2. The Measurement of External Debt: Definition and Core Accounting Principles
- International Monetary Fund
- Published Date:
- June 2003
2.1 This chapter begins by updating the definition of external debt so that it is consistent with the concepts of 1993 SNA and BPM5. The definition of external debt remains based on the notion that if a resident has a current liability to a nonresident that requires payments of principal and/or interest in the future, this liability represents a future claim on the resources of the economy of the resident, and so is external debt of that economy. Such an approach provides a comprehensive measure of external debt that is consistent across the range of debt instruments regardless of how they may be structured. The focus of the definition remains on gross liabilities—that is, excluding any assets.
2.2 A common theme throughout the Guide is that analysis of the gross external debt position of an economy requires information that, as far as possible, is compatible with related data series both within and among countries. Compatibility enhances the analytical usefulness and the reliability of data by allowing interrelationships with other related macroeconomic data series to be examined and comparisons across countries to be undertaken on a clear and consistent basis. Also, compatibility encourages the rationalization of collection procedures, through the integration of domestic and external debt data (thus lowering of the costs of data production). For these reasons, this chapter introduces accounting concepts for the measurement of external debt that are drawn from the 1993 SNA and BPM5.
Definition of External Debt
2.3 The Guide defines gross external debt as follows: Gross external debt, at any given time, is the outstanding amount of those actual current, and not contingent, liabilities that require payment(s) of principal and/or interest by the debtor at some point(s) in the future and that are owed to nonresidents by residents of an economy.
Outstanding and Actual Current Liabilities
2.4 For a liability to be included in external debt it must exist and be outstanding. The decisive consideration is whether a creditor owns a claim on the debtor. Debt liabilities are typically established through the provision of economic value—that is, assets (financial or nonfinancial including goods), services, and/or income—by one institutional unit, the creditor, to another, the debtor, normally under a contractual arrangement.1 Debt liabilities can also be created by the force of law,2 and by events that require future transfer payments.3 Debt liabilities include arrears of principal and interest. Commitments to provide economic value in the future cannot establish debt liabilities until items change ownership, services are rendered, or income accrues; for instance, amounts yet to be disbursed under a loan or export credit commitment are not to be included in the gross external debt position.
Principal and Interest
2.5 The provision of economic value by the creditor, or the creation of debt liabilities through other means, establishes a principal liability for the debtor, which, until extinguished, may change in value over time. For debt instruments alone, for the use of the principal, interest can (and usually does) accrue on the principal amount, resulting in an interest cost for the debtor. When this cost is paid periodically, as commonly occurs, it is known in the Guide as an interest payment. All other payments of economic value by the debtor to the creditor that reduce the principal amount outstanding are known as principal payments.
2.6 For long-term debt instruments, interest costs paid periodically are defined as those to be paid by the debtor to the creditor annually or more frequently; for short-term instruments (that is, with an original maturity of one year or less), interest costs paid periodically are defined as those to be paid by the debtor to the creditor before the redemption date of the instrument.
2.7 The definition of external debt does not distinguish between whether the payments that are required are principal or interest, or both. For instance, interest-free loans are debt instruments although no interest is paid, while perpetual bonds are debt instruments although no principal is to be repaid. In addition, while it may normally be expected that payments will be made in the form of financial assets, such as currency and deposits, the definition does not specify the form in which payments need to be made. For instance, payments could be made in the form of goods and services. It is the future requirement to make payments, not the form of those payments, that determines whether a liability is a debt instrument or not.
2.8 Also, the definition does not specify that the timing of the future payments of principal and/or interest need be known for a liability to be classified as debt. In many instances, the schedule of payments is known, such as on debt securities and loans. However, in other instances the exact schedule of payments may not be known. For example, the timing of payment might be at the demand of the creditor, such as non-interest-bearing demand deposits; the debtor may be in arrears, and it is not known when the arrears will actually be paid; or the timing of a payment may depend on certain events, such as the exercise of an embedded put (right to sell) or call (right to buy) option. Once again, it is the requirement to make the payment that determines whether the liability is debt, rather than the timing of the payment. So, the liabilities of pension funds and life insurance companies to their nonresident participants and policyholders are regarded as debt of those institutions because at some point in time a payment is due, even though the timing of that payment may be unknown.
