net change inclaims on nonresidents by residents and the netchange in claims on residents by nonresidentsduring a period is considered to be of more interestthan the total value of financial claims that changed hands during the period. Therefore, most categoriesin the financial account are shown on a netbasis.16 The only exception specified in the BPM to

net recording in the financial account is fordrawings and repayments on long-term loans andtrade credits, which are shown as supplementaryclassifications.

Valuation and Timing

472. Transactions in financial items are recorded inthe financial account at market values whenchanges of ownership occur. The concepts of marketvalue and time of recording are discussed in detail inchapters 5 and 6 of the BPM. These concepts andthe application thereof to financial transactions arefurther elaborated in chapters 9, 10, 11, and 12(which deal with the various items in the financialaccount) of the Textbook. Financial items arerecorded in the balance of payments when thecreditor and debtor enter, respectively, the claim andthe liability in their books.

Classification

473. In the development of a BOP classificationscheme for financial items, emphasis was given todistinguishing categories of transactions that exhibitdifferent patterns of behavior. On this basis, fivemain approaches are used to classify financial items.

Functional Types of Investment

474. In the BPM, three broad categories ofinvestment exhibiting different behaviors and afourth residual category are distinguished. Thefollowing discussion focuses on the salient featuresof these categories. A more detailed discussion oneach of the categories is provided in chapters 9–12.

Reserve Assets

475. Reserve assets are instruments available togovernmental authorities for financing or regulatingpayment imbalances. Reserve assets are comprised ofmonetary gold, special drawing rights (SDRs) in theIMF, reserve positions in the IMF, and claims onnonresidents (such as foreign exchange) available tothe central authorities. Under a fixed exchange ratesystem, changes in holdings of reserves usuallyreflect a response to an aggregate surplus or deficitresulting from transactions undertaken for their ownsake. These transactions are called autonomoustransactions. For example, if the sum of allautonomous transactions between residents andnonresidents of an economy produces an overall


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16Even on the net basis used for recording in the balance of payments,transactions in financial assets are shown separately from transactions inliabilities.

deficit, this deficit may be financed by drawingdown on reserves.

476. In flexible exchange rate systems, changes inreserves may also reflect actions (such as interventionin the foreign exchange market to affect theexchange rate for the national currency) taken bythe authorities to influence autonomous trans-actions. For instance, if the currency of a country isunder pressure in foreign exchange markets, theauthorities may decide to prevent depreciation intheir country’s currency by selling foreign exchangeassets in support of the currency. This policy wouldresult in a reduction of the country’s reserves.

Direct Investment

477. The direct investor is usually different fromother investors because the direct investor seeks tohave, on a lasting basis, an effective voice in themanagement of an enterprise (the direct investmententerprise) in which the direct investor’s investmentis made. To achieve this purpose, the investornormally owns a significant percentage of the equitycapital invested in the direct investment enterprise.In addition, the direct investor may provide othertypes of capital (such as loans and trade credits) andtechnical expertise to the direct investmententerprise. Because of this special relationshipbetween the direct investor and the direct investmententerprise, direct investment capital flows often showcharacteristic behavior that differs from the flows ofportfolio investment and other investment. For thisreason, direct investment flows are recordedseparately in the balance of payments.

Portfolio Investment

478. The portfolio investment category coversinvestment—other than investment classified asreserve assets or direct investment—in equities, othersecurities, and financial derivatives. Nonequitysecurities include bonds, bills, negotiable certificatesof deposit, preference shares (except participatingpreference shares), bankers’ acceptances, andmarketable promissory notes. Stocks and shares areexamples of equities. Financial derivatives aresecondary market instruments that give the holder aqualified right to receive an economic benefit in theform of cash or another primary financial instrumentat some future point in time.

479. Portfolio investors are primarily concerned withthe safety of their investment, the likelihood of an

appreciation in the value of that investment, and thereturn they will obtain from their investment. Ifcircumstances change, the portfolio investor—unlikethe direct investor—can often easily shift theinvestment to another area.

Other Investment

480. Other investment is a residual categorycomprising all other kinds of financial transactions,including loans, trade credits, and bank deposits.The transactions included here are diverse and, forthis reason, it is difficult to make further meaningfuldistinctions along functional lines.

Assets and Liabilities

481. There is no doubt that a distinction betweenassets and liabilities is important for analyzing acountry’s international investment position. Thisdistinction is important even for financialintermediaries that borrow and re-lend abroad thesame funds because conditions (such as rates ofinterest and maturity) for the borrowing and lendingare usually different. Therefore, these ostensiblyoffsetting flows may have different implications forthe BOP. A strict distinction between assets andliabilities is less important for direct investmentcapital because of the related nature of thetransactors. However, even within direct investment,the standard BOP classification allows for adistinction between assets and liabilities.

Type of Instrument

482. The method by which an investor chooses tomake an investment—that is, the instrument ofinvestment—is often important in BOP analysis. The many instruments available for investment maybe divided into two broad categories: equity anddebt. Equity instruments are those that entitle theholder to a share in the profits of the issuingenterprise or a claim on the residual value of theenterprise after all of the other liabilities of theenterprise have been met. Debt instruments, on theother hand, entitle the holder to a return that is notrelated to the profitability or net worth of theissuing enterprise.

483. The three main equity instruments are shares inincorporated enterprises, equity in unincorporatedenterprises, and direct investors’ shares of thereinvested earnings of direct investment enterprises.

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Within debt instruments, the major subcategories areloans (including use of Fund credit), trade credits,currency and deposits, bonds and notes, moneymarket instruments, and financial derivatives. Whilenot debt instruments in the strictest sense (becausethere is no debtor associated with these instruments),monetary gold and SDRs are generally grouped withdebt instruments in presentations of BOP and otherrelated statistics.

Domestic Sector

484. The institutional sector of the domestic(resident) creditor is often a factor that influencesfinancial transactions in assets. Likewise, theinstitutional sector of the debtor often influencesfinancial transactions in liabilities. Accordingly, forportfolio investment and other investment, foursectors are distinguished in the BOP standardcomponents: general government, monetaryauthorities, banks, and other. For direct investment,however, the domestic institutional sector is notparticularly important for explaining the behavior ofinvestments. Accordingly, direct investmenttransactions are not classified by sector in thestandard components of the balance of payments.Monetary authorities can be presumed to be eitherdirectly or indirectly responsible for reserve assettransactions; therefore, sectoral classification is notrequired for these transactions.

485. The classification of BOP transactions by sectoralso plays a significant role in linking BOP statisticswith other statistical systems, such as the system ofnational accounts, money and banking statistics, andgovernment finance statistics.

486. The principle of classification by sector, whichis specified in the BPM, is to identify the domesticcreditor for assets and the domestic debtor forliabilities. The identification of assets by domesticcreditor does not present any problems because thecreditor is always the owner of an asset and thusone of the parties to transactions involving the asset. Therefore, for assets, sector attribution bycreditor and by transactor coincides. However, this coincidence does not always apply in the caseof liabilities. For example, a resident of Coonawarra purchases 40 units worth of 90-daygovernment notes in the financial market ofHughesavia. Subsequently, a resident of Hughesaviapurchases these notes from the resident ofCoonawarra. The following transactions would

be recorded in the balance of payments ofHughesavia:

Initial transaction Credit Debit

Portfolio investment-liabilities Money market instruments-general government 40


Subsequent transaction Credit Debit

Portfolio investment-liabilities Money market instruments-general government 40


487. Entries appearing in the previous exampleshow that a claim on a domestic debtor (theHughesavian government) changes ownership froma nonresident creditor to a domestic creditor. Thedomestic debtor (the Hughesavian government) isnot a party to the subsequent transaction betweenthe nonresident investor and the resident ofHughesavia who acquires the claim. Nevertheless,according to the BPM, the sector of the debtordetermines the classification of the transaction. Theoriginal nature of the liability is generally consideredmore significant than the identity of the presentclaim-holder. The second transaction in the exampleis attributed to the debtor in Hughesavia who issuesthe notes and not to the resident who acquires thesesecurities from the nonresident investor.

488. Sectoral attribution of transactions in financialitems should be interpreted quite strictly. Guaranteesand financial intermediation (when the intermediaryis not actually the legal creditor or debtor)undoutedly have an influence on investors.However, such factors do not constitute the primarymotivation of those engaging in the transactions. Agovernment guarantee for repayment of a loan to anenterprise may have a favorable impact on a lender.Nonetheless, the basic motivation for the transactionis the decision of the enterprise to borrow.

Long- and Short-Term Investments

489. The criterion used in the BPM fordistinguishing between long- and short-terminvestments is the original contractual maturity.Long-term investment is defined as investment withan original contractual maturity of more than oneyear or an investment with no stated maturity (such


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as corporate equities). Short-term investment isdefined as investment payable on demand or withan original contractual maturity of one year or less;short-term investment includes currency. Thedefinitions of long- and short-term investments arenot sufficient or satisfactory for distinguishingbetween long- and short-term movements. Often,the original maturity does not have much influenceon the length of time a financial asset will be held.Nevertheless, it appears to be one of the factors thatinvestors take into account with regard to certaininstruments.

490. While a number of the innovations in financialmarkets have somewhat diminished the usefulnessof classifying many of the BOP financial transactionsby maturity, it is still seen as an importantclassification for the trade credit, loans, and otherassets and liabilities components of otherinvestment. Accordingly, it is recommended in theBPM that transactions in these instruments beclassified in this way. However, for investment inother instruments, the maturity classification is notviewed as particularly useful and is notrecommended.

Supplementary Classifications

491. In addition to the five primary classifications offinancial transactions, there are—according to theBPM—two other classifications that can be used toanalyze financial account transactions: liabilitiesconstituting foreign authorities’ reserves (LCFAR) andexceptional financing transactions. However, as theBOP analysis that uses these classifications tends tobe more specialized than analysis undertaken on thebasis of other classifications, LCFAR and exceptionalfinancing are not included in the BOP standardcomponents. Instead, these classifications are shownas supplementary classifications.

Liabilities Constituting Foreign Authorities’ Reserves

492. A BOP analyst may wish to group certainliabilities with reserve assets if he or she considersthese liabilities to perform a function similar to thatof reserve assets. The relationship between mostliabilities and reserve assets is, however, not alwaysstraightforward. Reserve assets may be used toperform more than one function, and the liabilitiesrelated to each of the functions may be different. Itmay also be difficult to identify the underlying

causes of changes in certain liabilities. Therefore,the BPM recommendation is to identify any liabilitythat constitutes a reserve asset from the point ofview of the nonresident creditor. In certain cases, itmay be very difficult—from the debtor’s point ofview—to determine whether a creditor will classifya claim as part of reserve assets. For example, thecentral bank of Nostaw could purchase, through abroker, securities issued by a resident of Namdarband place these securities in the reserve assets ofNostaw. It would be difficult for the BOP compilerof Namdarb to determine whether these securitiesare held as reserve assets by Nostaw. As a practicalmatter, BOP compilers in debtor countries canfollow a rule of thumb to identify liabilities thatconstitute foreign authorities’ reserves.

493. The rule of thumb is based on the assumptionthat a nonresident creditor will probably classify asreserve assets any liability of the compiling economythat is:

repayable on demand or in the short-term (i.e.,marketable) or that the debtor is prepared to redeemon short notice;

repayable in a form that the debtor regards as areserve asset;

owed to a central bank, central government, or otheragency (except a public nonmonetary enterprise) ofthe central authority.

All of these conditions need not be met or besimultaneously applicable. One of the following tworules is sometimes applied. The overwhelmingmajority of monetary assets (that is, assets that canbe used to make payments) owned bygovernmental authorities will be reserve assets.Therefore, in the absence of information to thecontrary, the debtor economy could consider anyliabilities to foreign central authorities to beclassified as liabilities constituting foreignauthorities’ reserves. Alternatively, the debtoreconomy could decide to classify as LCFAR only itsliabilities to foreign monetary authorities. Thisdecision could be made if the the availableevidence suggests that a significant portion of thedebtor economy’s liabilities to other foreign centralauthorities is comprised of types of assets that arenot likely to constitute part of the reserve assets ofthe creditor economies.17

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17That is, central authorities other than monetary authorities

494. According to the BPM, liabilities that constitutereserve assets of the creditor economy are shown asa supplementary classification, even though thecompiling country itself (the debtor) may not, in fact,regard some or any of the liabilities as an additionalmeans of financing its BOP deficit or as an offset toits reserve assets.

Exceptional Financing

495. Exceptional financing transactions consist ofany arrangements (other than the use of reserveassets, Fund credit and loans from the Fund, andLCFARs) made by the authorities of an economy tofinance BOP imbalances. The category of exceptionalfinancing transactions therefore covers BOPfinancing items not included in categories for reserveassets and liabilities constituting foreign authorities’reserves. There are three main forms of exceptionalfinancing: external borrowing, repayment of arrears,and forgiveness of debt.

External Borrowing

496. Instead of using reserve assets to finance a BOPdeficit, authorities may engage in external borrowingfor that purpose. For example, to bolster foreignexchange reserves, the central bank of a countryborrows 100 units on a short-term basis. The BOPentries would be:

Credit Debit

Exceptional financingOther investment-liabilities-

drawings on new loans-general government* 100

Reserve assets 100*In this and other examples of the recording of exceptional financing trans-actions, the exceptional financing element of the transaction is classifiedaccording to the supplementary exceptional financing classification ratherthan the BOP standard components classification.

Both entries are shown “below the line” because theborrowing is not an autonomous transactionaffecting the BOP deficit of the country but a meansof financing the deficit.

497. The main practical problem in classifyingofficial borrowing is the necessity of distinguishingbetween BOP financing and project financing. (Thelatter is always shown “above the line” as a factorcontributing to the overall BOP position of thecountry.) No objective criterion, such as originalmaturity or sector of transactor, can be dependedupon to provide the desired distinction. Rather, the

purpose of the borrowing must be determined onthe basis of available information.

498. Some borrowings that are encouraged orinspired by governmental authorities but do notconstitute official liabilities may nonetheless beregarded as exceptional financing transactions. Forexample, authorities may use commercial banks toconduct external borrowing operations. When theproceeds of commercial bank borrowings areeffectively subject to the control of the authorities,the borrowings should be categorized as exceptionalfinancing. (Such proceeds are analogous to reserveassets legally owned by commercial banks but underthe effective control of authorities and thereforeconsidered part of official reserves.) Compilers mustdetermine whether authorities are exercising controlover proceeds and whether the borrowings wereundertaken for the purpose of BOP financing. Thedetermination may be very difficult to make and, insome situations, quite important because of the largemovements that sometimes occur in commercialbanking funds.

499. Without becoming the legal debtors, govern-mental authorities may also encourage borrowingabroad by offering exchange rate guarantees or otherinducements to public enterprises, local govern-ments, or the private sector. The authorities may evenstate that their purpose is the improvement of thecountry’s BOP position. The existence of such apolicy is certainly a relevant fact to be noted inappraising a country’s position. Nevertheless, officialinducement is rarely the only reason that suchborrowing takes place. Therefore, treating this debtas official financing exaggerates the influence thatauthorities can exert in an indirect manner. Moreover,most financial flows are likely to be affected byactions of the authorities, and those actions are nodoubt taken with the BOP impact in mind. However,the indirect BOP effects cannot be quantified, andcases do arise in which an inducement offered byauthorities seems the most reasonable explanation fora certain financial inflow. In that circumstance, theborrowing should undoubtedly be shown “below theline” in measuring the balance of payments.

500. The repayment of a loan is not usually adiscretionary act on the part of the debtor.Therefore, with one exception, only originaldrawings on loans constitute exceptional financingtransactions. The exception occurs when, forbalance of payments reasons, loan repayments aremade on schedules that differ from predetermined


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schedules. If authorities choose, with or without theconsent of the creditor, not to make a loanrepayment on schedule, the obligation is treated as ifit had in fact been satisfied and a new, replacementobligation is created. Specifically, a debit entry forreduction of the liability is made “above the line,”and an offsetting credit entry for an increase inofficial borrowing is made in exceptional financing.Similarly, a loan repayment made by authorities inadvance of the due date is sometimes shown asexceptional financing. If the loan prepayment ismade for other than BOP purposes (to improve thedebtor’s standing in the credit market, for example),the prepayment is not included in exceptionalfinancing transactions.

501. If the short-term borrowing described inparagraph 496 were repaid on time and if interest of10 units were charged, entries for the repaymentwould be:

Credit Debit

Interest 10Other investment-liabilities-loans-

short-term-general government 100Reserve assets 110

Thus, even though the drawing of the loan wasshown “below the line” as an exceptional financingtransaction, repayment of the loan is shown “abovethe line.”

Payments in Arrears

502. Payments in arrears are simply payments thatare not made when due. According to the BPM,such payments are recorded as if the payments weremade, and new liabilities are created for theoutstanding debts. Payments in arrears are includedin exceptional financing transactions if monetaryauthorities fail to provide the necessary foreignexchange but not if the payments are in arrearsbecause a debtor refuses or is unable to pay innational currency.

503. For example, in period 1, a manufacturerimports some materials on credit. In period 2, when the debt falls due, the manufacturer tries toconvert his national currency into foreign exchangeto make the payment. The country is experiencingBOP difficulties, and the central bank cannot allocate the necessary foreign exchange. Thepayment, therefore, is not made. Principal andinterest due amount to 150 units and 10 units,

respectively. Entries in the balance of paymentswould be:


Goods 150Other investment-liabilities-trade

credit-other sectors 150


Interest 10Other investment-liabilities-trade

credit-other sectors 150Exceptional financing

Other investment-liabilities-other sectors-accumulation of arrears-principal on short-term debt 150original interest 10

504. As with external borrowing, debt repaymentsare included in exceptional financing transactionsonly if the repayments are unscheduled. Such isusually the case for payments in arrears. To extendthe previous example—in period 3, the exchangerestrictions are lifted and the repayment is made.The entries would be:


Exceptional financingOther investment-liabilities-other

sectors-repayments of arrears-principal 150interest 10

Reserve assets 160

505. When payments are in arrears, debts are oftenrenegotiated and new contracts arranged. Undersuch circumstances, changes in the nature of theexceptional financing are recorded as repayments ofthe payments in arrears and drawings of new loans.If the debt were rescheduled for payment over twoyears, the entries would be:

Credit Debit

Exceptional financingOther investment-liabilities-other

sectors-repayments of arrears-principal 150interest 10rescheduling of existing debt 160

New loan repayments, if made according toschedule, are shown “above the line” in the periodsin which the repayments are made.

506. If repayments other than those scheduled forthe current period are rescheduled, only therescheduling of the repayment for the current periodis shown as exceptional financing. The remainder of

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the rescheduled repayments are shown “above theline” as the repayment of the old liability and thecreation of a new one.

Debt Forgiveness

507. Occasionally, a creditor will forgive all, or part,of the debt of a debtor in a country experiencingBOP problems. This debt forgiveness will also affectthe exceptional financing category. The liability isreduced “above the line” for the amount forgiven.That part of the offsetting capital transfer relating tothe scheduled repayment for the current period is

shown as part of exceptional financing transactions.The remainder of the transfer is shown “above theline.”

Other Exceptional Financing Transactions

508. In addition to the three types discussed inprevious paragraphs, there are other types of trans-actions (such as debt-equity swaps and grantsreceived from Fund subsidy accounts) that could beconsidered exceptional financing transactions.Additional details on these transactions may befound in chapter 22 of the BPM.


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The Concept of Direct Investment

509. Direct investment is a category of internationalinvestment in which a resident entity in oneeconomy (the direct investor) acquires a lastinginterest in an enterprise resident in anothereconomy (the direct investment enterprise). Directinvestment implies a long-term relationship betweenthe direct investor and the direct investmententerprise and a significant degree of influence bythe direct investor on the management of the directinvestment enterprise. Direct investment comprisesthe initial transaction between the two entities—thatis, the transaction that establishes the directinvestment relationship—and all subsequenttransactions between the entities and amongaffiliated enterprises, both incorporated andunincorporated.