2.9 To qualify as external debt, the debt liabilities must be owed by a resident to a nonresident. Residence is determined by where the debtor and creditor have their centers of economic interest—typically, where they are ordinarily located—and not by their nationality. The definition of residence is explained in more detail later in this chapter and is the same as in BPM5 and the 1993 SNA. Clarification of the determination of residence for entities legally incorporated or domiciled in “offshore centers” is provided.
Current and Not Contingent
2.10 Contingent liabilities are not included in the definition of external debt. These are defined as arrangements under which one or more conditions must be fulfilled before a financial transaction takes place.4 However, from the viewpoint of understanding vulnerability, there is analytical interest in the potential impact of contingent liabilities on an economy and on particular institutional sectors, such as government. For instance, the amount of external debt liabilities that an economy potentially faces may be greater than is evident from the published external debt data if cross-border guarantees have been given. Indeed, the Guide encourages countries to set up systems to monitor and disseminate data on contingent liabilities, as is discussed in more detail in Chapter 9.
Relationship with Instruments in the 1993 SNA
2.11 From the viewpoint of the national accounts, the definition of external debt is such that it includes all financial liabilities recognized by the 1993 SNA as financial instruments—except for shares and other equity, and financial derivatives—that are owed to nonresidents. Shares and other equity are excluded because they do not require the payment of principal or interest. For the same reason, financial derivatives, both forwards and options, are excluded—no principal amount is advanced that is required to be repaid, and no interest accrues on any financial derivative instrument. Both forwards and options are described in more detail in Chapter 3. Nonetheless, an overdue obligation to settle a financial derivatives contract would, like any arrears, be a debt liability because a payment is required. Monetary gold and IMF special drawing rights (SDRs) are financial assets included in the 1993 SNA but are not debt instruments because they are, by convention, assets without a corresponding liability.
Core Accounting Principles
2.12 This section considers the concepts of residence, time of recording, valuation, the unit of account and exchange rate conversion, and maturity. Unless otherwise specified, these concepts are applicable throughout the Guide.
2.13 Debt liabilities of residents that are owed to nonresidents are to be included in the presentation of an economy’s gross external debt position. Debt liabilities owed to residents are excluded. Hence the definition of residence is central to the definition of external debt. In the Guide, as in the BPM5 and the 1993 SNA, an institutional unit—that is, an entity such as a household, corporation, government agency, etc., that is capable, in its own right, of owning assets, incurring liabilities, and engaging in economic activities and in transactions with other entities—is a resident of an economy when it has its center of economic interest in the economic territory of that country.
2.14 To determine residence, the terms “economic territory” and “center of economic interest” also require definition. A country’s economic territory consists of a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely. Economic territory may not be identical with boundaries recognized for political purposes, although there is usually a close correspondence. For maritime countries, geographic territory includes any islands subject to the same fiscal and monetary authorities as the mainland. International (multilateral) organizations have their own territorial enclave(s) over which they have jurisdiction and are not considered residents of any national economy in which the organizations are located or conduct affairs; although employees of these bodies are residents of the national economy—specifically, of the economies in which they are expected to maintain their abodes for one year or more.
2.15 An institutional unit has a center of economic interest and is a resident unit of a country when, from some location (dwelling, place of production, or other premises) within the economic territory of the country, the unit engages and intends to continue engaging (indefinitely or for a finite but long period of time) in economic activities and transactions on a significant scale. The location need not be fixed as long as it remains within the economic territory. For statistical purposes, the conduct or intention to conduct economic activities for a year or more in an economic territory normally implies residence of that economy. But the one-year period is suggested only as a guideline and not as an inflexible rule.