510. The Organisation for Economic Cooperationand Development (OECD) presents the sameconcept of direct investment in the DetailedBenchmark Definition of Foreign Direct Investment(BMD). The BMD is complementary to the Balanceof Payments Manual. The purpose of the BMD is toprovide a detailed operational definition of directinvestment to serve as a reference, or standard,against which each country can compare itsstatistical system by using the concept and definitionof direct investment contained in the Balance ofPayments Manual. The BMD supplements theinformation provided in the Balance of PaymentsManual.

511. The concept of direct investment differs fromthe concept of control. To be classified as a directinvestor, an investor need not have the controllingshare, or even the largest share, of ownership in anenterprise.

Motivation for Direct Investment

512. Direct investors expect to derive benefits fromhaving a voice in the management of an enterprise.Portfolio investors, who do not exercise significant

influence over the enterprises in which they invest,expect to obtain different benefits. From a directinvestment perspective, enterprises often representunits in a multinational operation, the overallprofitability of which depends on advantages gainedby deploying resources available to each unit in away that best enhances the synergy of the group.For example, the direct investor may be able toobtain resources or access to markets that mightotherwise be unavailable to the enterprise. Directinvestors may also be able to increase enterpriseprofitability and value through management skillsand other expertise. Direct investment may alsoallow the direct investor to diversify and manage riskmore effectively.

513. Therefore, direct investors may receivebenefits in addition to income that would otherwiseaccrue on invested capital. In contrast, portfolioinvestors are primarily concerned about return oninvestment and the likelihood of appreciation invalue. Portfolio investors generally evaluateprospective investment units separately and oftenshift their investments according to changes inprospects.

Defining the Direct Investment Relationship

514. The direct investor may be an individual, anincorporated or unincorporated private or publicenterprise, an associated group of individuals orenterprises, or a government or government agency that owns a direct investment enterprise (asdescribed subsequently) in an economy other thanthat in which the direct investor resides. A directinvestment enterprise is an incorporated orunincorporated enterprise in which a direct investor owns 10 percent or more of the ordinaryshares or voting power (for an incorporatedenterprise) or the equivalent (for an unincorporatedenterprise). The direct investment relationshipextends to direct investment enterprise subsidiaries,direct investment enterprise associates, and branches directly or indirectly owned by the directinvestor.

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IX. Direct Investment

515. Enterprise X is a subsidiary of enterprise Nonly if:

(1) enterprise N owns more than half of the share-holders’ or members’ voting power in X

or

(2) enterprise X is a subsidiary of any otherenterprise that is a subsidiary of N.

Enterprise K is an associate of enterprise N only if:

(1) enterprise N and its subsidiaries own 10 percentor more of the shareholders’ voting power inenterprise K and enterprise K is not a subsidiaryof N

or

(2) enterprise K is a subsidiary of any otherenterprise that is an associate of N.

Therefore, an investor need not control or be thelargest shareholder in an enterprise for a directinvestment relationship to exist between them. Theconcept of direct investment is fundamentallydifferent from the concept of foreign-controlledenterprises. While all foreign-controlled enterprisesare direct investment enterprises, enterprises notconsidered foreign controlled may also be in directinvestment relationships with nonresident directinvestors.

516. The rule of 10 percent is used to ensureconsistent classification of investor/investeerelationships for all countries’ statistics. In manycountries, regulatory and other authorities consider10 percent ownership to constitute a relationshipimplying a degree of influence by the investor.Sometimes, investors who own 10 percent or moreof an enterprise have little or no influence onenterprise management (e.g., pension funds notinvolved in the management of enterprises in which the funds have substantial investments). On the other hand, investors who own less than10 percent may have an effective voice in enterprise management (for example, by being ableto appoint managing directors). In the interest ofcomparability, however, use of the 10 percent ruleis preferable to subjective judgment. Furthermore, as most direct investment enterprises are branchesor subsidiaries that are wholly or majority owned by nonresidents, borderline cases are relativelyinsignificant.

517. Illustrated below are subsidiary and associaterelationships. Enterprise N has these investments:

According to the definition of direct investment:

A is a subsidiary of N.

B is a subsidiary of A and therefore a subsidiary ofN, even though only 33 percent of B is indirectlyattributable to N.

C is an associate of B and therefore an associate ofN through N’s subsidiary B, even though only 4percent of C’s capital is indirectly attributable to N.

D is an associate of N.

E is a subsidiary of D and therefore an associate ofN, even though only 6 percent of E is indirectlyattributable to N.

F is an associate of N.

G is an associate of F but not of N as F is only anassociate of N.

H is neither a subsidiary nor an associate of N.

J is a subsidiary of H but neither a subsidiary nor anassociate of N.

K is a subsidiary of N.

L is a branch of K and thus a branch of N.

Therefore, enterprises A, B, C, D, E, F, K, and L areinvolved in a direct investment relationship with Nand in direct investment relationships with eachother. Transactions between company E andcompany K, for example, represent direct investmenttransactions.

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N

60% 10% 30% 9% 70%

Company A Company D Company F Company H Company K

55% 60% 25% 100% 100%

Company B Company E Company G Company J Branch L

12%

Company C

518. For purposes of the balance of payments andthe national accounts, enterprises that havesignificant long-term (that is, more than one year)operations in more than one economy are dividedinto separate entities in each economy. Theseentities are always in a direct investmentrelationship; the head office constitutes the directinvestor and the branches constitute the directinvestment enterprises. Land and structures directlyowned by nonresidents (other than foreigngovernments) are, in the balance of payments andthe national accounts, considered to be owned bynotional resident units that are in direct investmentrelationships with the legal owners of the land. Alsoconsidered to be owned by enterprises that areresident in the host country and in direct investmentrelationships with the actual operators of equipment(such as ships, aircraft, gas and oil drilling rigs) ismobile equipment that operates in an economy forat least one year, is accounted for separately by theoperator, and is recognized by taxation and similarauthorities of the host country as part of thecountry’s capital stock.

Direct Investment Capital

519. Direct investment capital is (1) capital providedby the direct investor—either directly or throughother enterprises related to that investor—to thedirect investment enterprise or (2) capital receivedby the direct investor from the direct investmententerprise. Direct investment capital includes equitycapital, reinvested earnings, and other capitalinvolved in various intercompany debt transactions.Direct investment capital includes only actualamounts provided; for example, funds for which thedirect investor merely makes the arrangements orguarantees repayment are not considered directinvestment capital.

520. Equity capital covers equity in branches, allshares (whether voting or nonvoting) in subsidiariesand associates, and other capital contributions (forexample, the provision of machinery—whichconstitutes part of the capital of the direct investmententerprise—by a direct investor to a directinvestment enterprise). Equity capital also covers theacquisition by a direct investment enterprise ofshares in its direct investor. Reinvested earnings arethe direct investors’ shares (in proportion to equityheld) of the undistributed earnings of the directinvestment enterprise. These reinvested earnings arerecorded as income with an offsetting capital

transaction. The rationale for including reinvestedearnings in the balance of payments is discussed inchapter 6.

521. Other capital (or intercompany debttransactions) covers the borrowing and lending offunds, including debt securities and trade credits,between direct investors and direct investmententerprises and between two direct investmententerprises that share the same direct investor. Debtclaims on the direct investor by the direct investmententerprise are also recorded as direct investmentcapital.

522. However, in regards to investments betweenaffiliated banks and other financial intermediaries,only those investments associated with equity andpermanent debt (that is, loan capital) are consideredto be direct investment. Other debt investment (such as deposits and other claims and liabilitiesrelated to normal banking activity) betweenaffiliated banks and other financial intermediaries isconsidered to be portfolio investment or otherinvestment.

523. In practice, it is sometimes difficult todistinguish between the equity capital and the other capital of direct investment enterprises.Differentiation is particularly difficult when anenterprise is 100 percent owned by a direct investor. In these situations, the classification ofcapital for the balance of payments could be thesame as that used in the direct investor’s (or directinvestment enterprise’s) accounting records. That is,when a claim of the direct investor on the directinvestment enterprise is considered—in theaccounting records of the direct investor or theenterprise—to be equity capital or shareholderfunds, this claim is also considered equity capital inthe balance of payments.

524. Capital provided to a direct investmententerprise by economic units other than the directinvestor and enterprises related to the direct investoris not direct investment capital. For example, if adirect investment enterprise borrows money from anenterprise that is not affiliated with the directinvestor, this borrowing is classified in the balance ofpayments as other investment.

525. The following example illustrates the conceptof direct investment capital. Enterprise X in Namdarbis 50 percent owned by enterprise Z in Coonawarra.Forty-five percent of enterprise X’s shares are owned

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by residents of Namdarb, and 5 percent are ownedby a resident in Cromania. In a particular year,enterprise X undertakes the following transactions:

(1) One hundred shares of new equity are issued,and these are purchased by shareholders ofenterprise X in proportions equal to their existingshareholdings.

(2) Enterprise Z provides enterprise X with 20 units’worth of machinery, which is entered in theaccounting records of enterprise X as non-votingequity.

(3) Enterprise Z sells goods worth 40 units toenterprise X. Enterprise X pays 20 units, and theremaining 20 units are entered, in the accountingrecords of enterprise X, as a trade credit payable.

(4) Acting as a guarantor for the loan, enterprise Zarranges for an unrelated bank in Dromesia to lendenterprise X 75 units.

(5) Enterprise X’s operating profit, after tax andinterest expenses, for the year is 10 units. EnterpriseX does not pay any dividends during the year.

526. These entries would be made in Namdarb’sbalance of payments:

Credit Debit

Goods 20 (2)40 (3)

Income-investment income-direct investment-earnings on equity-reinvested earnings 5 (5)

Direct investment in NamdarbEquity capital 50 (1)

20 (2)Reinvested earnings 5 (5)Other capital 20 (3)

Portfolio investment-liabilities-equity 5 (1)Other investment-liabilities-

loans-other sectors 75 (4)Reserve assets (or other appropriate

financial account item) 20 (3) 55 (1)75 (4)

A direct investment relationship is created when aninvestor (or group of related investors) obtains 10percent or more of the shares in an enterprise. If aninvestor does not own any shares in an enterpriseprior to becoming a direct investor, the entireacquisition of shares is recorded as a directinvestment transaction. Conversely, if an investor hasenterprise shareholdings of less than 10 percent priorto becoming the direct investor, only the sharesacquired in the transaction that makes the investor adirect investor are classified as a direct investment

transaction. In other words, the reclassification ofshares previously classified as portfolio investment todirect investment is not recorded in the balance ofpayments but is reflected instead in the internationalinvestment position.

527. For example, enterprise P in Pokolbinpurchases, for 8,000 units, 8 percent of the shares in enterprise M in Madornia. One month later,enterprise P acquires, for 6,000 units, another 5percent of the shares of enterprise M. The followingtransactions would be shown in Madornia’s balanceof payments:

Credit Debit

Portfolio investment-liabilities-equity 8,000Reserve assets (or other appropriate

financial account item) 8,000Direct investment in Madornia

Equity capital 6,000Reserve assets (or other appropriate


528. If enterprise P’s investment in Madornia isvalued at 15,000 units at the end of the period, thefollowing entries would be shown in Madornia’s IIPstatement:

Level Levelat Start Trans- Other at Endof Period actions Changes of Period

LiabilitiesDirect Investment

Equity 0 6,000 9,000 15,000Portfolio Investment

Equity 0 8,000 –8,000 10,000Total 0 14,000 1,000 15,000

Direction of Investment

529. Unlike other financial investments, directinvestment is not recorded in the balance ofpayments on a strict asset/liability basis. Instead,direct investment is recorded on a directionalbasis—resident direct investment abroad andnonresident direct investment in the reportingeconomy. Capital invested by the direct investmententerprise in its direct investor (reverse investment)is regarded as an offset to capital invested in thedirect investment enterprises by a direct investorand its related enterprises. That is, such capital isregarded as disinvestment by the direct investorrather than as an asset of the direct investmententerprise. For purposes of analysis, theseinvestments are recorded separately in the BOPstandard components. When a direct investmententerprise invests in an enterprise related to its

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110

direct investor, this investment is recorded, by theeconomy providing the investment, as residentdirect investment-abroad and, by the economy ofthe enterprise receiving the investment, as directinvestment-reporting economy.

530. In some instances, two enterprises or groupsof related enterprises hold 10 percent or more ofeach other’s voting shares. Thus, two directinvestment relationships are established, andinvestments between the two enterprises or groups of enterprises are recorded on a full assetand liability basis—that is, as direct investment-reporting economy and as direct investment-abroad.

531. The following two examples illustrate thedirectional basis for recording direct investmenttransactions. In the first example, enterprise A inAlgornia is 100 percent owned by enterprise N inNostaw. Enterprise N owns 100 percent of enterpriseE in Essendonia. In a particular period, enterprise Ais involved in the following transactions:

Enterprise N provides machinery worth 50 units toenterprise A. The machinery is recorded as anequity investment in the accounting records ofenterprise A.

Enterprise A lends enterprise E 100 units. The loan isrepayable in five years. Enterprise E pays interest of5 units on the loan during the year.

Enterprise E sells to enterprise A goods worth 50units. Enterprise A provides payment in the form oftrade credit, which remains outstanding at the end ofthe year. Enterprise A pays interest of 4 units on thetrade credit.

Enterprise A purchases 80 units of bonds issued byenterprise N and receives 8 units in interest income.

Enterprise A’s operating profit, after taxes andinterest, is 25 units; dividends equal to this amountare paid.

The following entries would be recorded inAlgornia’s balance of payments:

Credit Debit

Goods 100Income

Direct investmentIncome on equity-dividends 25Income on debt 15 –4

Direct investment in AlgorniaEquity capital

Liabilities to direct investor 50

(continued) Credit Debit

Other capitalLiabilities to direct investor 50Claims on direct investor 80

Direct investment abroadOther capital 100


532. In the second example, enterprise H operatingin Hughesavia is 50 percent owned by enterprise Lin Longa. In a particular year, these transactionsoccur in the order of presentation:

Enterprise H lends enterprise L 45 units.

Enterprise H purchases 20 percent of the shares ofenterprise L for 1,200 units.

Enterprise H lends another 15 units to enterprise L.

Enterprise H receives interest of 6 units on fundslent to enterprise L.

Enterprise H’s operating profit, after taxes andinterest, is 50 units. No dividends are paid.

Enterprise L’s operating profit, after taxes andinterest, is 80 units. Dividends of 40 units are paid toshareholders.

533. The following entries would be made inHughesavia’s balance of payments:

Credit Debit

Investment incomeDirect investment

Income on equityDividends 8Reinvested earnings 8 25

Income on debt 6Direct investment in Hughesavia

Reinvested earningsLiabilities to direct investor 25

Other capitalClaims on direct investor 45

Direct investment abroadEquity capital 1,200Reinvested earnings 8Other capital 15


Enterprise H’s first loan to enterprise L is shown asreverse investment because, at the time the loan ismade, enterprise H does not have a direct investmentinterest in enterprise L. The second loan, which ismade after enterprise H becomes a direct investor inenterprise L, is treated as direct investment-abroad.As all of the interest is paid after enterprise Hbecomes a direct investor in enterprise L, this amount

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is shown as a direct investment credit rather than asa negative direct investment income debit. The valueof enterprise H’s stock of direct investment abroadwould be shown in Hughesavia’s statement ofinternational investment position at the end of theperiod as the entire amount that enterprise H has lentto enterprise L. The reclassification of the first loanwould be shown as a non-transaction change inlevels.

Valuation

534. The recommendation of the BPM is that marketvalues be used to value direct investment financialflows, income transactions, and stock positions. Useof market values is consistent with valuation principles recommended for recording other entries inthe balance of payments and the internationalinvestment position. The recommendation to usemarket values for the valuation of direct investment ismade for two primary reasons. First, comparisons ofdirect investment and other financial investmentrecorded in the balance of payments and internationalinvestment position would be invalid if inconsistentvaluation bases were used. Second, market valuationprovides the most meaningful measure of theeconomic value of resources available to, ortransferred between, economies.

535. Unfortunately, because of the nature of thedirect investment relationship, the criterion used forestablishing market values is generally not satisfiedas a key aspect of this criterion is that the parties totransactions must be independent. With regard totransactions, values shown in the accounting recordsof the direct investor and direct investmententerprise often serve as acceptable proxies formarket valuations. However, in some instances,transactions occur between enterprises in a directinvestment relationship, and the values shown inthe accounting records of the transactors aresignificantly distorted from market values. Forexample, an enterprise may use prices that areunrelated to costs of production or acquisition inselling goods to a related enterprise. Such pricingmight be employed as a means of transferringprofits from one country to another for tax reasonsor because the country of the direct investmententerprise imposes restrictions on repatriation ofincome by more straightforward means. In otherinstances, transfer prices may be used as a meansby which a direct investor makes a capitalinvestment in a direct investment enterprise.

536. The recommendation of the BPM is that, whenthe actual transaction price of a transfer of realresources between enterprises in a direct investmentrelationship differs from the value that could havebeen expected if the enterprises had beenindependent, the BOP compiler should make anadjustment to these values as shown in the balanceof payments. The BPM also contains the cautionthat such adjustments should be made only whensignificant distortions are encountered.

537. When adjustments are made to one side of a BOP transaction, similar adjustments must bemade to the other side of the exchange to preserve equality between credit and debit entries.Offsetting adjustments are always made toinvestment income or to direct investment financialtransactions.

538. The following two examples illustrate theadjustment process. In the first example, direct investment enterprise U in Urangastan producescopper. Were this copper sold to an unrelatedenterprise, direct investment enterprise U couldexpect, on the basis of the production cost of thecopper, to earn 50 units per ton. However, thegovernment of Urangastan has imposed restrictionson the repatriation of income to nonresidents.Therefore, enterprise U sells—to direct investor C inClintonstan—1,000 tons of copper at only 10 unitsper ton. In this case, direct investment enterprise Uand direct investor C are using transfer pricing toachieve a repatriation, which would otherwise notbe permitted, of income to Clintonstan. These entrieswould be made:

Balance of Payments of Urangastan

Credit Debit

GoodsAs shown in transactors’

accounting records 10,000Adjustment to market valuation 40,000

Direct investment incomeIncome on equity 40,000


539. In the second example, direct investor D inDaniherland wishes to increase his investment inwholly owned subsidiary B in Bushland. However,Bushland’s foreign investment policy restricts further explicit financial investment. To circumventthis policy, direct investor D sells machinery tosubsidiary B for 2,000 units. Direct investor D could have sold this machinery to an unrelated

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enterprise for 5,000 units. The following entrieswould be shown in Daniherland’s balance ofpayments:

Credit Debit

GoodsAs shown in transactors’ books 2,000Adjustment to market valuation 3,000

Credit Debit

Direct investment abroadEquity capital 3,000


540. The concept of market valuation can also bedifficult to apply to direct investment relationshipsfor valuations of equity positions in the IIPstatement. Stock positions for equities and othersecurities are generally valued by using pricesprevailing in an independent market on the date forwhich the IIP statement is prepared. As anindependent market often does not exist for equityinvestment in direct investment enterprises, the BPMrecommendation is that market value proxies beused. In the absence of regular market trading, thevalue of equity investment could be calculated as thenet worth of an enterprise; one would apply currentmarket values to the assets (including intangibles)and liabilities of the enterprise and determine thedifference. See chapter 13 for valuation of directinvestment equity stocks.

Special Cases

541. Four types of direct investment requireelaboration: (1) special purpose entities,(2) construction enterprises, (3) investment in land,and (4) mobile equipment stationed in an economyfor more than one year.

Special Purpose Entities (SPEs)

542. Special purpose entities (SPEs) are (1) generallyorganized or established in economies other thanthose in which the parent companies are resident and(2) engage primarily in international transactions butin few or no local operations. SPEs meeting thecriteria presented in paragraphs 514–518 are included,with one exception, as direct investment enterprises.Excepted are SPEs with the sole purpose of serving asfinancial intermediaries; for these, investmentsrecorded under direct investment are limited to equitycapital and permanent debt.

543. Two examples illustrate the BOP treatment of SPEs. An Australian enterprise sets up anenterprise in Bermuda with share capital of $2. The enterprise is (1) to purchase and hold $2million of portfolio equity investment in the UnitedStates; (2) to purchase and hold $1 million of bondsissued by a German company; and (3) to purchase,for $5 million, and hold a 50 percent interest in aUnited Kingdom company. Half of the $8 millionrequired for the investments is provided by theAustralian direct investor and half is provided by abank in the Netherlands Antilles. Bermuda’s balance of payments would show the followingtransactions:

Credit DebitDirect investment in Bermuda

Equity capital 2Other capital 4,000,000

Direct investment abroadEquity capital 5,000,000

Portfolio investment-assetsEquities 2,000,000Bonds 1,000,000

Other investment-liabilitiesLoans-other sectors 4,000,000


As the enterprise in Bermuda is not purely afinancial intermediary, BOP transactions with relatedenterprises are recorded on the same basis as otherdirect investment transactions are—although theenterprise has no operations in Bermuda.

544. A New Zealand company wishes to borrowfunds on the U.S. capital market by issuing bondsvalued at $3 million. Under U.S. regulations, onlyresident companies are allowed to issue suchsecurities on the U.S. market. So the New Zealandcompany establishes “a $2 subsidiary” in Delaware(a U.S. state) and the subsidiary issues the bondsand lends the proceeds to its parent. As this SPEacts purely as a financial intermediary, only equity capital and any permanent debt provided bythe direct investor are classified as direct investment.The following transactions would be recorded inNew Zealand’s balance of payments:

Credit Debit

Direct investment abroadEquity capital 2

Portfolio investment-liabilitiesBonds 3,000,000

Reserve assets (or other appro-priate financial account item) 2,999,998

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Construction Enterprises

545. The treatment of international constructionactivity has been described in chapters 2 and 5.However, some reiteration is justified because of therelative complexity, from a BOP perspective, of thisactivity and its impact on direct investment statisticsfor some countries.

546. Work undertaken in one economy by aconstruction enterprise resident in another economycan be treated (1) as work performed by a notionalenterprise that is resident in the host economy andengaged in a direct investment relationship with theparent enterprise or (2) as a service imported by thehost economy. The important issue is determinationof the economy to which production is attributed. Ifan enterprise maintains, or expects to maintain, apresence in the host economy for more than a year,and if separate and appropriate records are kept inrespect of the enterprise’s work in the hosteconomy, production should be attributed to thehost economy. In such a case, a direct investmententerprise is created in the economy. Otherwise, nodirect investment relationship is established and animport, by the host economy, would be shown inthe balance of payments.

547. An example illustrates the recording ofconstruction activity in the balance of payments ifthe creation of a direct investment enterprise isnecessary. Enterprise J in Jaymaranda wins aconstruction contract that is valued at 100,000 unitsand is to be fulfilled in Central Paradiso. The projecttakes two years to complete. At commencement,enterprise J deposits 60,000 units in local currencywith banks in Central Paradiso. Enterprise J alsosends a machine worth 8,000 units to CentralParadiso. A payment of 40,000 units is received atthe end of the first year and one of 60,000 units atthe end of the second year. These payments areimmediately repatriated to Jaymaranda. These costsare incurred in association with the project:

Year 1 Year 2Material purchased in

Central Paradiso 20,000 15,000Salaries paid to residents of

Central Paradiso 10,000 15,000

Depreciation on machinery 1,000 1,000______ ______

Total costs 31,000 31,000

548. The first item to be calculated is the year-by-yearprofit on the project. If a constant ratio of cost toprofit is assumed, the profit for each of year 1 and

year 2 is half of the total profit on the project becausehalf the total cost of the project is incurred in eachyear.18 As project remittances are greater than profitsin both years, a portion of the total remittance isconsidered a remittance of profit and the remainder isconsidered a withdrawal of direct investment capital.19

549. As the project is a long-term one and separateproject records are kept, a notional direct investmententerprise that is resident in Central Paradiso iscreated to account for the construction activity. Thefollowing BOP entries would therefore be recordedfor Jaymaranda:

Year 1 Credit Debit

(1)Goods 8,000(2)Direct investment abroad

(2)Equity capital 68,000(2)Reserve assets (or other

(2)appropriate financial (2)account item) 60,000

(2)Investment income(2)Direct investment

(2)Income on equity-remitted profits 19,000

(2)Direct investment abroad(2)Equity capital 21,000

(2)Reserve assets (or other appropriate (2)financial account item) 40,000

Transaction (1) reflects the initial capital provided tothe direct investment enterprise in the form ofmachinery and working capital. Transaction (2)shows repatriation of the first year’s progresspayment, a portion of which is allocated toinvestment income and the remainder of which isconsidered a withdrawal of direct investment capital.

Year 2 Credit Debit

Goods 6,000Investment income

Direct investmentIncome on equity-remitted profits 19,000

Direct investment abroad 47,000Reserve assets (or other


In entries for year 2, return of the machinery(recorded at written-down value) and repatriation of

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114

18The total profit from the project is equal to the value of output (100,000units) less costs incurred in producing the output (62,000 units). As costsare equally incurred in both years, the 38,000–unit profit is equallyattributable to both years. Were two-thirds of the cost incurred in year 1and one-third in year 2, two-thirds and one-third—respectively—of theprofit would be attributable to year 1 and year 2.

19Direct investment income can only relate to operating profits (describedin chapter 6) earned in either the current or the previous period. Whenremittances exceed earnings, a withdrawal of capital should be recorded inthe balance of payments.

the progress payment beyond the amount coveringsecond-year profits are both shown as withdrawalsof direct investment- abroad.

Foreign Ownership of Land

550. According to conventions presented in the BPMand the SNA, land, structures and other immovableobjects can only be owned by resident entities.20

When a nonresident acquires legal ownership ofland, a notional resident entity owned by thenonresident is, for BOP purposes, created to own theland. The relationship between the nonresident legalowner of the land and the notional entity is a directinvestment relationship. The initial investment by thedirect investor is equal to the purchase price of theland. The net rent from the land—that is, gross rentminus expenses incurred in the host country—isconsidered income earned by the direct investor fromthe direct investment enterprise. If the land issubsequently sold, the sale is considered awithdrawal of direct investment, which is recordedon the basis of the sale price. This treatment appliesto all types of immovable assets, whether or not theassets are used for productive purposes. Forexample, a household’s ownership of a holidayhouse in a foreign country is treated in this manner.

551. An example illustrates the treatment ofnonresident ownership of land. A resident of Japanpurchases land and buildings located in Hawaii andvalued at US$ 250 million. In the first year, gross rentreceivable is $20 million, and property taxes andother costs incurred in the United States are $5million. The net rent, $15 million, is repatriated toJapan. In the second year, the same amount of netrent is received. At the end of the second year, theJapanese resident sells the land and buildings to aU.S. investor for $280 million. The following entrieswould be recorded (in millions of US$) in Japan’sbalance of payments:

Year 1 Credit Debit

Direct investment incomeIncome on equity-remitted profits 15

Direct investment in the United StatesEquity capital 250


Year 2 Credit Debit

Direct investment incomeIncome on equity-remitted profits 15

Direct investment in the United StatesEquity capital 280


Mobile Equipment

552. As noted in chapter 2, mobile equipment thatoperates in an economy for more than one year, isaccounted for separately, and is recognized bytaxation and other authorities as part of the capitalstock of the host economy is regarded as beingoperated by a resident enterprise. If such an enter-prise does not actually exist, the BOP compilershould create a notional enterprise. This notionalenterprise is a direct investment enterprise and thedirect investor is the actual operator of theequipment.

553. In these cases, the initial investment in thenotional enterprise is equal to the value of themobile equipment at the time the equipment entersthe host economy. Net profits from mobileequipment operations in the host economy areconsidered direct investment income. In calculatingnet profit, it is important to include, as a cost,depreciation on the equipment. However, asdepreciation typically involves no actual payment ofmoney, the money received by the direct investorwill generally exceed the net operating profit afterallowance for depreciation. Receipts in excess ofdirect investment income represent a withdrawal ofcapital by the direct investor. If the mobileequipment eventually leaves the host economy, thenits departure also represents a withdrawal ofinvestment, which is recorded as an amount equal tothe value of the equipment at that time. Because ofdepreciation, the value of repatriated equipment willgenerally be less than the value of that equipmentwhen it entered the host economy.

554. An example illustrates previous points. An oilrig operated by a Pokolbin resident is chartered by aNamdarb oil company to drill for oil in waters justoff the Namdarb coast. The oil rig is valued at 500units when it enters Namdarb’s territorial waters. Inthe first year, net operating profit (beforedepreciation) from the oil rig is 55 units anddepreciation is recorded as 10 units; the amounts ofnet operating profit before depreciation anddepreciation for the second year are the same as

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20It is useful to recall the treatment of embassy land, etc. According toconventions presented in the BPM, such land is considered part of theterritory of the government using the land rather than part of the territoryof the host country.

those for the first year. At the end of the secondyear, the oil rig leaves Namdarb’s waters and returnsto Pokolbin. The following entries would be made inPokolbin’s balance of payments:

Year 1 Credit Debit

Goods 500Direct investment income

Income on equity-remitted profits 45Direct investment in Namdarb

Equity capital* 10 500Reserve assets (or other appropriate

financial account item) 55*In the presentation of BOP statistics, this item is shown on a net basis.Gross entries are shown here for illustrative purposes.

Year 2 Credit Debit

Goods 480Direct investment income

Income on equity-remitted profits 45Direct investment in Namdarb

Equity capital 490Reserve assets (or other appropriate


In the foregoing example, income on equity isshown net of depreciation, which is shown as awithdrawal of capital. Furthermore, the value of theoil rig when returned to Pokolbin is recorded at thewritten-down value of 480 units—that is, 500 unitsminus two years of depreciation at 10 units per year.

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116

555. The portfolio investment component of thefinancial account covers transactions in equities,other securities, and financial derivatives—exceptwhen these transactions relate to the directinvestment or reserve assets components of thefinancial account. Both short- and long-terminstruments are covered under portfolio investment.The essential characteristic of instruments classifiedas portfolio investment is that such instruments aretraded or tradable. That is, the instruments offerinvestors the flexibility to shift, regardless of theunderlying maturity of the instrument, investedcapital from one instrument to another. Portfolioinvestors are more concerned than direct investorsabout rates of return that are independent of anyinfluence investors may have and about being able to move funds quickly if circumstances sodictate.

556. Portfolio investment transactions are classifiedas those involving an economy’s financial assets andthose involving an economy’s financial liabilities.Within these asset and liability classifications,portfolio investment transactions are classified bytype of instrument. Four types of instruments areincluded in the BOP standard components: (1) equities, (2) bonds and notes, (3) money marketinstruments, and (4) financial derivatives. Trans-actions recorded in these categories are subsequentlydiscussed in more detail. Within each instrumentcategory, classification of transactions by residentsector is recommended in the BPM.

Equity

557. Equity securities are instrumentsacknowledging the holder’s claim to the residualvalue or residual income of the issuing enterpriseafter the claims of all other creditors have been met.Shares or similar documents (such as AmericanDepositary Receipts) usually denote ownership ofequity. Preferred stock or shares that provide forparticipation in the distribution of residual earningsor in the residual value upon liquidation areincluded as equity. However, preference shares are

not considered equity when the specified return andfixed value at maturity to which the holder isentitled are both independent of the underlyingprofitability of the issuing enterprise. Instead,transactions in these instruments should be classifiedas bonds and notes.21

558. Regardless of the types of investment made bythe trust or fund, the ownership of trusts, mutualfunds, and other similar investments also representsequity investment. For example, if a resident ofClintonstan invests in a cash management trust inCoonawarra, which in turn invests only in debtsecurities issued by the government of Nostaw,Clintonstan’s balance of payments would reflect anequity investment. Coonawarra’s balance ofpayments would reflect an equity liability and a debtasset, while Nostaw’s balance of payments wouldshow a debt liability.

559. The ownership of life insurance policies orsimilar claims on commercially operated pensionfunds is also considered equity investment as theseclaims generally entitle the holder to the residualincome of the life insurance or pension fund.However, as these insurance policies are typicallynot tradable, such policies are not consideredportfolio investments. Instead, transactions in theseinstruments are classified as other assets or otherliabilities under other investment.

Bonds and Notes

560. In the BOP standard components, the categoryfor bonds and notes includes debt securities withoriginal contractual maturities of more than one year(long-term). Generally, the portfolio investmentinstruments classified in this category are debtsecurities that give the holder the unconditional rightto a fixed money income or to a contractuallydetermined variable money income that is notdependent on the earnings of the issuer. However,

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X. Portfolio Investment

21When these types of nonparticipating preference shares are issued withmaturities of less than one year, such shares are recorded as money marketinstruments.

some securities with this characteristic should beclassified as money market instruments if thesecurities are issued with maturities of one year orless (short-term). Similarly, some debt securities withcharacteristics similar to money market instruments(which are discussed subsequently) should beclassified as bonds and notes if the securities areissued with long-term maturities.

561. Apart from bonds and notes, other securities—if issued with maturities of more than one year—recorded in this classification are debentures;nonparticipating preference shares; convertiblebonds; perpetual bonds; negotiable certificates ofdeposit; collateralized mortgage obligations; dualcurrency, zero coupon, and other deep discountedbonds; floating rate bonds; and index-linked bonds.

562. Perpetual bonds are bonds that never mature.That is, such a bond theoretically provides theholder with an infinite stream of income payments.In a number of countries, perpetual bonds areclassified as second-tier equity in the balance sheetsof the issuing enterprises. Nevertheless, as theincome payable on these bonds is typicallyindependent of the earnings of the issuingenterprise, perpetual bonds are classified as bondsand notes, rather than equity, in the balance ofpayments.

563. Collateralized mortgage obligations and otherasset-backed securities are instruments thatspecifically relate to an asset or group of assets heldby the issuing enterprise. For example, a bank mightissue securities based on mortgage loans made bythe bank to households. The income that the bankearns from lending activities is used to pay intereston the securities and the mortgages are used ascollateral for the securities. The holder of the asset-backed security does not own the asset backing thesecurity; the collateral provided with the security iscontingent. Securities based on mortgage obligationsare favored by lending institutions as it is possiblewith such securities to match the maturity of anenterprise’s assets (its mortgages) with the maturityof its liabilities (the securities). There are other typesof asset-backed securities that enable the issuingenterprise to have access to cash before the relatedassets mature.

564. Index-linked securities are instruments forwhich coupon payments or principal amountspayable at maturity are linked to a commodity priceindex, an exchange rate index, or some other index.

Such securities are often used to conserve thepurchasing power of an investment during periodsof inflation.

565. Transactions recorded in the balance ofpayments for bonds and notes are those relating toissues, redemptions, purchases, sales, and the offsetto interest accrued but not due for payment. Withregard to the accrual of interest, the financialtransaction represents the offset to the income entryrecorded in the current account. This accrual ofinterest is likely to be most significant for zerocoupon and other deep discounted bonds and forindex-linked securities for which repayments ofprincipal at maturity are linked to specific indexes.For discounted bonds, the amount of interest accruedin a particular period is based on prevailing interestrates and adjusted for any coupon payments madeduring the period. (However, the issuer of thesecurity will often accrue interest on the basis of theinterest rate prevailing at the time the security wasissued.) For index-linked securities, the interestaccrued in a particular period is based on themovement that occurs in the underlying index duringthat period. Chapter 6 provides further elaboration,including examples of the recording of accruedinterest on securities. The issue price is recorded asthe value of a transaction at the time the security isissued and the redemption price is recorded as thevalue of a transaction at the time of maturity.

566. Bonds, notes, and similar instruments—with theexception of perpetual bonds—entitle the holder tothe right to a specified amount at redemption. Thisamount is generally, but not necessarily, paid in cash.Some bonds convert to other instruments, such asequity, upon redemption. Until such a conversionoccurs, these instruments are treated as bonds, notequity, in the balance of payments. At conversion,the withdrawal of investment in bonds and theoffsetting increased investment in equity are recordedin the balance of payments. The withdrawal in bondsis valued at the current market value of the equityacquired.

Money Market Instruments

567. Money market instruments are debt securitiesissued with maturities of one year or less. Theseshort-term instruments generally give holders theunconditional rights to receive stated amounts onmaturity. Money market instruments are usuallyissued and traded in organized markets at discounts

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to redemption values. It is the discounts, rather thancoupon payments of interest, that provide holders ofthese instruments with income on their investments.However, instruments that share the characteristics ofmoney market instruments but are issued withmaturities of more than one year are classified asbonds and notes. Short-term tradable instrumentsthat provide investors with returns by means ofcoupon payments, rather than discounts, are treatedas money market instruments.

568. Types of instruments generally classified asmoney market instruments include treasury bills,commercial paper, bankers’ acceptances, short-termnegotiable certificates of deposit, and short-termnotes issued under note issuance facilities (NIFs)—even though these facilities are typically long-term innature. Entries are recorded in the BOP financialaccount for (1) transactions relating to the issue,purchase and sale, and redemption of money marketinstruments and (2) offsets to interest incomeaccrued but not due for payment on theseinstruments.22 However, “purchases” and “sales” ofmoney market instruments under repurchase (repo)agreements should not be recorded as transactionsin money market instruments. These agreementsrepresent collateralized borrowing and are recordedas part of other investment-loans in the financialaccount. Repurchase agreements are discussed inparagraph 597 of chapter 11.

569. A note issuance facility (NIF) is a form ofrevolving credit consisting of the periodic issuanceof paper by an enterprise when the enterpriserequires funds.23 NIFs are usually long-termagreements in which an enterprise (generally abank) or a group of enterprises underwrites notesissued by another enterprise. The notes are generallyshort-term instruments. The underwriters purchaseany of the notes that cannot be sold in the market-place. For their services, the underwriters receivefees and, on any notes that they are required topurchase, the underwriters receive interest.

570. For BOP recording, the NIF itself is acontingent facility that does not generate any entriesin the financial account. (However, any fees paid

to the underwriters are recorded in the currentaccount as financial services.) Only the actualissuance of notes and any subsequent trading andredemption of these notes are recorded as financialtransactions in the balance of payments. Any notespurchased by underwriters are treated byunderwriters as investments.

571. The following example illustrates the treatmentof NIFs in the balance of payments. A bank inCoonawarra provides a three-year NIF for anenterprise resident in Clintonstan. The enterprise inClintonstan pays the bank 100 units each year forproviding the facility. In the first year, no notes areissued under the facility. At the beginning of thesecond year, 1000 three-month notes with face valuesof 100 units each are issued. Of these, 700 notes aresold to residents of Algornia, and the underwritingbank purchases the other 300 notes. The notes areissued for 95 units each and there are no couponpayments. At the end of the three months, the notesare rolled over. This time, all 1000 notes are sold,with the issue price remaining at 95 units, to residentsof Algornia. After the end of the second three months,the notes are redeemed and no further notes areissued under the facility. The following entries areshown in Clintonstan’s balance of payments:

Year 1 Credit Debit

Financial services (Coonawarra) 100Reserve assets (or other appropriate


Year 2 Credit Debit

Financial services (Coonawarra) 100Portfolio investment income-interest

First set of notes (Coonawarra) 1,500(Algornia) 3,500Second set of notes (Algornia) 5,000

Portfolio investment-money market instruments*

First set of notes (issue)Coonawarra 28,500Algornia 66,500

First set of notes (accrual of interest)Coonawarra 1,500Algornia 3,500

First set of notes (redemption)Coonawarra 30,000Algornia 70,000

Second set of notes (issue)Algornia 95,000

Second set of notes (accrual of interest)Algornia 5,000

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22For many of these short-term securities, interest income will be accruedand paid—whether by way of the difference between redemption andissue price or by way of coupon—in the same accounting period. Inpractice, therefore, the recording of interest on money market instrumentsclosely approximates the due-for-payment basis on which investment income is recorded.