2.16 In essence, an institutional unit is a resident of the economy in which it is ordinarily located. For instance, a branch or subsidiary is resident in the economy in which it is ordinarily located, because it engages in economic activity and transactions from that location, rather than necessarily the economy in which its parent corporation is located. Unincorporated site offices of major construction and similar projects, such as oil and gas exploration, that take over a year to complete and are carried out and managed by nonresident enterprises will, in most instances, meet the criteria of resident entities in the economy in which they are located, and so can have external debt (although the claims on the office by the parent might well represent an equity investment).6
2.17 The residence of offshore enterprises—including those engaged in the assembly of components manufactured elsewhere, those engaged in trade and financial operations, and those located in special zones—is attributed to the economies in which they are located. For instance, in some countries, banks, including branches of foreign banks, that are licensed to take deposits from and lend primarily, or even only, to residents of other economies are treated as “offshore banks” under exchange control and/or other regulations. These banks usually face different supervisory requirements and may not be required to provide the same amount of information to supervisors as “onshore” banks. Nonetheless, the liabilities of the offshore banks should be included in the external debt statistics of the economy in which they are located, provided that the liabilities meet the definition of external debt.
2.18 Similar issues can arise with “brass plate companies,” “shell companies,” or “special purpose entities” (SPEs). These entities may have little physical presence in the economy in which they are legally incorporated or legally domiciled (for example, registered or licensed), and any substantive work of the entity may be conducted in another economy. In such circumstances, there might be debate about where the center of economic interest for such entities lies. The Guide attributes external debt to the economy in which the entity, which has the liabilities on its balance sheet, and so on whom the creditor has a claim, is legally incorporated, or in the absence of legal incorporation, is legally domiciled. So, debt issues on the balance sheet of entities legally incorporated or domiciled in an offshore center are to be classified as external debt of the economy in which the offshore center is located. Any subsequent on-lending of the funds raised through such debt issues to a nonresident, such as to a parent or subsidiary corporation, is classified as an external asset of the offshore entity and external debt of the borrowing entity.
2.19 In some economies, separate identification of the gross external debt (and external assets) of resident “offshore banks” and other “offshore entities” is necessary because of the potential size of their liabilities relative to the rest of the economy.
2.20 In contrast, a nonresident may set up an agency in the resident economy usually to generate business in that economy. So, for instance, a resident agent may arrange for its parent foreign bank to lend funds to a fellow resident (the borrower). Unless the agent takes the transactions between the borrower and the creditor bank onto its own balance sheet, the borrower records external debt and not the agent. This is because the debtor/creditor relationship is between the lending bank and the borrowing entity, with the agent merely facilitating the transaction by bringing the borrower and lender together. If the agent does take the transactions onto its balance sheet then it, not the final borrower, should record external debt from its parent foreign bank.
2.21 A regional central bank is an international financial organization that acts as a common central bank for a group of member countries. Such a bank has its headquarters in one country and usually maintains national offices in each of the member countries. Each national office acts as central bank for that country and is treated as a resident institutional unit in that country. The headquarters, however, is an international organization, and thus a nonresident from the perspective of the national central banks. However, for statistics relating to the economic territory of the whole group of member countries, the regional central bank is a resident institutional unit of this territory.
Time of Recording7
2.22 The guiding principle for whether claims and liabilities exist and are outstanding is determined at any moment in time by the principle of ownership. The creditor owns a claim on the debtor, and the debtor has an obligation to the creditor.8 Transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished.
2.23 When a transaction occurs in assets, both financial and nonfinancial, the date of the change of ownership (the value date), and so the day the position is recorded, is when both creditor and debtor have entered the claim and liability, respectively, in their books. This date may actually be specified to ensure matching entries in the books of both parties. If no precise date can be fixed, the date on which the creditor receives payment or some other financial claim is decisive. For example, loan drawings are entered in the accounts when actual disbursements are made, and so when financial claims are established, and not necessarily when an agreement is signed.
2.24 For other transactions, when a service is rendered, interest accrues, or an event occurs that creates a transfer claim (such as under nonlife insurance), a debt liability is created and exists until payment is made or forgiven. Although not usual, like interest, service charges can accrue continuously. Although equity securities are not debt instruments, dividends once they are declared payable are recorded in other debt liabilities until paid.