23Note issuance facilities (NIFs) are also referred to by other names, suchas revolving underwriting facilities (RUFs).

*Entries for this item would normally be shown on a net basis in thebalance of payments. Gross entries are shown in this example forillustrative purposes only.

Year 2 (continued) Credit Debit

Second set of notes (redemption)Algornia 100,000

Reserve assets (or other appropriate financial account item)Fee 100First set of notes (net) 5,000Second set of notes (net) 5,000

Year 3 Credit Debit

Financial services (Coonawarra) 100Reserve assets (or other


The only entries in the first and third years relate tothe fee payable to the bank in Coonawarra forarranging and underwriting the NIF facility. In thesecond year, the Coonawarra bank’s acquisition ofnotes that could not be sold to Algornia is shownas an investment by Coonawarra in Clintonstan. The interest income payable on the notes represents the difference between the issue price(95 units) and the amount payable on redemption(100 units). This accrued interest, which is part ofthe amount paid at redemption, is “reinvested” inthe notes.

Financial Derivatives

Options and Warrants

572. Options are financial instruments that provideone party (the holder) with the right, but not theobligation, to buy (call option) or sell (put option) aspecified financial or real asset for a predeterminedprice (the strike price) from another party (theoption writer).24 If the option holder exercises his orher right, then he or she is said to exercise theoption. Exercise can take either of two forms: (1) actual delivery of the underlying asset for thestrike price or (2) a cash settlement based on thedifference between the prevailing market price ofthe underlying asset and the strike price. Table 10.1provides an overview of the terminology associatedwith options, and table 10.2 shows factors thatdetermine the values of options.

573. If the option holder and option writer areresidents of different countries, the creation andexercise of option contracts constitute transactionsthat are recorded in the BOP statements of therelevant countries. Also, the trading of optionsbetween residents of different countries results inBOP transactions for the countries concerned.

574. The following example illustrates the treatmentof options in the balance of payments. A resident of Pokolbin writes a three-month call option on


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Table 10.1 Option Terminology

Call option—an option that gives the holder the right,but not the obligation, to buy an underlying asset

Put option—an option that gives the holder the right,but not the obligation, to sell an underlying asset

Strike price—the price, stated in the option contract,at which transactions, if any, in the underlyingasset take place

Expiration date—the final date for exercise of anoption

European option—an option that can be exercisedonly on the expiration date

American option—an option that can be exercised atany time up to and including the expiration date

Writer—the party that issues the option; that is, thedebtor

Premium—the initial cash paidMargin—an amount paid by the writer to a broker or

some other financial intermediary as securityagainst the writer’s future obligations

In-the-money—an option that has a strike price that isless than the prevailing market price for theunderlying asset

Out-of-the-money—an option that has a strike pricethat is greater than the prevailing market pricefor the underlying asset

Black-Scholes model—a mathematical formula used tovalue options

Table 10.2 Factors Determining the Values of Options

Factor 1—the difference between the strike price (A)and the value of the underlying asset (B)

For call options, if A > B, the bigger the difference, theless an option is worth. (An option can never have anegative value.) If B > A, the bigger the difference, themore an option is worth. For put options, the reverse istrue.

Factor 2—the current interest rateThe higher the interest rate, the less an option is worth.

Factor 3—the price volatility of the underlying asset The more volatile the price, the more an option isworth.

Factor 4—the time remaining to expiration The closer an option is to expiration, the less it is worth.

24Warrants are options written by an enterprise on its own shares. In thebalance of payments, warrants are treated in the same manner as othertypes of options.

10 shares in an enterprise located in Cromania; thestrike price is $15 per share. The option is purchasedfrom the writer by a resident of Coonawarra for $20.The following transactions would be recorded in thebalance of payments of Pokolbin:

Credit Debit

Portfolio investment—liabilitiesFinancial derivatives 20


575. After three months, the price of shares in theenterprise in Cromania rises to $18 per share, andthe option holder in Coonawarra decides to exercisethe option. The resident of Coonawarra acquiresownership of 10 shares, with a market value of $180,in the enterprise located in Cromania. However, only$150 (10 x $15) is actually paid. The remaining $30represents the extinguishment of the option contractat the time of exercise. The following transactionswould be recorded in the balance of payments ofPokolbin:25

Credit Debit

Portfolio investment—assetsEquities 180



In this example, the underlying asset is deliveredwhen the option is exercised. However, the optionholder in Coonawarra could, instead, have accepteda cash settlement of $30, in which case the followingentries would be recorded in the balance ofpayments of Pokolbin:

Credit Debit



576. Table 10.3 shows the common transactions andhow such transactions are recorded, in associationwith options, in the balance of payments.

577. An international transactions reporting system(ITRS) or enterprise surveys (ES) could be used tocollect, for the balance of payments, information ontransactions involving options. However, if an ITRSis used, particular care should be taken to ensure

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25Pokolbin owned the shares in the Cromanian enterprise prior to theexercise of the option contract. Otherwise, Pokolbin would have topurchase these shares (at market value) in order to deliver the shares toCoonawarra. Such a purchase could result in the recording of additionaltransactions in Pokolbin’s balance of payments.

Table 10.3 Common Transactions Associatedwith Options

Issue of an option—In the balance of payments of theoption writer’s country, credit portfolio investment-liabilities-options and debit the financial instrument(e.g., currency) acquired in exchange. In the balanceof payments of the option holder’s country, debitportfolio investment-assets-options and credit thefinancial instrument (e.g., currency) provided inexchange.

Sale of option from one holder to another—In thebalance of payments of the option seller’s country,credit portfolio investment-assets-options and debitthe financial instrument (e.g., currency) acquired inexchange. In the balance of payments of the optionbuyer’s country, debit portfolio investment-assets-options and credit the financial instrument (e.g.,currency) provided in exchange.

Exercise of a call option; delivery of underlyingasset—In the balance of payments of the optionwriter’s country, debit (1) portfolio investment-liabilities-options (at a value representing thedifference between the strike price and the prevailingmarket price of the underlying asset) and (2) thefinancial instrument (e.g., currency) acquired; creditthe underlying asset that is given up (at a valuerepresenting the prevailing market price for thatasset). In the balance of payments of the optionholder’s country, credit (1) portfolio investment-assets-options (at a value representing the differencebetween the strike price and the prevailing marketprice of the underlying asset) and (2) the financialinstrument (e.g., currency) provided; debit theunderlying asset received (at a value representing theprevailing market price for that asset).

Exercise of a put option; delivery of underlyingasset—In the balance of payments of the optionwriter’s country, debit (1) portfolio investment-liabilities-options (at a value representing thedifference between the strike price and the prevailingmarket price of the underlying asset) and (2) theunderlying asset received (at a value representing theprevailing market price for that asset); credit thefinancial instrument provided in exchange. In thebalance of payments of the option holder’s country,credit (1) portfolio investment-assets-options (valuedas the difference between the strike price and theprevailing market price of the underlying asset) andthe underlying asset sold (valued at the prevailingmarket price for that asset); debit the financialinstrument received in exchange.

Exercise of an option; settlement in cash—In thebalance of payments of the option writer’s country,debit portfolio investment-liabilities-options and creditthe financial instrument (e.g., currency) paid to theholder. In the balance of payments of the optionholder’s country, credit portfolio investment-assets-options and debit the financial instrument (e.g.,currency) received from the option writer.

Option expires without being exercised—No BOPtransactions are recorded.

correct recording of transactions that result indelivery of the underlying asset. Unlesssupplementary information is sought, an ITRSrespondent would probably (1) record thetransaction in the underlying asset at the optionstrike price rather than at the market value at thetime of transaction and (2) fail to record theextinguishment of the option contract.

Other Derivatives

578. Derivatives other than options typically involvecontracts in which two parties agree to exchangespecified assets, either real or financial, at somefuture point or points in time. Such contracts areeither (1) tradable or (2) settled, on a net basis, forcash rather than an actual exchange of theunderlying assets. Such derivatives are consideredfinancial instruments and include forward foreignexchange contracts, futures, and currency swaps. If transactions in these instruments involve residentsof different countries, the transactions are recordedin the BOP financial account.26 Transactions thatare recorded in relation to derivative instrumentsinclude any trading in the contracts and the netvalue of settlements made. It may also be necessaryto record transactions associated with theestablishment of derivative contracts. Frequently,however, two parties will enter into a derivativecontract but neither will make any payment to theother. In these cases, the value of the transactionestablishing the contract is nil, and no entry isactually required in the balance of payments.

579. Fees paid to financial intermediaries (such asbanks and brokers) to establish derivative contractsdo not represent transactions in derivatives per se.These fees are classified as financial services andrecorded in the services component of the currentaccount. Likewise, margin payments provided byone party to another as security against futureobligations do not represent transactions inderivatives. These margin payments are reflected inthe currency and deposits item in the otherinvestment component of the financial account.

580. Two more examples provide illustration of thetreatment of derivatives in the balance of payments.A resident of Namdarb purchases a tradable futurescontract from a broker in Clintonstan for 100 units

and pays brokerage fees of 12 units. The resident ofNamdarb is also asked to make a margin paymentof 250 units to the broker as security againstadverse market movements. The followingtransactions are recorded in the balance ofpayments of Namdarb:

Credit Debit

Current accountFinancial services 12

Financial accountPortfolio investment—assets

Financial derivatives 100Other investment—assets

Currency and deposits 362 250

581. When the futures contract expires after threemonths, the market has moved against the residentof Namdarb, and he is required to pay 180 units assettlement. This settlement is deducted from themargin payment previously made, and the balanceof 70 units is returned to the resident of Namdarb.The following transactions are recorded in thebalance of payments of Namdarb:

Credit Debit

Financial accountPortfolio investment—liabilities


Currency and deposits 250 70

In this example, the financial derivative contract has“flipped”—as a result of adverse market movements—from being an asset to being a liability for theresident of Namdarb. Such “flipping” can occur withderivative contracts other than options. Movementsin prices of underlying assets cause such movementsin value and are reflected in the price changecomponent of the reconciliation statement betweenstocks and flows.

582. In the second example, an enterprise inDaniherland enters into a currency swap with anenterprise in Hughesavia. No money changes handsat the start of the contract. In six months, because offavorable movements in exchange rates, theenterprise in Daniherland receives a net settlementof 80 units from the swap partner in Hughesavia.The following transactions are recorded in thebalance of payments of Daniherland:

Credit Debit

Financial accountPortfolio investment—assets


Currency and deposits 80


122

26An exception is derivatives (such as interest rate swaps and forward rateagreements) associated with interest rates. Transactions in these instrumentsare recorded in the investment income component of the current account.

583. One or both parties to a derivative contractmay enter into the contract to hedge against adversemovements in some other position. For example, anenterprise borrowing in U.S. dollars but preferringliabilities in Japanese yen may enter into a currencyswap in which the enterprise receives U.S. dollarsfor Japanese yen. In BOP recording, transactions in

derivative contracts are recorded separately from anytransactions involving the position being hedged.Otherwise, asymmetries could arise in the recordingof BOP transactions, and distortions could occur inthe analysis of BOP items. If compilers wish toprovide users with information on the impact ofhedges, such data could be shown in satellite tables.

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584. Other investment is a residual category thatincludes all financial transactions not considereddirect investment, portfolio investment, or reserveassets. Like portfolio investment, other investment isprimarily divided into investments that represent thefinancial assets and liabilities of an economy. Withinthese asset and liability classifications, otherinvestment transactions are further divided byinstrument and resident institutional sector. Fivetypes of instruments are identified in the BOPstandard components: (1) trade credits, (2) use of atFund credit and loans from the Fund, (3) otherloans, (4) currency and deposits, and (5) other assetsand liabilities. Each type of instrument is discussedin more detail in subsequent paragraphs.

585. Loans, deposits, and similar transactionsbetween enterprises in a direct investmentrelationship are generally recorded as direct, ratherthan other, investment. However, as noted in chapter9, when banks and other financial intermediaries arein a direct investment relationship, only thosetransactions relating to permanent debt and equityinvestment are recorded as direct investment.Therefore, the loans and deposits of such institutionsare generally recorded as other investment, even if adirect investment relationship exists between thecreditor and the debtor.

586. Other investment transactions include offsets tointerest accrued but not paid on other investment.27

Such interest is reflected as increased investment inthe underlying instrument on which the interest hasbeen earned. When an accrued amount becomesdue for payment, this amount is reflected as adecrease in investment in the underlying instrumentand offset by a transaction in foreign exchange or asimilar instrument. If actual payment is not made,the decrease in the underlying instrument is offsetby increased investment in the other assets or otherliabilities items of other investment.

Trade Credits

587. Trade credits are to assets and liabilities thatarise from the direct extension, during the normalcourse of trading, of credit from a supplier to abuyer—that is, when payment for goods andservices is made at a time that differs from the timewhen ownership of the underlying goods or serviceschanges. Trade credit arrangements usually containpre-specified limits on the amounts involved and thetimes at which payments must be made. Tradecredits do not involve the issue of securities.Tradable securities (such as import and export bills)used to finance international trade should beclassified as portfolio investment, rather than otherinvestment, in the balance of payments. While thedividing line between trade credits and loans is notalways clear, trade credits are ordinarily the result ofongoing or open book arrangements betweenpurchasers and suppliers, whereas loans are specificagreements tailored to particular circumstances.Funding provided by an enterprise other than thesupplier for the purpose of purchasing goods orservices is generally regarded as a loan and not astrade credit.

588. There are two types of trade credit assets: (1) prepayments on imports and (2) trade creditextended on exports. Assets represented byprepayments on imports are extinguished upondelivery of the goods or services and assetsrepresented by trade credit on exports areextinguished by actual payment (postpayment).Trade credit liabilities arise from the prepayment ofexports or trade credit received on imports.Delivery of exports extinguishes the former andactual payment (postpayment) extinguishes thelatter.

589. The following example illustrates the treatmentof trade credit in the balance of payments. In aparticular period, Clintonstan exports goods worth1,000 units. Of this amount, 100 units were paid last period, 500 units are paid this period, and 400 units will be paid in the next period.Furthermore, payments of 130 units are received

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27Interest accrued but not paid on direct investment should be offset by anincrease in non-equity direct investment, and interest accrued but not paidon portfolio securities should be “reinvested” in the securities.

for exports that will be delivered in the next period,and payments of 280 units are received for exportsdelivered in the previous period. The followingentries would be made in Clintonstan’s balance ofpayments:

Credit Debit

Goods 1,000Other investment

AssetsTrade credits 280 400

LiabilitiesTrade credits 130 100


590. Trade credits can be measured directly orindirectly. Direct measurements can be made byapproaching enterprises receiving or extendingtrade credits. Indirect measurement methodsinclude the use of official records if, for example,trade credits are registered with a governmentorganization for the purpose of monitoring foreignexchange. Another way of indirectly measuringtrade credits in the balance of payments is tocalculate the difference between actual imports andexports (as measured by customs authorities) andpayments for imports and exports (as measuredthrough the banking system). The disadvantagewith the latter method is that it will not always beclear what part of the calculated trade credittransactions represents transactions in an economy’sassets and what part represents transactions in aneconomy’s liabilities.

Use of Fund Credit and Loans from the Fund

591. Membership in the International MonetaryFund provides countries that are experiencing BOPdifficulties with opportunities to use credit extendedby the IMF or to borrow money from the IMF.Generally, these arrangements with the IMF areconditional in nature; that is, a member countryaccessing IMF resources agrees to meet a set ofconditions that are negotiated with the organization.Both Fund credit and loans from the Fund aredenominated in SDRs.

592. Economically, the use of Fund credit and theuse of loans from the Fund result in the sameoutcome—that is, the country entering into theseagreements has access to foreign exchange in returnfor agreeing to meet a set of conditions. However,the two types of arrangements are actually executed

in somewhat different ways. A loan from the Fundis simply an agreement by which the membercountry borrows foreign exchange with acommitment to repay. On the other hand, when acountry uses Fund credit, the country “sells” itsnational currency to the IMF in return for foreignexchange. If the value of the country’s nationalcurrency changes in relation to the SDR,“maintenance of value payments” are made in thecountry’s national currency to maintain a constantSDR liability. Liabilities under Fund creditarrangements are extinguished when the countryuses foreign exchange to “repurchase” its nationalcurrency. In the balance of payments, the IMF is notshown as having a claim on a country in the formof that country’s national currency. Instead, therequirement for the national authorities to pay backthe foreign exchange is recognized by a BOPpresentation that shows the economic nature ofthese transactions. Furthermore, as this requirementis denominated in SDRs, the maintenance of valuepayments are not entered as transactions in thebalance of payments because such payments simply represent the manner in which amountsconverted to national currencies are revalued whenthese currencies depreciate or appreciate in relationto the SDR.

Other Loans

593. Loans are financial assets (1) created throughthe lending of funds by a creditor (lender) directly toa debtor (borrower); the lender receives no securityevidencing the transaction or receives a non-negotiable document or instrument.28 Included areloans (different from trade credits) to finance trade,mortgages, and other loans and advances. Financialleases and repurchase agreements are alsoconsidered loans.

594. Financial leases are included under loans assuch leases are, in essence, a method of financingthe purchase of goods. (Refer to chapter 4 forelaboration of the nature of financial leasearrangements.) The BPM recommendation onfinancial leases is that a change of ownership of thegood being leased be imputed at the inception ofthe lease. In the BOP of the economy of the lessee,the entry for imports will be matched by an entryunder financial account-loans for the increase in

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28The term funds refers to the provision of real and financial assets forwhich there exists an agreement specifying repayment terms.

financial liabilities. The value of the equipment,which should be the market value, and the valueplaced on the loan will be the same. The value ofthe loan will not necessarily equal the discountedvalue of future lease payments.

595. The lease payments contain two elements: (1) interest on the outstanding liability and (2) repayment of the loan liability. Upon terminationof the lease, an entry is recorded for theextinguishment of any remaining liability. This entryis offset by a transaction in goods (if the leasedgoods are returned to the lessor) or a transaction insome other financial item (if the goods are legallyacquired by the lessee).

596. The following example illustrates thetreatment, in the balance of payments, of a financial leasing arrangement. At thecommencement of a lease, the market value of the equipment being leased is estimated at 1,000 units. Lease payments are to run for nineyears at an annual rate of 100 units. Ten percent of the first annual lease payment is estimated to bethe interest, which declines as a proportion of totallease payments in subsequent years. The leasecontract calls for the lessee to purchase the goods,at written-down value, at the termination of thelease. In the first year, entries for the balance ofpayments would be:

Lessee’s Balance of Payments—first year

Credit Debit

Goods 1,000Investment income-other investment 10Other investment-liabilities-loans 1,000 90Reserve assets (or other appropriate


In the second year, the entries would be:

Lessee’s Balance of Payments—second year

Credit Debit

Investment income-other investment 9Other investment-liabilities-loans 91Reserve assets (or other appropriate


At the end of the lease, the written-down value of the asset is 155 units (the difference between the original 1,000 units and the repayment total of 845 units). The lessee pays this amount in foreign exchange to acquire legal ownership of

the asset. Hence, BOP entries for the final periodwould be:

Lessee’s Balance of Payments—final year

Credit DebitOther investment-liabilities-loans 155Reserve assets (or other appropriate


597. A repurchase agreement consists of the sale,made with the intention that the transaction will bereversed at a specified future date, of a security(such as a government bond) by one institution toanother. In the balance of payments, repurchaseagreements are treated as a form of securitizedlending and not as transactions in the underlyingsecurities. The economic nature of the transactiontakes precedence over the legal form, andrepurchases are classified as part of the loans itemunder other investment in the financial account.

598. Loan repayments are recorded when due. Ifactual payment is not made upon the due date, theoffset to the loan repayment is the creation of ashort-term asset (from the creditor’s point of view) orliability (from the debtor’s point of view) to reflectthe payment arrears. This asset or liability is recordedunder the other assets or other liabilities items in theother investment component of the financialaccount and is extinguished when payment is finallymade or when alternative arrangements are madebetween the creditor and the debtor.