2.25 The Guide recommends that interest costs accrue continuously on debt instruments, thus matching the cost of capital with the provision of capital. This recommendation is consistent with the approach taken in related international statistical manuals and in commercial accounting standards (see Box 2.1). For interest costs that accrue in a recording period, there are three measurement possibilities: (1) they are paid within the reporting period, in which instance there is no impact on the gross external debt position; (2) they are not paid because they are not yet payable (referred to hereafter as “interest costs that have accrued and are not yet payable”)—for example, interest is paid each six months on a loan or security, and the gross external debt position is measured after the first three months of this period—in which instance the gross external debt position increases by the amount of interest that has accrued during the three-month period; and (3) they are not paid when due, in which instance the gross external debt position increases by the amount of interest costs that have accrued during the period and are in arrears at the end of the period.
Interest costs that have accrued and are not yet payable
2.26 Traditionally, external debt-recording systems have not recorded as external debt interest costs that have accrued and are not yet payable. At the time of publication of this Guide, the preference of many debt compilers remains to continue to exclude such interest costs from the gross external debt position. This is for two reasons. First, for countries with a few large external loans, borrowed at irregular periods, that have annual or semiannual interest payments, significant variation over time in the debt stock could arise from the inclusion of interest costs that have accrued and are not yet payable. Second, from a practical viewpoint, for some countries the inclusion of such interest costs in the gross external debt position could take some time to implement because it could involve a significant change to their present compilation system.
2.27 It is thus recognized that the recording of interest costs accruing on deposits and loans may have to follow national practices and be classified under other debt liabilities. Nonetheless, for those countries that can do so, the Guide recommends including interest costs that have accrued and are not yet payable as part of the value of the underlying instruments. That is, the accrual of interest costs not yet payable continuously increases the principal amount outstanding of the debt instrument until these interest costs are paid. This is consistent with the approach in the 1993 SNA and BPM5. However, in order to maintain comparability of external debt statistics across time and across countries and to identify the variation introduced by the timing of recording of interest costs that have accrued and are not yet payable, the Guide requires that countries recording such interest costs complete the memorandum item identifying the sectoral and maturity breakdown of the item (as described in Chapter 4, paragraphs 4.8 and 4.9).
2.28 When bond securities (including deep-discount and zero-coupon bonds), bills, and similar short-term securities are issued at a discount (or at a premium), the difference between the issue price and its face or redemption value at maturity is treated, on an accrual basis, as interest (negative interest) over the life of the bond. When issued at a discount, the interest costs that accrue each period are recorded as being reinvested in the bond, increasing the principal amount outstanding. This approach can be described as the capitalization of interest; it is not a holding gain for the security owner. When issued at a premium, the amount accruing each period reduces the value of the bond.
2.29 When principal or interest payments are not made when due, such as on a loan, arrears are created (a short-term liability that is included under other debt liabilities). But to ensure that the debt is not counted twice, there is a corresponding reduction in the appropriate debt instrument (for example, a loan). So, the nonpayment, when due, of principal and/or interest results in a reduction in the amount outstanding of the appropriate instrument, such as a loan, and an increase in arrears, leaving the external debt position unchanged. Arrears should continue to be reported from their creation—that is, when payments are not made9—until they are extinguished, such as when they are repaid, rescheduled, or forgiven by the creditor.
Box 2.1.The Choice of a Recording Basis: The Case for Accrual Accounting1
Meaning of the Term “Recording Basis”
In the context of a macroeconomic statistical system, recording bases are defined mainly according to the time at which transactions are recorded in that system. Alternative recording bases are possible because for many transactions there can be a time lag between the change of ownership of the underlying item, the due date for payment, and the actual date for payment. Also, given the nature of the different recording bases the transactions and positions captured by them will also differ. Thus, an important consideration in choosing a recording basis is the information intended to be conveyed in the statistical system. For external debt statistics, the intention is to provide users of these data with a comprehensive measure of external debt liabilities at the end of the reporting period, and to allow them to identify the types of flows during the reporting period that affect the size and composition of these liabilities. Consequently, the Guide introduces the use of the accrual recording basis, for reasons explained below.