Currency and Deposits

599. Currency consists of notes and coins incirculation. In this regard, an economy’s externalassets consist of notes and coins issued by foreigngovernments and held by residents. These notes andcoins represent claims that holders have on issuinggovernments. An economy’s external liabilities, inrespect to notes and coins, consist of notes andcoins that are issued by the economy’s governmentand held by nonresidents.

600. For example, a Canadian shopkeeper acceptsU.S. notes for purchases, and a U.S. traveler inCanada spends $100 with the shopkeeper. TheCanadian resident has a claim on the U.S.government for the notes that she receives in thetransaction. This transaction would be recorded inCanada’s balance of payments as:

Credit DebitTravel 100Other investment-assets

Currency and deposits-other sectors 100

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In the balance of payments of the United States, thefollowing transactions would be recorded:

Credit Debit

Travel 100Other investment-liabilities

Currency and deposits-monetary authorities 100

601. In practice, it will be often difficult for acountry to determine the extent of nonresidentholdings of its notes. This difficulty could lead to neterrors and omissions in the balance of payments.

602. Deposits consist of transferable deposits andother deposits; however, negotiable certificates ofdeposit, which are classified as part of portfolioinvestment because of their tradable nature, areexcluded from this item. Transferable deposits (ordemand deposits) are exchangeable on demand atpar without restriction or penalty and are freelytransferable. Checking accounts generally satisfy thecriteria for transferable deposits. Other depositsinclude: nontransferable savings deposits; timedeposits; and deposits in savings and loanassociations, credit unions, building societies, etc.These deposits are generally redeemable on demandor on short notice but cannot be readily transferredto another party by way of check or similar paymentorder. “Deposit accounts” that cannot be redeemedon demand or on short notice should be classified inthe balance of payments as loans, rather thandeposits, as their economic behavior is more akin tothe former.

603. Deposits may be denominated in the domesticcurrency of the compiling country or in foreigncurrencies. The currency classification is not relevantfor determining whether or not the deposits arerecorded in the balance of payments. What isrelevant is that a nonresident must hold a depositwith a resident financial institution (liability of thecompiling economy) or a resident must hold adeposit with a nonresident financial institution (assetof the compiling economy) in order for transactionsin deposits to be reflected in the balance ofpayments.

604. The following example illustrates the treatment of deposits. An importer in Cromaniapurchases goods worth 500 units from an exporterin Longa. Payment for these imports is made by acheck drawn on the importer’s bank account with a Cromanian resident bank. When the check is presented by the exporter, the funds are

transferred to the exporter’s bank account with thesame bank. The transfer increases Cromania’sdeposit liabilities to nonresidents. The transactionwould be recorded in Cromania’s balance ofpayments as:

Credit Debit

Goods 500Other investment-liabilities

Currency and deposits 500

Other Assets and Liabilities

605. Other assets and other liabilities are residualitems that include all external financial assets andliabilities not recorded elsewhere in the financialaccount. Among the types of assets and liabilitiesrecorded in these items are:

household equity in life insurance and commercialpension funds;

miscellaneous accounts receivable and payable (forexample, accounts relating to interest payments inarrears, loan payments in arrears, wages and salariesoutstanding, prepayments of insurance premiums,taxes outstanding, etc.);

capital subscriptions to international nonmonetaryorganizations.

606. With regard to household equity in lifeinsurance and commercial pension funds, premiumspayable—minus the estimated service charge—arerecorded as increases in policyholder claims on lifeinsurance and pension funds; claims payable arerecorded as withdrawal of investment. While mostinvestments of this type are held over long periods,policies may also be “surrendered” prior to maturity.Such “surrendering” of policies is treated aswithdrawal of investment as well. Life insurance andpension fund policyholders generally receiveincome (often referred to as bonuses) on theirpolicies, and this income is reflected as an increasein the holder’s investment in the fund. In thebalance of payments, such bonuses are recorded as income receivable by the policyholder and offset by an increase in the policyholder’s claim onthe fund.

607. The treatment of life insurance and investmentin commercially operated pension funds is discussedin chapter 5. However, another example may serveto elaborate this treatment. During a particularperiod, Hughesavian residents receive bonuses of500 units on life insurance policies held with a

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128

fund that is resident in Namdarb, and claims of 200 units became payable on these policies. Entrieswould be recorded thus in Hughesavia’s balance ofpayments:

Credit Debit

Portfolio investment income-equity 500Portfolio investment-assets-equity 200 500Reserve assets (or other appropriate


608. With regard to payments in arrears, refer tochapter 6 (time of recording) and chapter 8(exceptional financing) for a discussion of the BOPtreatment of these transactions.

609. With regard to capital subscriptions tointernational nonmonetary organizations, amountspaid to international organizations in the form ofgrants should be recorded as transfers rather than asassets of the providing economy.

610. Reserve assets are one of the four functionaltypes of investment distinguished in the balance ofpayments. Reserve assets consist of financialinstruments available to the central authorities forfinancing or absorbing an imbalance of payments orfor regulating the size of such imbalances. (Theauthorities may regulate the size of imbalances byintervening in the market to influence the exchangerate of the national currency.) Reserve assets aredistinctly different from other types of investments.The principal function of reserve assets is to provideor absorb the liquidity necessary to facilitate, byvarious means, the adjustment of an imbalance ofpayments between a country and the rest of theworld. In addition, reserve assets may be held forother reasons. For example, reserve assets may beheld to preserve confidence, to satisfy domestic legalrequirements, or to serve as collateral for borrowingabroad.

611. Reserve assets determine some importantaspects of the relationship between the InternationalMonetary Fund and member countries. Reserveholdings are one of the factors on which a membercountry’s quota is based, and such assets also affecta member country’s eligibility to draw on its reservetranche and to use Fund credit. Information on acountry’s reserve holdings is used by the IMF in thedesignation of SDRs.

612. Because reserve assets play an important role inthe adjustment process and in relations between theIMF and member countries, there is considerableinterest in fully assessing changes in membercountries’ stocks of reserves. (Such changes may bethe result of transactions, the result of fluctuations invalue, or the result of certain other occurrencesunrelated to transactions.) Previous editions of theBPM addressed this interest through recommenda-tions that supplementary information on totalchanges and valuation changes in reserve holdingsbe recorded in the BOP statement. However, in thefifth edition of the BPM, the conceptual frameworkwas expanded to provide a means of assessingstocks (and changes in stocks) of reserves and all ofan economy’s external financial assets and liabilities.

Accordingly, information relating to stocks ofreserves (as distinct from transactions) can beobtained by analyzing the reserve assets componentof an economy’s international investment position.

Reserve Assets and the Adjustment Process

613. In theory, freely fluctuating exchange rates aresufficient to bring about continuous adjustments inimbalances of payments; it should not be necessaryfor reserve assets to play a significant role in theadjustment process. However, free-floating exchangerates may affect the established patterns ofinternational trade and finance, existing legislation,the outlook for obligations under long-terminternational contracts, and similar circumstances ofa structural nature. For many countries, theintroduction of totally free-floating exchange rateswould represent a disruptive and costly means ofadjustment. Therefore, a broader range of adjustmentmeasures, including a prominent role for reserves, isgenerally employed by these countries.

614. The monetary authorities of a country mayadjust an imbalance of payments by a variety ofmeans. In addition to expending or accumulatingreserves, the authorities may finance imbalancesdirectly through increases or reductions in netborrowing from official entities of other countries orfrom private financial markets. They may financeimbalances indirectly by encouraging other sectors ofthe economy to engage in financial transactions thatare expected to offset imbalances. Moreover, acountry’s authorities may take recourse to regulatorymeasures (such as controls on capital flows) orintervene in exchange markets to move theexchange rate of the national currency towards alevel consistent with their adjustment objective. Themonetary authorities of a country can also adjustdomestic interest rates to influence the exchangerate. When confronted with a serious imbalance ofpayments, monetary authorities usually do notconfine themselves to a single adjustment option.

615. However, factors such as limited access tofinancial markets, domestic political and economic

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considerations, or regard for other countries’concerns may constrain monetary authorities fromexercising some options. Certain constraints(including those of exchange rate arrangements)arise directly from the obligations that membercountries have under the Articles of Agreement ofthe International Monetary Fund.

616. The authorities of many countries cooperatewith each other in numerous ways to facilitateadjustment of imbalances of payments. Cooperationmay include exchanges of information, interventionin exchange markets as an agent of a partnercountry, ad hoc arrangements to avert developmentsof mutual concern, reciprocal swap agreements thatcan be activated on short notice between centralbanks, and permanent and formal monetary andexchange rate cooperation agreements betweencountries of a particular region. The mostcomprehensive cooperation occurs through IMFconsultation procedures, which include input fromthe Fund’s surveillance of exchange rate practices.

617. The options available for dealing withimbalances of payments and the circumstancesunder which countries must deal with them makethe adjustment process a complex one for individualcountries and for the world. Because of thiscomplexity, it is often difficult for anyone (other thanthe monetary authorities themselves) to determinewhich of the actions taken actually led to theachievement of the desired adjustment during aparticular phase.

618. Nonetheless, reserve holdings are prominentlyand continuously involved in the adjustmentprocess—through financing, or interventionoperations, or both. An accumulation of reserveassets or a decline in holdings may be interpreted asan early indication of, and response to, theaggregate surplus or deficit resulting fromautonomous transactions (those undertaken for theirown sake) between residents of an economy and therest of the world. While reserve assets are not theonly resources available to manage aggregatesurpluses or deficits, reserves usually finance orabsorb a significant portion of the correspondingimbalances in the very short term. Consequently,reserve holdings fluctuate with the evolution ofsurpluses or deficits. Monetary authorities may ormay not consider these fluctuations to be cause forconcern.

619. For example, during short periods, surplusesand deficits can be minor enough to offset eachother. Small holdings of reserves are usuallysufficient for coping with these limited fluctuations.Seasonal fluctuations that exhibit no discernibletrend of increasing deficits or surpluses may alsooccur. In these instances, a country’s monetaryauthorities determine—on the basis of observationsconcerning the effects, on the country’s balance ofpayments, of seasonality and related factors—thelevel of reserves necessary to finance or absorb suchimbalances in the short to medium term. If there isreasonable expectation of a surplus in the near term,the authorities might consider borrowing fromabroad on a short-term basis to augment thecountry’s reserves during deficit periods.

620. In the absence of factors with sufficient impactto effect relatively rapid self-adjustment in acountry’s imbalance of payments, reserve holdingsfinance or absorb the initial impact of the imbalance.However, there are limitations on the time and theextent to which reserve assets are employed in thisway. Whether reserves are used in financing or inintervention operations, a country’s monetaryauthorities normally do not permit reserve holdingsto decrease below the level considered minimallyappropriate or adequate for the country. A highpriority objective of most adjustment policies is themaintenance of an adequate level of reserves andthe restoration, in the course of the adjustmentprocess, of depleted reserves. In view of thefinancial and psychological implications of permittingreserve holdings to decrease to critical levels,monetary authorities can be expected to implementalternative measures.

621. Monetary authorities often react rathercautiously to deviations, which could become causefor concern, from established BOP patterns.Although evolving imbalances are continuouslymonitored, decisions regarding the implementationof additional measures—and the determination ofwhich measures are most appropriate—cannot bereached instantly. Time is required to assess thenature of developments, to implement correctivemeasures, and to permit corrective measures to takeeffect—especially as such measures are usuallydesigned to avoid disruptive movements in exchangeand financial markets and in other internationaltransactions. Reserve assets are therefore continuouslyused (expended or accumulated, as the case maybe) to finance or absorb rising imbalances and forintervention in exchange markets during transition

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130

phases in which adjustments to more stable positionstake place. When deficits are increasing, substantialreserve holdings allow the authorities to extendadjustment policies over longer periods.

622. The level of reserve assets appropriate for aparticular country (referred to as the country’sdemand for reserves) depends upon factors such asthe openness of the country’s economy, themagnitude of fluctuations in its imbalance ofpayments, and the cost of holding reserves. Each ofthese factors can be measured or otherwiseevaluated to provide the authorities of the countrywith guidance in developing and implementingreserve policies. The openness of an economy,which is a reflection of a country’s interdependencywith the world economy, can be determined bymeasures such as the ratio of the country’s exports(or imports) of goods and services to gross domesticproduct. The volatility of a country’s balance ofpayments can be measured by observations, whichare made over time, of deviations from an average,and the cost of holding reserves can be measured byappropriate interest rate differentials.

623. A common measure of the adequacy of reserveholdings is the ratio of reserve assets to imports ofgoods. This ratio is sometimes expressed as thenumber of days’ or weeks’ or months’ worth ofimports that could be paid for from a specific stockof reserve assets. Such a measure must not, ofcourse, be taken as a rigid standard; ratios can varyconsiderably from country to country. For example,although U.S. participation in international trade isextremely significant, the United States requires onlya limited level of nongold reserve assets because ofthe dominant role of the U.S. dollar as a reservecurrency. However, in many cases, the ratio ofreserve assets to imports is useful for analyzing theadequacy of reserve holdings because the ratiorelates reserve assets to the predominant componentin many countries’ external transactions. Moreover,trade statistics on goods are usually available sooner(and at more frequent intervals) than those for othercurrent transactions.

624. In summary form, the principal attributes ofreserve assets are:

(1) Reserve assets—the external assets available tothe monetary authorities of an economy—areinternationally recognized financial instrumentsthat constitute the basis of a country’s ability todeal with continuous imbalances (surpluses or

deficits) arising from the economy’s autonomousinternational transactions.

(2) Reserve assets are used to finance or absorbimbalances and to regulate the size of suchimbalances through intervention, by a country’smonetary authorities, in exchange markets toinfluence the exchange rate of the nationalcurrency.

(3) Excessive use of reserves—that is, to an extentthat reduces or increases reserve holdingsbeyond an appropriate range—does not usuallyoccur. In the event of persisting imbalances,monetary authorities generally engage inalternative or additional policies of adjustment.

(4) The principal function of reserves is to provideor absorb liquidity during a limited period whiledecisions are made and alternative measures ofadjustment aimed at correcting imbalancesarising from international transactions areimplemented.

(5) The use of reserve assets thereby permitscountries to avoid recourse to totally free-floatingexchange rates or to restrictive regulatorymeasures. Either of these two responses to animbalance of payments could adversely affect theinternational transactions of other countries, andthe latter action could well be inconsistent withprovisions of the IMF Articles of Agreement.

The Relationship Between Reserve Assetsand Liabilities

625. In the BPM, reserve assets are defined asmonetary gold held by the authorities of a country,the authorities’ claims on nonresidents, holdings ofIMF special drawing rights (SDRs), and a country’sreserve position in the Fund. These four componentsare commonly referred to as the gross external assetsof the central authorities.

626. To conceive of reserve assets solely as externalassets is to concentrate on limited aspects ofinternational liquidity. A concept of reserve assetsthat includes selected liabilities (usually some or allof the external liabilities of a country’s monetaryauthorities) permits a more comprehensive view ofBOP financing. Net reserves can, in fact, beconsidered a corollary of the analytic measure of anoverall balance, which distinguishes autonomoustransactions recorded “above the line” fromaccommodating transactions recorded “below the

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line.” According to this measure, reserve assets andselected official liabilities are the financing (oraccommodating) items of the net surplus or deficitresulting from above-the-line (or autonomous)transactions.

627. Official liabilities included in net reserves aregenerally those incurred to finance deficits orextinguished to absorb surpluses. For example, inthe event a country experiences an overall surplus,the monetary authorities may, with the concurrenceof the creditor, elect to reduce outstandingliabilities—sometimes before the due dates—insteadof accumulating reserves. Conversely, in the event ofa deficit, the authorities may incur liabilities insteadof expending reserve assets, or they may borrowreserve assets outright from the authorities of anothercountry. Transactions in such reserve-relatedliabilities can be netted against transactions in reserveassets, and outstanding liabilities can be nettedagainst holdings of reserve assets because suchliabilities can be regarded as direct claims on thereserve assets of a country. By defining net reservesas those that include liabilities substituting for reserveassets, it is possible to measure reserves that areactually available.

628. To the extent that all such reserve-relatedliabilities are considered liabilities to foreignmonetary authorities and to the extent that holdersof corresponding claims regard such claims asreserve assets, there is symmetry in the relationshipbetween official reserve-related liabilities and reserveassets. Such symmetry permits meaningfulcomparisons—between countries—of officialsettlements or overall balances and net reservepositions between countries, and regional or worldaggregates of net reserve positions can be calculatedin a consistent way.

629. In practice, however, there will be divergencefrom country to country regarding the types ofclaims that are considered reserves and the types ofliabilities that are considered reserve-relatedliabilities. Indeed, there is no compelling reason toconsider the notional border of the official monetarysector as the essential factor for determining whichclaims are regarded as reserve assets and whichliabilities as reserve liabilities.

630. The most obvious case is that of claims oncountries (especially the United States) withcurrencies typically held as reserve assets. In 1971,the United States officially declared that gold (itsprincipal reserve asset) would no longer be

exchanged for U.S. dollars held by foreignauthorities. Even before 1971, reserve assetsconsisting of U.S. dollar claims of monetaryauthorities of other countries were regarded asreserve-related liabilities by the United States only ifsuch claims were held in official U.S. securities.However, a large portion of such claims were andare held in the form of liquid claims on privatebanks in the United States.

631. Likewise, reserve assets held in the form ofclaims denominated in other major currencies arenot necessarily claims on the monetary authorities ofthe countries issuing those currencies or directclaims against the reserve assets of those countries.To a large extent, reserve assets denominated inmajor currencies represent claims on private banksin countries issuing such currencies. Some claimsmay be officially guaranteed, or the exchange valuesof the claims may be guaranteed by the authoritiesof the debtor countries. The existence of suchguarantees can be a factor in determinations ofwhether or not certain financial instruments areconsidered reserve assets. The fact that some claimsheld as reserve assets are claims against internationalfinancial institutions (such as the World Bank) alsoadds to asymmetries because corresponding officialliabilities are not incurred by any country.Fortunately, such claims are relatively small andeasily identifiable and thus do not pose practicalproblems for analyses based on the net reservesconcept.

632. Another source of asymmetry is use of thedegree of liquidity as a criterion to determinewhether or not a claim is considered a reserve asset.Although application of this standard normallyinvolves little variation in judgment, the authoritiesof one country may apply the standard in anextremely rigid way and the authorities of anothermay apply it more leniently. On the basis of liquidityconsiderations, some claims of one country may beregarded as reserve assets but the correspondingliabilities of another may not be considered reserve-related liabilities—and vice versa. Consequently,there may be asymmetrical recordings of the sametypes of claims under equally defensible positions.

633. On the other hand, not all reserve-relatedliabilities are owed to foreign monetary authorities.To supplement reserve assets, a country may, forexample, borrow from private banks located abroad.

634. For the foregoing reasons, items shown underreserve assets in the standard components of the

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balance of payments are restricted to gross reserves.Liabilities related to an economy’s reserve assets arerecorded under other BOP items.

635. Another type of liability related to reserveassets may be incurred through the use of Fundcredit by member countries. In a sense, theavailability of such resources makes them anextension of the reserve assets of these countries. IfBOP problems arise, a member country may—aftermaking a formal declaration of need—obtain theuse of IMF resources through reserve tranchepurchases or through various IMF facilities. In thecase of reserve tranche drawings, conditionality isnot an issue. To use Fund credit, however, themember country must propose and agree toimplement reforms, which are reviewed andapproved by the executive board, to ensure that themember’s BOP problem will be solved in a mannerconsistent with provisions of the IMF Articles ofAgreement and that there are adequate safeguardsfor the return of IMF resources. This conditionalityis an important factor for classification of a country’stransactions with the IMF. Transactions relating to acountry’s reserve position in the Fund are treated aspart of the country’s gross reserves. Transactionsrelating to the conditional use of IMF resources aretreated as transactions in a liability related toreserves (rather than as transactions in reserves) andrecorded as other investment-liabilities-use of Fundcredit and loans from the Fund in the BOPfinancial account.

636. An analysis of overall balances and netreserves may be undertaken on the basis of itemsclassified according to the BOP standardcomponents. All of the liabilities identified asliabilities of the monetary authorities, or liabilities ofthe resident official sector, or some of these liabilities(such as short-term loan liabilities of the residentofficial sector) may—with some degree offlexibility—be selected as financing items forconstructing official settlements or an overall balancesuitable for a particular country.

637. To provide further assistance for analyzing the financing of imbalances of payments, a specialcategory of exceptional financing transactions isincluded in the Selected Supplementary Informationtable that accompanies the listing of BOP standardcomponents contained in chapter 3. (Transactions inthis category are also published in the Balance ofPayments Statistics Yearbook.) The exceptionalfinancing category highlights transactions

undertaken with the recognizable intent of financing an imbalance of payments by means otherthan gross reserves. The financial flows shown inthis category reflect a wide variety of alternatives tothe use of reserve assets for financing imbalances.The alternatives range from long-term borrowingthrough bond issues, certain grants received, andtemporary accumulations of payments in arrears.Nevertheless, this category emphasizes theexceptional nature of such financing. Exceptionalfinancing transactions, including grants receivedfrom IMF-administered subsidy accounts and loans from the Fund, are discussed in detail in chapter 8.

638. Liabilities constituting foreign authorities’reserves (LCFAR) are also closely related to acountry’s reserves. LCFARs may or may not beincluded in the liabilities of the official sector. Forexample, a portion of the reserves of an economymay be held in the form of deposits withnonresident commercial banks. In this case, the bankliabilities represent LCFARs of the economies inwhich the banks are residents.

639. It is difficult to develop criteria for identifyingLCFARs, and the nature of their relationship toreserve assets is not always clear. Nevertheless, it isuseful (for example, for bilateral and internationalcomparisons of reserve asset data) for the compiling(debtor) economy to attempt identification ofliabilities considered by other countries to be part oftheir reserve assets. LCFARs, which are not reflectedin the listing of BOP standard components, areshown in the accompanying Selected SupplementaryInformation table on pages 34–35.

640. In certain analytic presentations (includingthose of the IMF) of the balance of payments,LCFARs are grouped together with reserve assets andexceptional financing as below-the-line items, that is,as a means of financing imbalances of payments.Interpretation of the behavior of LCFARs depends onthe purpose of the analysis and the factors thatbrought about the changes recorded in the balanceof payments. Moreover, interpretations aresometimes uncertain. For example, an increase in acentral bank’s claims on a commercial bank may ormay not indicate strength in the BOP position of theeconomy of the commercial bank. Nevertheless,changes in liabilities that are counterparts of anothercountry’s reserve assets can be relevant inunderstanding the global process of reserve creationand neutralization.

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Coverage of Reserve Assets

641. According to the BPM, reserve assets cannot beunambiguously identified through the application ofobjective criteria. The readily observablecharacteristics—legal ownership, original contractualmaturity of a claim, marketability, currency ofdenomination, and the like—are not sufficient toestablish whether an asset is actually available tocentral authorities to use for financing imbalances orfor intervention operations in exchange markets.Reserve assets must actually exist; foreign exchangethat could be obtained through swap agreements,other lines of credit, or credit from IMF stand-byarrangements does not constitute an existing claim.Conversely, assets that are pledged, committed,earmarked, set aside in sinking funds, blocked, soldforward or otherwise encumbered by the holders arenonetheless existing assets and are not precluded onthose grounds alone from constituting part of reserveassets.

642. What assets, in addition to those actuallyowned by the central authorities, can be consideredeffectively at their disposal? Which of the assetscontrolled by the central authorities are available foruse if the need arises? The test inherent in the firstquestion is an entirely domestic one. The authoritiesmay achieve effective control (which is tantamountto having the assets at their disposal) over externalassets by holding legal title to such assets or byexercising their statutory powers. The test inherent inthe second question concerns requirementsdetermined outside the reporting economy. If acountry’s central authorities consider specificexternal assets to be available for their use, suchassets are usually considered by other countries tobe at the disposal of the relevant central authorities.

Effective Control

643. As ownership of external assets is sufficient toestablish control, the test of effective control can beconfined to institutional arrangements that confersome measure of control on the central authoritieswhen they do not legally hold title to the assets.Such arrangements exist in a number of countries.However, such arrangements often are not made forthe exclusive purpose of placing external assets notowned by the central authorities at their disposal foruse as reserves. Some countries maintain exchangecontrols primarily to forestall undesirable outflows ofcapital and thereby subject all dealings in externalassets to explicit authorization. In many such

countries, only official financial institutions andselected private banks may be authorized to holdand/or legally own external assets. In addition,effective control over these assets is maintainedthrough terms specified by the authorities or throughother forms of authorization under which suchinstitutions are permitted to deal in external assets.

644. Controls of this type must actually be in forceif the external assets are to be considered at thedisposal of central authorities. For example, astatutory provision permitting the authorities of acountry to introduce or to tighten (even on veryshort notice) regulations endowing them withcontrol over external assets is not a sufficientindication that the relevant external assets areeffectively controlled by the country’s authorities.

645. However, control of the authorities overexternal assets owned by the private sector shouldnot be interpreted as extending beyond the assets ofdepository institutions. It is unlikely that a country’sauthorities could obtain accurate and completeinformation about foreign exchange that is privatelyheld outside the country’s depository institutions. Asinformation is a prerequisite to effective control, theexercise of control cannot meaningfully be extendedinto areas for which information cannot be obtained.

646. There are some countries where arrangementsunrelated to exchange regulations provide thecentral authorities with effective control overexternal assets that they do not legally own. Bycomparison with the size of the economies, theofficial sectors of some countries are very large, andexternal assets may be held and owned by a varietyof agencies that are part of the general governmentor closely associated with it. External assets may beheld by state governments, various public financialor nonfinancial institutions, marketing boards, andsimilar organizations. Some of these institutions maybe rather independent from the central authorities.Although they are part of the public sector, it cannotbe assumed that their external assets are effectivelycontrolled by the central authorities. Arrangementsexisting between the central authorities and theseagencies should be examined to determine which ofthe external assets are at the disposal of the centralauthorities.

647. Arrangements subjecting external assets notowned by the central authorities of a country to theireffective control must be definite in intent as well asactually in force. Arrangements that merely provideincentives to the owners of foreign exchange to

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transfer their holdings to the central authorities arenot a form of effective control.

648. Temporary transfers made on the basis ofrepurchase agreements or swaps often take placebetween central banks and private deposit banks.Those transfers of foreign exchange assets fromprivate banks to the central bank are frequentlyimplemented as “window dressing,” and domesticliquidity is often the motive for transfers in theopposite direction. Effective control over suchforeign exchange assets is, according to the BPM,exercised by a country’s authorities for the periodduring which they hold the foreign exchangetransferred to them by the private banks. Control offoreign exchange temporarily transferred to privatebanks remains in the hands of the authorities.

649. For external assets to be considered reserveassets, arrangements conferring control of them tothe authorities of a country must be definite and inforce. In addition, the assets must actually exist.Many countries prepare for contingencies by makingarrangements (often reciprocal) to obtain additionalforeign exchange reserves through lines of credit orreciprocal swap agreements between centralauthorities and also through stand-by arrangementswith the IMF. Such arrangements are an importantcomponent of an adjustment strategy, but availablelines of credit do not constitute reserves at thedisposal of a country’s authorities—unless, and tothe extent that, drawings have actually been madeon these facilities and reserve assets have therebybeen created.

650. The issue of effective control pertains to allreserve assets, but only foreign exchange assets areactually subject to the procedures and criteriadiscussed in the preceding paragraphs. Unlikeforeign exchange claims, monetary gold is, bydefinition, a reserve asset. While virtually all goldheld as monetary gold is actually owned by variousauthorities, arrangements may sometimes exist underwhich gold is owned by others but effectivelycontrolled by the central authorities. However, asmonetary gold unambiguously constitutes reserves, itmust be at the disposal of the authorities as itotherwise could not be classified as monetary gold.

651. The issue of effective control does not apply toreserve positions in the Fund. According to the termsof the Articles of Agreement of the InternationalMonetary Fund, only the central authorities ofmember countries may hold reserve positions in theFund. The articles, which constitute an international

agreement, may be signed by sovereign countriesonly.

652. SDRs may be held only by the centralauthorities of IMF member countries and otherholders designated by the IMF.29 SDRs owned byother holders are not subject to the effective controlof national authorities, even if the nationalauthorities are members of international and regionalbodies consisting of other holders.

Availability for Use

653. BPM references to the availability of reserveassets for use in the event of need pertain to avariety of situations and do not specifically address aparticular one. For most countries, the need to usereserve assets can arise in the course of any businessday. To be available for use in daily markettransactions, assets must be free of conditionsrestricting subsequent use by those who accept theseassets. Therefore, two elements constitute theacceptability (or the availability for use) of externalassets:

(1) the universal use, which is determined byconvertibility, that can be made of a specificasset;

(2) the immediate usability, which is determined byliquidity, that a specific asset affords.

654. References to the liquidity of external assets,especially in a context of international or worldliquidity, almost automatically imply the notion ofconvertibility. Any asset that is immediately availablebut not freely convertible is not, in an internationalcontext, regarded as liquid.

Foreign Exchange, SDRs, and Reserve Position inthe Fund

655. Liquid balances in convertible currencies arecommonly held to meet immediate needs (usually inrelation to requirements determined by the volumeof day-to-day transactions but often in excess ofactual requirements) and to provide a margin forunforeseeable fluctuations. Such deposits are now

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29Other holders include the Bank for International Settlements, theInternational Bank for Reconstruction and Development, the InternationalDevelopment Association, the Andean Reserve Fund, the Arab MonetaryFund, the Central Bank of West African States, the Bank of Central AfricanStates, the Eastern Caribbean Currency Authority, the International Fund forAgricultural Development, the Nordic Investment Bank, the Swiss NationalBank, the Asian Development Bank, the East African Development Bank,and the Islamic Development Bank.

held in a number of currencies—usually some or allof the major trading currencies such as the U.S.dollar, deutsche mark, Swiss franc, Japanese yen,pound sterling, French franc, and Netherlandsguilder—and in other currencies in which significantsettlements are regularly made. The medium forintervention in virtually all major exchange marketsis the U.S. dollar—the currency in which a majorportion of the foreign exchange holdings of othercountries is often maintained. The composition of acountry’s foreign exchange reserves is determined byconsiderations of a practical nature and, in morerecent years, by the objective of protecting the valueof foreign exchange reserves from changes in thevalues of individual currencies.

656. SDRs, which are reserve assets created by theIMF, are equivalent to liquid balances in convertiblecurrencies in nearly every respect. SDRs are as liquidas demand deposits and, within the limits set by theIMF’s Articles of Agreement and By-Laws,unconditional in their convertibility. SDRs (the unitof account for all Fund accounting) can be used tosettle financial obligations, to extend loans or makedonations, and to obtain foreign exchange fromother participants in the Fund’s Special DrawingRights Department or from other holders designatedby the IMF. While the amounts and most of theterms associated with SDRs are determined byagreement between the transactors, SDRs cannot beexchanged for gold. The exchange rate calculated bythe IMF is binding for all settlements.

657. Reserve positions in the Fund can also beconsidered liquid. While a member country mustpresent a declaration of BOP-related need to makea purchase in the reserve tranche (reduction inreserve position), the IMF does not challenge amember’s statement of need. Convertible currenciesfrom a reserve tranche purchase may be madeavailable within days. Paragraphs 674–679 include adiscussion of the transactions associated with amember country’s reserve position in the Fund.

658. In addition to liquid balances of foreignexchange, SDRs, and reserve positions in the Fund,most countries hold reserves in monetary gold andin the form of medium- or long-term claims. Tominimize the costs of holding reserves, countriesmay invest assets in financial instruments that offerhigher yields but less liquidity. In addition toholding external assets for reserve-related purposes,a country may also hold external assets (forexample, investments in World Bank bonds, which

provide development aid) for other reasons orpurposes.

659. Although the presence of additional motivesfor holding external assets does not preclude suchassets from qualifying as reserves, the test ofavailability for use in the event of need must,nonetheless, be passed. A judgment as to an asset’spotential availability for use would have to follow anassessment of constraints that might be encounteredwere it necessary to transform such an asset intoimmediately usable liquid foreign exchange.

660. Objective criteria alone are often insufficientfor determining the availability of external assets tobe used as reserves. The degree of marketability ofan asset that has a relatively distant maturity orconditionalities attached to an asset considered forclassification as a reserve asset must be evaluated inthe context of a specific situation to determine theimpact that these factors have on the transformationof such an asset into a liquid one. Usually, it will bepossible to express the degree of marketability of anasset in terms of the cost that arises from liquidationprior to maturity. The amount that an assetrepresents, as well as other conditions such as yieldand time remaining to maturity, may require that theprice be negotiated if the asset cannot be absorbedby readily acceptable bids from the market. The costand time involved in the liquidation of an asset mayvary with changing market conditions, but a realisticassessment of the asset’s marketability in these termsis the only basis for judging the availability of anasset for use in the event of need.

661. Assets designated for specific uses cannot beexcluded from reserves for this reason alone. On theother hand, assets redeemable only in inconvertiblecurrencies or assets with uses restricted or blockedby the issuers are affected by conditions that theholders did not unilaterally impose and do not havethe power to change. External assets held in theform of long-term loans extended to providedevelopment assistance or to promote exports,deposits held in inconvertible currenciesaccumulated from export contracts at concessionalterms, or repayments of loans extended undersimilar terms are among the more obvious examplesof assets that could not, in virtually all conceivablecircumstances, qualify as reserves.

Payments Agreements

662. In evaluations of the reserve character offoreign exchange assets, asset balances arising from

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payments agreements are particularly difficult tocategorize. Such agreements have commonly beenused to facilitate exchanges of goods and servicesbetween countries when one or both of the relevantcountries lack sufficient resources of convertiblecurrencies to sustain such exchanges under regularmarket conditions. The terms of such agreementsvary. Settlements of outstanding balances may takeplace at periodic intervals; or balances may bepermitted to increase (swing) to certain ceilings, andamounts in excess of such ceilings must be settledwhen due.

663. Limited convertibility is the primary factor thatleads to the exclusion (from reserve assets) of assetbalances held in connection with arrangements ofthis kind. The very existence of paymentsagreement arrangements appears to be sufficientproof that assets (particularly those constrained bybilateral arrangements) in this form are not availablefor use in the event of imbalances of payments.However, some multilateral arrangements that arewider in scope may permit related asset balances to be available for use in the event of need.Moreover, the primary motivation for some of thesearrangements is not the absence of sufficientresources in the form of convertible assets. Suchagreements may even require the settlement ofbalances in convertible assets. The agreementscontained in the framework of the Latin AmericanIntegration Association, for example, were primarilymotivated by the desire to provide a strongerincentive for intra-regional exchange and aninstitutional mechanism for correspondingsettlements. In presentations in the Balance ofPayments Statistics Yearbook, asset balances arisingfrom these agreements have therefore beenrecognized as part of the reserves of participatingcountries.

Monetary Gold

664. After a prolonged period of rapid growth in themarket price of gold and the development of asignificant gap between that price and the officialprice (based on the Bretton Woods system) ofmonetary gold, the official price of gold wasabolished, as of April 1978, by the secondamendment to the IMF Articles of Agreement. Duringthe period of increasing disparities between officialand market prices of gold, use of monetary gold as areserve asset was severely curtailed because of theabsence of a commonly accepted price.

665. Lack of common acceptance does notnecessarily imply that the price of gold should havebeen a stable one; the prices of assets denominatedin major trading currencies and even thosedenominated in SDRs also began to fluctuate as aresult of floating exchange rates. However, changesin the value of this latter group of assets werecommonly accepted because the prices of suchforeign exchange assets were regarded asrepresentative. This acceptance reflects the fact thatthe trading volume of such assets in relation toholdings of them was far greater than the tradingvolume of gold in relation to holdings of monetarygold.

666. The volatility, which resulted in part from thethin market, of the price of gold in turn imposed aconstraint on the potential availability of monetarygold for use as a reserve asset. (Lack of availability isnot characteristic of liquid reserve assets.) The priceat which monetary gold was acceptable to theparties of a potential settlement had to be negotiatedor otherwise determined before monetary gold couldbe deemed available for use.

667. The long-range objective, which is stated in the second amendment to the IMF Articles ofAgreement, of making the SDR the principal reserveasset in the international monetary system alsoaffected the use of monetary gold. Although pricedetermination for monetary gold remains an openissue, the continued inclusion of monetary gold inthe reserve assets category is unequivocal. Therefore,monetary gold should unambiguously be treated aspart of reserve assets.

Other Claims

668. The other claims component of reserve assetsincludes any claims—other than holdings ofmonetary gold by monetary authorities, SDRs,reserve position in the Fund, and foreignexchange—that constitute reserve assets. Forexample, the foreign exchange component may notcover working balances of government nonmonetaryagencies or external financial assets held by privatebanks and subject to control by a country’sauthorities.

669. In addition to these claims, the other claimscomponent is used to facilitate reconciliation ofpresentations in the Balance of Payments StatisticsYearbook. The series on foreign exchange in theinternational liquidity section is published in

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International Financial Statistics (IFS). As apublication presenting monthly data, IFS may not—for practical reasons—include minor asset positionsfor which it is sometimes difficult to obtaininformation on a current basis or at monthlyintervals. Also, the data in IFS may occasionallypertain to the last workday—rather than the lastcalendar day—of a month, quarter, or year.

Transactions with the InternationalMonetary Fund

Determination of Quotas

670. On joining the IMF, a country is assigned aquota. Quotas, which are stated in SDRs, areassessed on the basis of comparisons between thenew member country’s economic characteristics andthose of other member countries similar in size. Amember country’s voting power, the quantity of IMFresources to which a country has potential access,and a country’s share in allocations of SDRs aredetermined by quota size.

671. Each member country is required to pay 25percent of its quota in SDRs or in currencies that areissued by other IMF members and are acceptable tothe Fund. (In all cases, the currencies must be fullyconvertible.) This 25 percent portion of the quotadetermines the initial value of the member’s reserveposition in the Fund, which is a component of themember’s reserve assets. In the balance of payments,a transaction involving a reduction in foreignexchange reserves (credit) would be offset by anincrease in the reserve position in the Fund (debit).The 25 percent portion of the quota (minus theFund’s net use—if any—of the member’s currency;see paragraph 674) also comprises a membercountry’s reserve tranche. The other 75 percent ofthe quota is payable in the member’s own currency.However, no payments are actually made at thecommencement of membership. Rather, the memberagrees that the IMF may have access to this amountif and when it is required. The country thereforeopens an account for the Fund (typically called theNumber 1 Account) in its central bank or issues tothe IMF a non-negotiable security that can be cashedat any time. In economic terms, the 75 percentportion of quota represents a contingent liability ofthe member country to the IMF. Consequently, notransaction is recorded in the member’s balance ofpayments. No interest is payable on either thedeposit account or the security.

Change in Quotas

672. For two primary reasons, the IMF periodicallyreviews the size of member quotas. First, a generalincrease in quotas may be necessary so that the IMFcan obtain additional capital to carry out operations.Second, it may be desirable to make adjustments inthe relative sizes of quotas to reflect developmentsthat take place in member countries’ economies afterquotas are initially assigned. If, as a result of suchreviews, it appears that changes in quotas arenecessary or desirable, the membership votes on theproposed changes. When sufficient votes are receivedin favor, quota changes take effect.

673. Transactions reflecting a change in a member’squota are similar to those that take place when thequota is initially paid. That is, 25 percent of thequota increase is normally paid in a currencyacceptable to the IMF; the remaining 75 percent ispayable in the member country’s currency and madeavailable to the IMF if and when the amount isrequired. Only the 25 percent paid in foreignexchange is recorded in the balance of payments asan increase in the member country’s reserve positionin the Fund (debit) and offset by a reduction inforeign exchange reserves (credit).