Main Types of Recording Bases
Three types of recording bases have most commonly been used in macroeconomic statistical systems: cash recording; due-for-payment recording; and accrual recording. In practice, variations on each of these main bases are often found.
With cash recording, transactions are recorded when a payment is made or received, irrespective of when the assets involved change ownership. In its strictest form, only those flows that involve cash as the medium of exchange are included (that is, cash inflows and outflows). The stocks recorded at the end of the reporting period in such a system are restricted to cash balances. But in practice, cash reporting basis is often modified to include other balances such as debt balances. In other words, when cash is disbursed on a debt instrument, an outstanding debt stock is recorded, and subsequent repayments of principal, in cash, reduce that outstanding debt.
A due-for-payment recording basis records transactions when receipts or payments arising from the transaction fall due, rather than when the cash is actually received or paid. The due-for-payment basis can be considered as a modification of the cash basis. In addition to cash balances, the due-for-payment basis takes into account amounts due or overdue for payment. Typically, a due-for-payment basis of recording will record debt stocks on the basis of the redemption amount of the outstanding liability—the amount due for payment at maturity.2 This amount may differ from the amount originally disbursed for a variety of reasons, including discounts and premiums between the issue and redemption price, repayment of principal, and revaluation of the debt due to indexation. Also, this recording basis will capture debt arising from some noncash transactions, such as arrears and the assumption of debt from one entity to another (for example, to the government).
On an accrual recording basis, transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is a change of ownership. The accrual reporting basis thus recognizes transactions in the reporting period in which they occur, regardless of when cash is received or paid, or when payments are due. Gross external debt positions at the end of a reporting period depend on the stock of gross external debt at the beginning of the period, and transactions and any other flows that have taken place during the period.3 The accrual recording basis records what an entity owes from the perspective of economic, not payment, considerations.
The different approaches of the three recording bases can be illustrated by the example of a loan, on which interest costs are paid periodically until the loan is repaid at maturity. The initial loan disbursement would be recorded in all three recording bases at the same time—that is, when the disbursement is made. All three systems would record a debt liability.4 However, on an accrual reporting basis, interest costs are recorded as accruing continuously, reflecting the cost of the use of capital, and increasing the outstanding amount of the debt liability during the life of the loan, until the interest costs become payable. But on a cash or due-for-payment basis, no such increase would arise.
Interest payments on the loan and repayment of principal at maturity are recognized at the same time in all three systems, provided that these payments are made in the reporting period in which they are due. But if payments are not made when due, arrears would be recorded on the due-for-payment and accrual recording bases, but not on the cash basis (although in practice, a cash-based system might well be modified to include arrears). In the due-for-payment and accrual recording bases, a debt payment would be recorded as though made by the debtor, with an associated increase in (short-term) liabilities (arrears). Arrears are reduced when the payment is actually made. On a cash basis, no transactions would be recorded until the (overdue) payment is actually made; no arrears are recorded.
Thus, from the above example it can be seen that the accrual recording basis will record transactions at the same time as or before the cash and due-for-payment bases, and the due-for-payment basis would record transactions at the same time as or before the cash basis. For positions, on a cash basis, only amounts disbursed in cash and repaid in cash are taken into account; on a due-for-payment basis, amounts disbursed and repaid in cash are recognized along with any outstanding liabilities arising from noncash transactions—such as arrears; the accrual recording basis, in contrast, recognizes all existing liabilities regardless of whether cash has been disbursed or repaid, or payment is due or not.
Measuring External Debt Positions
Disadvantages of Cash and Due-for-Payment Bases
Both the cash and the due-for-payment bases have deficiencies in providing a comprehensive measure of gross external debt positions.