Other Transactions

674. A member country’s reserve position in theFund constitutes part of that country’s reserve assets.Therefore, such reserves are available for use bymember countries experiencing an imbalance ofpayments. To use its reserve position in the Fund toalleviate an imbalance, a country purchases foreignexchange from the IMF by “selling” its own currencyto the Fund. In essence, there is an increase in theamount of the member country’s currency availableto the IMF. The “sale” occurs through an increase inthe Fund’s Number 1 Account with the membercountry’s central bank or through the country’sissuance, to the IMF, of a security with a value equalto the amount of currency “sold” to the IMF by themember country. The economic outcome of thistransaction is a reduction in the member country’sreserve position in the Fund. The reduction is offsetby an increase in the member country’s foreignexchange reserves. Both the reduction and the offsetare recorded in the balance of payments.30

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30In formal terms, a country’s reserve position in the Fund equals thecountry’s quota, minus the holdings in the Fund’s Number 1 Account, ofthe country’s national currency (or equivalent in securities), minus anyoutstanding purchases of Fund credit made by the country.

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675. When a member country purchases foreignexchange from the IMF, the Fund often provides thisforeign exchange from funds made available byanother member country as part of that country’scontribution to its quota. In these cases, the firstcountry’s reduction in its reserve position in theFund is matched by an increase in the secondcountry’s reserve position in the Fund. For thesecond country, this transaction is offset by anincrease in liabilities, which are denominated in thecountry’s currency, to nonresidents.

676. A country that experiences BOP difficulties can“repurchase” its own currency with foreigncurrencies or SDRs when the situation improves. Insuch a case, the member country’s foreign exchangeholdings decrease (credit), and the decrease is offsetby an increase (debit) in the country’s reserveposition in the Fund.

677. When a country exhausts its reserve tranche, itgenerally must make use of Fund credit to acquireadditional foreign exchange from the IMF. As isrequired for use a of country’s reserve position inthe Fund, the country must demonstrate that it isexperiencing an imbalance of payments. However,when a country uses Fund credit, it must also agreeto adopt and adhere to IMF-approved policies.There is, in addition, a formal agreement for thecountry to repurchase its own currency during aspecified period. These conditions make the use ofFund credit a transaction in the user’s liabilitiesrather than in its assets. Accordingly, the use ofFund credit is classified as a loan liability underother investment in the financial account. Further discussion on this issue is contained inchapter 11.

678. When a country’s reserve position in the Fundexceeds a certain level, which is determined byapplication of a Fund-calculated ratio to the country’squota, the IMF pays the country “remuneration” on aquarterly basis. This remuneration represents incomeand is typically recorded in the recipient country’sbalance of payments as investment income-otherinvestment-interest (credit) and offset by an increasein the foreign exchange component of reserve assets(debit).

679. As well as maintaining a Number 1 Accountwith a member country’s central banks, the IMFtypically maintains a second account. The Number 2Account is used by the IMF for operational purposesand, unlike the Number 1 Account, is reflected inthe balance of payments of a member country as anexplicit liability. Transactions involving the Number 2Account are recorded as increases or decreases inthis liability and are offset by the source of funds (inthe case of an increase) or the use of funds (in thecase of a decrease). For example, when the IMFtransfers funds from the Number 1 Account to theNumber 2 Account in a member country, themember’s balance of payments shows an increase inits reserve position in the Fund (debit). The increasereflects the reduction in IMF holdings of thecountry’s currency in the Number 1 Account and isoffset by an increase in the country’s otherinvestment liabilities relating to currency anddeposits (credit). When the IMF uses funds from theNumber 2 Account to pay for the acquisition ofgoods and services in a country in which the Fundmaintains an office, the balance of payments of themember country shows a reduction in this account(debit) and an offset (credit) under governmentservices n.i.e. in the current account.

680. The IIP statement shows, at a particular point,the stock of an economy’s external financial assetsand liabilities. An economy’s external financialassets consist of claims on nonresidents and ofmonetary gold and SDRs held by the monetaryauthorities. The difference between an economy’sfinancial assets and liabilities is the economy’s netinternational investment position. When financialliabilities exceed financial assets, an economy has a negative net international investment position.

681. In concept, an IIP statement is similar to abalance sheet, which shows the assets, liabilities,and net worth of an economic unit at a particularpoint. However, there is an important differencebetween an economy’s net international investmentposition and an economy’s net worth. An economy’s holdings of nonfinancial assets, whichare not measured in the international investmentposition, are also included in the calculation of aneconomy’s net worth. For most economies, thevalue of nonfinancial assets far exceeds the value ofclaims on nonresidents (plus SDRs and monetarygold).

682. There is a close relationship between theinternational investment position and the balance ofpayments. The BOP financial account measures aneconomy’s transactions in external financial assetsand liabilities. Obviously, these transactions have an impact on the stock of external financial assetsand liabilities measured in the internationalinvestment position. However, over time, there areother factors (such as price changes) that also causechanges in stock values; the impact of these otherfactors is also reflected in the internationalinvestment position.

683. The international investment position is alsoclosely related to the investment incomecomponent of the BOP current account.Investment income consists of income accruing onexternal financial assets and liabilities. If all otherthings are equal, the greater the stock of externalfinancial assets and liabilities, the greater the

investment income accruing on these financial assetsand liabilities.31

684. There is also an indirect relationship betweenthe BOP current account and the internationalinvestment position. Because of the double entrynature of the balance of payments, the currentaccount balance must be offset by an equivalentbalance (with opposite sign) in the capital andfinancial account.32 As the financial accountimpacts directly upon the international investmentposition, to the extent that the financial accountoffsets the current account balance, the currentaccount indirectly affects the internationalinvestment position. These aspects of therelationship between the international investmentposition and the balance of payments are exploredin further detail in paragraphs 690–702.

Balance Sheets and the InternationalInvestment Position

685. A balance sheet shows, at a particular point, aneconomic unit’s assets, nonequity liabilities, and networth. Net worth is equal to the difference betweenassets and nonequity liabilities. The net worth of anenterprise consists of enterprise assets attributable tothe owners.

686. In theory, a balance sheet exists for alleconomic units—that is, the government, enterprises,and households—within an economy. As shown inillustration 13.1, a balance sheet can be divided intocomponents and sub-components. Assets can besplit into real and financial assets; the latter can bedivided into claims on residents and claims onnonresidents. Nonequity liabilities can be classifiedas liabilities to residents and liabilities tononresidents. The net worth (which is also calledequity) of an enterprise can be divided into net

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XIII. The International Investment Position

31Income accrued will also depend on other factors, such as the generallevel of interest rates and the perceived riskiness of investment.

32The balances of the two accounts will be equal with opposite signs ifthere are no net errors and omissions.

worth attributable to resident owners and net worthattributable to nonresident owners.

687. If balance sheets could be prepared for alleconomic units within an economy, a balance sheetcould be derived for the economy as a whole. Sucha derivation would involve two steps: (1) thesummation of balance sheet items from all economicunits and (2) consolidation. Consolidation results inthe cancellation of offsetting assets and liabilitiesinvolving two resident counterparts. For example, ahousehold has a deposit account with a residentbank. The account is shown as an asset on thehousehold’s balance sheet and as a liability on thebank’s balance sheet. However, the assets andliabilities of the economy as a whole are not affectedby this position. Therefore, this position can beeliminated from the balance sheet of the economy.

688. Consolidation, on an economy-wide basis, ofthe balance sheet entries shown in illustration 13.1would eliminate the entries for A.21, N.1, A.22, andL.1. After consolidation, an economy’s balance sheet could contain the entries shown in illustration 13.2.

689. The entries denoted A.23 (financial assets—claims on nonresidents, SDRs, and monetary gold),

L.2 (nonequity liabilities to nonresidents), and N.2 (net worth attributable to nonresident owners ofenterprises) in illustration 13.2 are recorded in aneconomy’s international investment position. However,calculation of an economy’s net worth (entry N.3 inillustration 13.1) requires consideration of aneconomy’s real assets (entry A.1). In other words, aneconomy’s net worth is equal to its net internationalinvestment position plus its holdings of real assets.

The Relationship Between the InternationalInvestment Position and the Balance ofPayments

690. The international investment position measuresan economy’s stock of external financial assets andliabilities; the BOP financial account measurestransactions in these assets and liabilities.Transactions in assets and liabilities also affect thestock of these assets and liabilities. For example, onJanuary 1, an enterprise has $100 in a bank accountand, on January 15, deposits (transaction) another$15. On January 31, the value (stock) of theenterprise bank account has obviously been affectedby the transaction. In fact, as there are no othertransactions and no other changes, the stock offinancial assets at the end of January is equal to the

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Illustration 13.1 Components of a Balance Sheet

Assets

A.1 Real assets (e.g., land, machinery, consumerdurables, inventories)

A.2 Financial assets

A.21 Claims on residents in the form of equity

A.22 Other claims on residents

A.23 Claims on nonresidents, SDRs, and monetarygold

Liabilities

L.1 Nonequity liabilities to residents

L.2 Nonequity liabilities to nonresidents

Net worth

N.1 Net worth of enterprises attributable to residentowners

N.2 Net worth of enterprise attributable to nonresidentowners

N.3 Net worth of households and government

Illustration 13.2 Consolidated Balance Sheet of an Economy

Assets

A.1 Real assets (e.g., land, machinery, consumerdurables, inventories)

A.23 Financial assets—claims on nonresidents, SDRs,and monetary gold

Liabilities

L.2 Nonequity liabilities to nonresidents

Net worth

N.2 Net worth of enterprises attributable tononresident owners

stock of financial assets at the beginning of Januaryplus the deposit transaction.

691. However, an enterprise may own an asset witha market price that changes on a day-to-day basis.For example, on January 1, an enterprise owns 10shares in another corporation and, on that date, thestock market price of these shares is $10 per share.The value of enterprise holdings is therefore equal to$100 (10 x $10). During January, the enterprise doesnot purchase or sell any shares and, on January 31,the stock market price of the shares has increased to$12 per share. The value of enterprise holdings onJanuary 31 is therefore $120 (10 x $12). In otherwords, a change attributable to price changes, whichare not recorded in the balance of payments,occurred in the stock of financial assets. Therefore,an international investment position can, over time,change as a result of factors that are not reflected inthe balance of payments.

692. Other non-transaction changes also occur.External financial assets or liabilities may bedenominated in currencies other than the currency(the unit of account) in which the internationalinvestment position is prepared. Changes in the ratesat which the other currencies and the unit of accountare exchanged consequently affect the values ofassets or liabilities. For example, Cromania compilesits international investment position in Cromaniandollars (C$) and on an annual basis. On December15, 1993, a Cromanian bank borrows US$ 1,000 froma German bank. At the end of 1993, the C$/US$exchange rate is C$ 1 = US$ 1. Therefore, the valueof Cromania’s liability (measured in its internationalinvestment position in terms of Cromanian dollars) atthe end of 1993 is C$ 1,000. There are no furthertransactions in 1994. At the end of 1994, Cromania’sexchange rate depreciates to C$ 1 = US $0.8, and thevalue of Cromania’s liability (in terms of C$)increases to C$ 1,250. Thus, the values shown inCromania’s international investment position changedover time even though there were no transactions.

693. The foregoing example illustrates an importantresult. When the unit of account depreciates againstthe currency of denomination, the impact—in termsof the unit of account—of exchange rate changeswill be positive. The corollary is that when the unitof account appreciates, the impact of exchange ratechanges will be negative.

694. In addition to transactions, price changes, andexchange rate variations, other adjustments mayhave an impact on the level of an economy’s

external financial assets and liabilities. Theseadjustments include the allocation or cancellation ofSDRs, the monetization or demonetization of gold,reclassifications, write-offs, and measurement errors.

695. Even though monetary gold and SDRs are notclaims on another party, by convention, these itemsrepresent financial assets. However, becausemonetary gold and SDRs do not represent claims,there are no transactions associated with the creationor extinguishment of these instruments.33

Nevertheless, the creation or extinguishment of theseinstruments does have an impact on the changes invalues shown in IIP statements.

696. Reclassifications (typically resulting fromchanges in investment motivations of creditors) ofassets and liabilities affect the composition of IIPstatements. Such reclassifications are not consideredtransactions as there is no provision of economicvalues by one party to another. For example, aninvestor purchases, for $600, 6 percent of the sharesof a nonresident enterprise. A week later, theinvestor purchases, for $500, another 5 percent ofthe shares of the same enterprise. The firsttransaction is classified as portfolio investment. Thesecond transaction, which raised the investor’sshareholding above the 10 percent threshold, isclassified as direct investment.34 The 6 percent ofshares purchased in the first transaction is thenreclassified from portfolio investment to directinvestment as these shares now constitute part of thedirect investment shareholding. The reclassification isnot recorded in the balance of payments; it is a non-transaction adjustment that explains the change inIIP statements from one period to the next.

697. In addition, write-offs of bad debts are notconsidered BOP transactions. However, such write-offs affect the values of financial assets and arereflected in non-transaction adjustments that explainchanges in IIP statements from period to period.

698. In practice, measurement errors also have animpact on the reconciliation of statements. Sucherrors may arise from—for example—the use of

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142

33A transaction consists of the transfer of economic value from oneeconomic unit to another. As the creation and extinguishment of SDRs andmonetary gold do not involve such transfers, no transactions take place. Inthe fourth edition of the BPM, creation and extinguishment of theseinstruments were considered transactions. However, to preserve the doubleentry nature of the system, corresponding and offsetting notional counter-part entries were required.

34Direct investment transactions include those transactions that establish thedirect investment relationship.

different sources to measure stocks and transactions,reporting errors made by data providers, orsampling. If different samples are used to measurestocks and transactions, or if there are changes fromperiod to period in samples used to measure stocks,the sample error present in any sample surveycontributes to reconciliation errors. Although somemeasurement errors may be unavoidable, theyshould be kept to a minimum. Any significant,unexplained changes in IIP statements should beinvestigated and resolved.

699. Period-to-period changes in a country’sinternational investment position can be explained in terms of BOP transactions, price changes,exchange rate changes, and other adjustments. To facilitate analysis of both the internationalinvestment position and the balance of payments,countries are encouraged to publish—at least forbroad aggregates—tables showing the reconciliationof changes in the international investment position.An example is provided in table 13.1.

700. The international investment position is alsoclosely related to the investment income componentof the current account. This component measuresincome accruing on an economy’s external financialassets and liabilities. The relationship betweenstocks and income is often expressed in terms ofyields, which—in simple form—can be determined

by expressing income as a percentage of theaverage stock of investment to which that incomerelates. The higher the yield, the greater the rate ofreturn on an investment. Yields are affected bymany factors, including (in the case of dividendsand other types of income in the form of profits)the profitability of the enterprise in which aninvestment is made, the general level of interestrates pertaining to the currency in which theinvestment is denominated, and the riskiness of theinvestment. The yield on a particular investmentmay change over time—as a result of changes in themarket value of the investment or in the incomeaccruing on the investment—or the yield mayremain fixed. The yield remains fixed (1) when themarket value of an investment is not subject to pricechanges (as is typically the case with instrumentslike deposits and loans) and the income is fixed or(2) when relative changes in the value of aninvestment and the income on the investment arethe same.

701. Because of the important relationship betweenstocks recorded in the international investmentposition and investment income, analysis of theinternational investment position and the balance ofpayments is often enhanced by presenting these twosets of statistics together. For example, table 13.1could be usefully augmented by the addition, on theright-hand side of the table, of a column listing the

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Table 13.1 Reconciliation of Essendonia’s IIP Statements

Changes in Position Reflecting:________________________________________________________

Position as of Price Exchange Rate Other Position as ofItem December 31, 1994 Transactions* Changes Changes Adjustments December 31, 1995

AssetsDirect investment 1,100 +106 +94 +203 +35 1,538Portfolio investment 850 +328 +78 +162 –35 1,383Other investment 2,320 –1,345 — +384 –13 1,346Reserve assets 1,640 +32 +107 +322 +72 2,173Total +5,910 –879 +279 +1,071 +59 6,440

LiabilitiesDirect investment 3,104 –158 –45 +95 –16 2,980Portfolio investment 252 +29 +12 +13 +18 324Other investment 2,445 +866 — +242 +7 3,560Total 5,801 +737 –33 +350 +9 6,864

Net International Investment Position** 109 –1,616 +312 +721 +50 –424

**A positive sign denotes a net increase in assets or liabilities; a negative sign denotes a net decrease. This sign convention differs from that used in BOPstatistics.

**Assets minus liabilities

investment income accrued on Essendonia’s externalfinancial assets and liabilities during 1995.

702. There is no direct relationship between IIP andBOP transactions other than those recorded in thefinancial account or as investment income.However, there is an indirect relationship because, inthe BOP double entry accounting system, thebalance recorded in the financial account must bematched by a balance of the same magnitude butopposite sign in all of the other items. Therefore, tothe extent that a BOP entry made outside thefinancial account has an offsetting entry in thefinancial account, the current account transactionaffects the international investment position.

Calculation of Price and Exchange Rate Changes

703. The impact of price changes on an economy’sexternal financial assets and liabilities can be directlymeasured only in exceptional circumstances, and theimpact of exchange rates can never be directlymeasured. Therefore, to show these items in the IIPreconciliation, the compiler (or data provider)typically resorts to indirect measurement. Thefollowing example illustrates the calculation of suchvaluation changes.

704. At the beginning of an accounting period, thecentral bank of Zebraland holds 10 units, eachvalued at £stg. 1 million, of British governmentsecurities. During the period, 2 units are sold at themarket value of £stg. 1.2 million each. The remaining8 units further appreciate in market price, to £stg. 1.4 million each, by the end of the period.35 Theexchange rate of the pound sterling (£stg.) vis-à-visthe Zebraland dollar ($Z), which is the unit ofaccount used to compile Zebraland’s IIP and BOP

statistics, is £stg. 1 = $Z l.7 at the beginning of theperiod, £stg. 1 = $Z l.75 at the time of the transaction,and £stg. 1 = $Z l.6 at the end of the accountingperiod. The average exchange rate for the period is£stg. 1 = $Z 1.8. For Zebraland, the values (expressedin millions of £stg and in millions of $Z) of stocks,transactions, and valuation changes in thesesecurities are shown in illustration 13.3.

705. Stock data at the beginning and end of theperiod and transaction values were calculated interms of Zebraland dollars by applying the relevantexchange rates shown in the table. The total changein stocks was derived by calculating the differencebetween opening and closing balances. The totalvaluation change was derived as a residual bydeducting transactions from the total change instocks. As shown in the table, the total valuationchange consists of two components. The valuationchange reflecting—in terms of the transactioncurrency (pounds sterling)—the change in the priceof the financial claim is equal to the total valuationchange because exchange rate changes do not haveany influence on this item. The price change inZebraland dollars was calculated by multiplying theprice change in pounds sterling by the periodaverage for the rate at which pounds sterling andZebraland dollars were exchanged.36 The valuationchange reflecting the change in the exchange rate ofthe transaction currency vis-à-vis the recording unitof account was derived as a residual. Both types ofvaluation changes in an economy’s external financialassets and liabilities are excluded from the balanceof payments.

706. The foregoing example contained no otheradjustments, such as reclassifications or write-offs. If


144

35For the sake of simplicity, it is assumed that the increase in the marketvalue of the securities is not attributable to interest accrued but not due forpayment. Such interest would be recorded as a transaction in the balanceof payments; see chapter 6 of the Textbook for further details.

Stocks Valuation Changes*___________________________________ _______________________________

Beginning End of Exchangeof Period Period Change Transactions* Total Price Rate

In millions of £stg. 10.00 11.20 +1.20 –2.40 +3.60 +3.60 —Exchange rate 1.7 1.6 1.75 1.8In millions of $Z 17.00 17.92 +0.92 –4.20 +5.12 +6.48 –1.36

*A positive sign denotes a net increase in assets; a negative sign denotes a net decrease. This sign convention differs from that used in BOP statistics.

36The exchange rate prevailing on the date that a valuation change occursshould theoretically be used to convert a valuation change denominated inone currency to another currency. In practice, it is unlikely that thecompiler will have access to such detailed information on the timing ofvaluation changes. Therefore, period average exchange rates are used inthe example.

Illustration 13.3

required, such adjustments are deducted, along withtransactions, from the total change in stocks in thecalculation of valuation changes. Other adjustmentsare converted from the currency of denomination tothe unit of account by using the exchange rateprevailing on the dates the adjustments took effect.If such information is unavailable, period averageexchange rates could be used.

707. In practice, the collection of statistics onvaluation changes can sometimes be very difficult.To compile these figures on the basis of balancesheet data only, the compiler must know the amountoutstanding whenever a change in the market pricetook place. This information must include anychange resulting from fluctuation—in relation to theunit of account in which the BOP statement iscompiled—of the exchange rate for the currency inwhich the asset is denominated. This method ofmeasuring valuation changes is not feasible in aperiod when exchange rates fluctuate frequently.Therefore, it is suggested that compilers collect dataon transactions, and that valuation changes becalculated by deducting transactions from changesderived from opening and closing balances. Inaddition, allowance should be made for reclass-ifications or changes in coverage of the economy orits residents because these changes also affect theoutstanding amounts of external assets and liabilities.

708. When the unit in which a financial item isdenominated differs from the unit in which the BOPstatement is expressed, total changes in value shouldbe calculated by first converting the outstandingamounts to the desired unit of account and thencalculating the difference. The impact of exchangerate changes on total changes in stocks can only bederived as a residual.

Classifying the International InvestmentPosition

709. The primary type of classification in aneconomy’s IIP statement is the distinction betweenassets and liabilities. For portfolio investment, reserveassets, and other investment, assets and liabilities aremeasured on a strict gross basis. For directinvestment, a directional basis (abroad or in thereporting economy) of measurement is used.Recorded under assets is an economy’s directinvestment abroad, which is equal to the claims ofresident direct investors on direct investmententerprises located abroad minus the claims of thesedirect investment enterprises on the resident direct

investors. Recorded under liabilities is directinvestment in the compiling economy, which isequal to the claims of nonresident direct investors ondirect investment enterprises located in the reportingeconomy minus the liabilities of the nonresidentdirect investors to the resident direct investmententerprises.

710. The second level of classification applied to theinternational investment position is that of function.Four functional types of investment are identified:direct investment, portfolio investment, otherinvestment, and reserve assets. The definitions ofthese functional types of investment are the same forthe international investment position and the balanceof payments.

711. The third level of classification in theinternational investment position is by instrument ofinvestment. Different instruments of investment areidentified for different functional types of investment.For example, direct investment is divided into (1) equity capital and reinvested earnings and (2) other capital; portfolio investment is divided intoequity securities and debt securities (bonds andnotes, money market instruments and financialderivatives). The definitions of each instrument arethe same for the international investment positionand the balance of payments.

712. Instruments recorded as portfolio investmentand other investment are further subdivided bydomestic sector. For assets, this sector is that of theasset holder. For liabilities, the sector of the debtor is recorded. The trade credits, loans, and othercomponents of other investment are also cross-classified by original maturity—that is, long- or short-term.37

713. The classification systems adopted for theinternational investment position and the BOPfinancial account are closely related and verysimilar. The main difference between the two is thetype of primary classification. The internationalinvestment position is divided primarily into assetand liability components; the BOP financialaccount is divided primarily by functional type ofinvestment. A close relationship also exists betweenthe classification of investment income in the BOPcurrent account and in the IIP classification,

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37A number of countries cross classify debt instruments by residual, as wellas original, maturities, although no such classification is shown in the BOPstandard components. Residual maturity comprises the time remaining fromthe date of an IIP statement to the expiration of a financial instrument.

although the former is far less detailed (in terms ofBOP standard components) than the latter.

Valuation of the International Investment Position

714. The principle of valuation used in compilationof the balance of payments and the internationalinvestment position is market valuation. Suchconsistency is important when analysis of both setsof statistics is undertaken concurrently.

715. In the BPM, market prices are defined asamounts of money that willing buyers pay to acquiresomething from willing sellers; the exchanges aremade between independent parties and on the basis ofcommercial considerations only. This definitionobviously pertains to transactions, and theinternational investment position measures stockpositions. When transactions in financial assets andliabilities occur on or very close to the reference datefor the international investment position, the marketprices pertaining to the transactions are goodmeasures of the market prices of the stock positionsattributable to the transactions. However, for stockpositions for which there are no very recenttransactions, alternative measures of market value arenecessary. For instruments that are readily tradable,the mid-point of bid and offer rates (typicallyavailable from an organized exchange) on the datefor which the international investment position isbeing prepared or the recent transaction price of asimilar instrument could be used. A range of marketvalue proxies, which are discussed subsequently,could be used for other types of instruments.

Equity Instruments (other than life insurance)

716. It should be possible to value positions inequity investments involving shares (stocks) inpublicly traded enterprises by using information fromstock exchanges on bid and offer rates or recenttransaction prices. This method will probably bepossible for most portfolio investment and someinstruments classified under direct investment-equity.For valuing other types of equity investment (forexample, equity investment by a parent enterprise ina wholly owned subsidiary), alternative methodsshould be used. Probably the best alternativemethod is the net asset value method.

717. The net asset method of valuation involvessubtracting the value of enterprise nonequity

liabilities from assets; the difference is equal toenterprise net asset value attributable toshareholders. Net asset value divided by the numberof shares outstanding equals net asset value pershare; to establish the value of a particularshareholder’s investment, the number of shares heldby the investor is multiplied by the net asset valueper share.38

718. To obtain—by the net asset value method—good quality estimates of the market values ofinvestments, enterprise assets (in particular) andnonequity liabilities must be valued at currentmarket prices and not at historical cost. If enterpriseaccounts are not prepared on this basis, the compilercould, in significant cases, seek supplementaryinformation from the enterprise in order to make thenecessary adjustments.

719. If an enterprise is unable to provide suchinformation, the compiler could adjust thosecomponents of the enterprise balance sheet mostlikely to be subject to price changes. The compilercould make such adjustments by using informationabout (1) the times at which assets were acquired orliabilities incurred and (2) price movements(typically established from price indexes) for theparticular class of asset or liability.

720. Alternatively, the compiler could establish anestimate of the market value of an equityinvestment by using price movements for a similartype of investment to adjust transactions associatedwith that investment. For example, in 1990, a directinvestor acquires 50 percent of an enterprise in thechemical industry for $100 million. Between 1990and 1994, the price of publicly traded shares ofchemical enterprises increases by an average of 35percent. The market value of the direct investor’sholding at the end of 1994 could then be estimatedat $135 million.39 More sophisticated models couldbe developed. For an example, see the modeldiscussed in paragraphs 721–722 of the Balance ofPayments Compilation Guide for measuring thestock of direct investment in land. For a generaldiscussion of deriving stocks from transactions inthe area of portfolio investment, see paragraphs


146

38This method is based on the assumption that each share carries equalweight. If each share does not, the calculation of net asset value per shareshould be amended accordingly.

39When such an approach is used to measure direct investment, it willprobably be necessary to adjust the price increases observed in relatedinvestments for the component of the price increase attributable toreinvested earnings, which are recorded as transactions in BOP statistics.

740–743 of the Guide. Another possibility forestablishing the market value of equity investmentis to obtain a directors’ valuation of the enterprise.

Life Insurance

721. The surrender values of life insurance policiesrepresent possible proxies for the market values ofthese policies. The surrender value is the amountthat an insurance enterprise would pay apolicyholder to redeem a policy prior to theexpiration of the policy term.

Financial Derivatives

722. Options should be valued on the basis ofmarket prices prevailing on the date on which theIIP statement is prepared. If no market exists for aparticular type of option, market value can beapproximated by using a financial formula known asthe Black-Scholes formula. (This formula is quitecomplex; however, compilers need not understandits exact nature.) Most organizations with significantoptions operations use (in their balance sheets orsupplementary accounts) this or similar formulae tovalue their positions. Therefore, in practice, thecompiler should accept the valuation of optionpositions provided by principals unless there isserious doubt as to the validity in terms of marketvaluation principles.

723. For the international investment position,financial derivatives other than options are valued byreference to market prices of similar instruments. Ifthe derivatives being valued are traded infrequently,they could be valued by calculating the net presentvalue (NPV) of the future transactions and receiptsexpected under the contract. (For an explanation ofNPV, see illustration 13.4.) If the NPV of futuretransactions is positive—that is, net receipts areexpected—the derivative contract should be shownin the international investment position as an asset.On the other hand, if net payments are expected,the contract should be shown as a liability.Enterprises with significant positions in derivativecontracts will, at least in management reports,probably value derivative positions in a similarmanner.

Other Securities

724. Current market prices should be used to valueother types of tradable investments (e.g., bonds andbills) for IIP positions. For debt securities not readily

tradable, the NPV (as described in illustration 13.4)of future payments could be used to estimate marketvalue. Alternatively, such debt securities could bevalued at issue prices, plus the amortization of anydiscounts or premiums, plus any non-discountinterest accrued but not due for payment.40 (Theamortized discount or premium would be reflectedas income in enterprise accounting records and usedto adjust the balance sheet value of the asset orliability.) The values derived from this method differfrom those derived by using the NPV method to the

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Illustration 13.4 Net Present Value (NPV)

The net present value (NPV) of any financialinstrument can be established by dividing the expectednet future receipts (that is, receipts minus payments)associated with the instrument by a relevant discountfactor. The discount factor is the compound interest raterelevant to the currency in which the instrument isdenominated and to the debtor institution. For example,if the interest rate for U.S. dollars applicable to aparticular enterprise is 10 percent per annum, paymentsdue in two years should be divided by 1.21 (1.12) toestablish the present value of those payments.

Formally:

PV = FA ((1 + i)n) in which

PV = present value

FA = future amount receivable or payable

i = an appropriate interest rate (expressed as adecimal)

n = number of periods before amount becomesdue

NPV = SUM(PVR) – SUM(PVP) in which

PVR = present value of future amounts receivable

PVP = present value of future amounts payable

If the NPV of an instrument is positive (that is, the PVof future amounts receivable is greater than the PV offuture amounts payable), the instrument is a financialasset. If the NPV is negative (that is, the PV of futureamounts receivable is less than the PV of futureamounts payable), the instrument is a liability.

40For any period t, the value of a discount (or premium) amortized for thatperiod can be calculated as:

ADt = ((Discount * i) / ((1 + i)n – 1)) * ((1 + i)(t–1)) in which

ADt = amortized discount applicable to period t

n = number of periods in life of security

i = (percentage interest rate prevailing at time of issue) / 100

Therefore, an estimate of the value of a security could be derived bysumming the discount (or premium) amortized for each period and addingthis amount (plus any non-discount income accrued but not due forpayment) to the issue price.

extent that interest rates change between the date asecurity is issued and the date for which theinternational investment position is being compiled.On conceptual grounds, the NPV method ispreferred.

725. Alternatively, it may be possible to derivestocks of investment from transactions. (Seeparagraphs 740–743 of the Balance of PaymentsCompilation Guide for further information.)

Monetary Gold, SDRs, Reserve Position inthe International Monetary Fund, and Useof Fund Credit and Loans from the Fund

726. Monetary gold is valued, in the internationalinvestment position, by reference to prevailingmarket prices for gold; monetary gold should not bevalued at acquisition price or some other notionalvalue such as SDR 35 per ounce. Holdings of SDRsare valued at face value (in SDRs) and converted tothe unit of account as appropriate. The valuation ofa country’s reserve position in the Fund is based onthe IMF’s calculations (in SDRs) and converted to theunit of account as appropriate.41

727. A country’s use of Fund credit is also valuedaccording to IMF calculations. In national currencyterms, this amount equals the value of anypurchases plus “maintenance of value payments”prescribed by the IMF. These maintenance of valuepayments maintain a constant position in SDR termsand are treated as exchange rate changes, ratherthan transactions, in the IIP reconciliation (innational currency terms). Loans from the Fund arevalued according to the amount outstanding (inSDRs) and converted to the unit of account asappropriate.

Loans Traded in Secondary Markets

728. In recent years, loans to a number of heavilyindebted countries have been subject to significantdiscounts in secondary markets. To conform withthe market value principle, secondary marketquotations—not legal obligations—are the basis forvaluation of positions in these instruments.However, debtor countries are likely to value

obligations on the basis of amounts that they arecontractually obliged to repay, and this practiceleads to asymmetries between debtor and creditorpositions.

Other Instruments

729. For IIP purposes, other (nontradable) assetsand liabilities (such as loans, deposits, currency, andtrade credits) are valued on the basis of the facevalue of amounts outstanding plus any interestaccrued but not due for payment. In general, suchvalues are considered acceptable proxies for marketvalues.

730. Because the values of nontradable debtinstruments are typically not subject to pricechanges, the procedure for deriving stocks fromtransactions is relatively straightforward if thecompiler has information on the currencies in whichthe instruments are denominated. If the compiler hasa base period estimate of stocks, he or she simplyadjusts for any write-offs, reclassifications, or othernon-transaction adjustments in order to deriveestimates of stocks of investment (in the currency ofdenomination) for successive periods. Theseestimates of stocks are converted to the unit ofaccount by using the exchange rates applicable tothe dates to which the estimates relate. The impactof exchange rate changes can then be derived as thedifference (in the unit of account) between IIPstatements and transactions (plus, when necessary,other adjustments).

A Practical Example of IIP Compilation

731. The following example illustrates the nature ofthe international investment position and the kind ofinformation that could be used to construct an IIPstatement. The example contains informationavailable to the BOP compilers of Zebraland and theDecember 31, 1991 IIP statement derived from thisinformation.

(1) BOP compilers in Zebraland prepare aconsolidated balance sheet dated December 31,1991. This consolidated balance sheet is based onbalance sheets prepared, on a historical cost basis,by the direct investment enterprises in Zebraland.All direct investment enterprises in Zebraland are 50 percent owned by nonresident direct investors;the other 50 percent of shares are owned byresidents.


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41A country’s reserve position in the International Monetary Fund equalsthe country’s quota, minus holdings of the country’s national currency inthe Fund’s Number 1 Account (or equivalent in securities), minus anyoutstanding purchases of Fund credit that the country has made.

Consolidated Balance Sheet of Zebraland as ofDecember 31, 1991

(in millions of Zebraland dollars)

Assets

Land and structures in Zebraland 100Machinery 60

less depreciation –15Loans to unrelated nonresidents 22Bank accounts with resident banks 48Trade credits extended to unrelated nonresidents 17

___

Total assets 232

Liabilities

Loans from nonresident direct investors 14Loans from resident banks 74Trade credits received from unrelated nonresidents 8Zero-coupon bonds issued to unrelated nonresidents

Value at issue 15Accrued interest 7

___

Total liabilities 118

Net worth

Subscribed capital 100Accumulated retained earnings 14

___

Total net worth 114

Further investigations by BOP compilers revealedthat the market value, as of December 31, 1991, ofland and structures held by direct investmententerprises was $Z 140 million.

(2) In 1991, nonresidents were, for the first time,allowed to purchase shares in enterprises traded onthe Zebraland stock exchange. In 1991, the value ofnonresident share purchases was $Z 60 million. Theaverage stock exchange index in 1991 was 120. Thestock exchange index at the end of 1991 was 132.

(3) A survey of importers and exporters, whichincluded the direct investment enterprises,established that, as of December 31, 1991,outstanding trade credit extended by Zebralandenterprises was $Z 35 million and outstanding tradecredit received was $Z 28 million.

(4) Zebraland’s banks, which are not directinvestment enterprises, reported the followingforeign assets and liabilities, which were valued onthe basis of market values, as of December 31, 1991.

The information is presented in millions ofZebraland dollars.

Assets

Deposits with unrelated banks 15Investment in fixed assets held by branches abroad 35Loans to branches abroad 180Securities issued by foreign governments 45

Liabilities

Deposits of unrelated banks 24Loans from unrelated foreign banks 65Commercial paper (3-month) held by nonresidents 82Perpetual bonds held by nonresidents 26

(5) The Debt Management Office of the Zebralandgovernment reported the following information, inmillions of Zebraland dollars, regarding Zebraland’sforeign liabilities:

Face value of outstanding loans to government as ofDecember 31, 1991 140

Face value of government securities on issue as ofDecember 31, 1991 70

Face value of outstanding private enterprise loansguaranteed by the Zebraland government as ofDecember 31, 1991 126

With regard to government securities, the policy ofthe Zebraland government is to issue 10-year bondsat face value. The BOP compilers found that,because of changes in interest rates, these bondswere trading, on average, at a 10 percent discountfrom face value.

The government does not guarantee the debt ofdirect investment enterprises or that of Zebraland’sbanks.

(6) The Central Bank of Zebraland reported thefollowing information on holdings of reserves as ofDecember 31, 1991:

Monetary gold 20,000 ouncesSDRs SDR 5 millionReserve position in the International

Monetary Fund SDR 4 millionHoldings of U.S. Treasury Bonds US$ 20 million$US deposits with German banks US$ 17 million

The BOP compilers determined that, at the close oftrading on December 31, 1991:

The market price of gold was $Z 400 per ounce.The midpoint $Z/$US exchange rate was US$ 1 = $Z 2.The SDR/$US exchange rate was SDR 1 = US$ 1.2.

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150

Statement of Zebraland’s International InvestmentPosition as of December 31, 1991

*Numbers in parentheses refer to sources of information used to compilethe items. When appropriate, notes describing the compilation method are

provided at the end of the table.

(in millions of Zebraland dollars)

AssetsDirect investment abroad

Equity capital and reinvested earnings

Claims on affiliated enterprises 35 (4)

Portfolio investmentDebt securities-banks 45 (4) See Note 1

Other investmentTrade credits-other sectors 35 (3) See Note 2Loans

Banks 180 (4) See Note 3Other sectors 22 (1)

Deposits-banks 15 (4)Reserve assets

Monetary gold 8 (6) See Note 4SDRs 12 (6) See Note 5Reserve position in the Fund 9.6 (6) See Note 6Foreign exchange

Currency and deposits-with banks 34 (6)

Securities-bonds and notes 40 (6)Total foreign financial assets 435.6

LiabilitiesDirect investment in Zebraland

Equity capital and reinvested earnings

Liabilities to direct investors 77 (1) See Note 7Other capital

Liabilities to direct investors 14 (1)Portfolio investment

Equity securities-other sectors 66 (2) See Note 8Debt securities

Bonds and notesGeneral government 63 (5) See Note 9Banks 26 (4)Other sectors 22 (1) See Note 10

Money market instruments-banks 82 (4)Other investment

Trade credits-other sectors 28 (3) See Note 11Loans

General government 140 (5)Banks 65 (4)Other sectors 126 (5)

Currency and deposits-banks 24 (4)Total foreign liabilities 733

Net international investment position –297.4

Notes to Zebraland’s Statement of InternationalInvestment Position as of December 31, 1991

Note 1—The information is insufficient to classify thesecurities as bonds and notes or money marketinstruments.

Note 2—Trade credits extended by direct investmententerprises are included in this estimate.

Note 3—It is assumed that bank loans to branches abroaddo not represent permanent debt capital.

Note 4—Valued at market values ($Z 400 per ounce)

Note 5—SDR 5 converted to US$ and then converted to $Zby use of market exchange rates

Note 6—SDR 4 converted to US$ and then converted to $Zby use of market exchange rates

Note 7—Direct investors’ share (50 percent) of net worth,at book values, of enterprise (114) plus impact ofrevaluing land to market values (140–100)

Note 8—The market value was calculated by multiplyingthe value of acquisitions made in 1991 by thestock exchange index at the end of 1991 and thendividing the result by the average stock exchangeindex for 1991.

Note 9—The face value of government securities held bynonresidents was discounted by 10 percent toderive a proxy for market valuation.

Note 10—Zero coupon bonds issued by direct investmententerprises. The accrued interest has been addedto the value at issue; the resulting amountshould be a reasonable proxy for marketvaluation.

Note 11—Trade credits received by direct investmententerprises are included in this estimate.

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