The cash recording basis contains information “only” on debt arising from cash flows; noncash transactions are not covered (for example, the provision of goods and services on which payment is delayed, and liabilities not met are not recognized, such as arrears). Thus, it provides insufficient coverage of external debt. Though the due-for-payment approach, as an extension of the cash basis, includes noncash transactions such as arrears and indexation, it still provides an incomplete measure of external debt. For instance, on a due-for-payment recording basis, payments not yet due for goods and services already delivered are not considered debt (unless, for example, there is a contractual agreement to extend trade credit). Also, interest is not recorded until due for payment, regardless of whether interest is in the form of a discount to the face value on issuance or in the form of interest payments (that is, paid periodically).
Advantage of an Accrual Basis
The accrual recording basis, which has long been used as the basis for commercial accounting, provides the most comprehensive information of the bases described, because it measures external debt on the basis of whether a creditor has ownership of a financial claim on a debtor. The accrual basis provides the most consistent measure of external debt, both in terms of coverage and size, in that it is indifferent (1) to the form of payment—debt can be created or extinguished through cash and/or noncash payments (that is through the provision of value); (2) to the time of payment—debt is created or extinguished dependent on the time at which ownership of a claim is established or relinquished; and (3) to whether the future payments required on existing liabilities are in the form of principal or interest.5 As financial markets continue to innovate, this consistency of approach helps to ensure that the size and coverage of external debt is determined foremost by economic, and not payment, considerations.6
Finally, recording external debt on an accrual basis has the advantage of being consistent with other macroeconomic statistical systems, such as the 1993 SNA and the BPM5, both of which employ an accrual basis of recording. These systems provide information on the types of economic flows during the reporting period that affect the size and composition of external debt. The Government Finance Statistics Manual (IMF, 2001) and the Monetary and Financial Statistics Manual (IMF, 2000d) are also on an accrual recording basis. Besides enhancing comparability of information across different sets of macroeconomic statistics for data users, the adoption of a common recording basis would also contribute to a reduction in compilation costs through the ability to use common data series in related statistical systems.
2.30 If debt payments are guaranteed by a third party, and the debtor defaults, the original debtor records an arrear until the creditor invokes the contract conditions permitting the guarantee to be called. Once the guarantee is called, the debt payment is attributed to the guarantor, and the arrear of the original debtor is extinguished, as though repaid. Depending on the contractual arrangements, in the event of a guarantee being called, the debt is not classified as arrears of the guarantor but instead is classified as a short-term other debt liability until any grace period for payment ends.
2.31 The Guide recommends that debt instruments are valued at the reference date at nominal value, and, for traded debt instruments, at market value as well. The nominal value of a debt instrument is a measure of value from the viewpoint of the debtor because at any moment in time it is the amount that the debtor owes to the creditor. This value is typically established by reference to the terms of a contract between the debtor and creditor, and it is frequently used to construct debt ratios, such as those described in Chapter 15. The market value of a traded debt instrument is determined by its prevailing market price, which, as the best indication of the value that economic agents currently attribute to specific financial claims, provides a measure of the opportunity cost to both the debtor and the creditor.11 It is the valuation principle adopted in the 1993 SNA and BPM5.
2.32 The nominal value of a debt instrument reflects the value of the debt at creation; any subsequent economic flows, such as transactions (for example, repayment of principal); valuation changes (including exchange rate and other valuation changes other than market price changes); and any other changes. Conceptually, the nominal value of a debt instrument can be calculated by discounting future interest and principal payments at the existing contractual interest rate(s)12 on the instrument; these interest rates may be fixed rate or variable rate. For fixed-rate instruments and instruments with contractually predetermined interest rates, this principle is straightforward to apply because the future payment schedule and the rate(s) to apply are known,13 but it is less straightforward to apply to debt liabilities with variable rates that change with market conditions. The appendix at the end of this chapter provides examples of calculating the nominal value of a debt instrument by discounting future payments of interest and principal.
2.33 Face value has been used to define nominal value in some instances, since face value is the undiscounted amount of principal to be repaid. While of interest in showing amounts contractually due to be paid at a future date, the use of face value as nominal value in measuring the gross external debt position can result in an inconsistent approach across all instruments and is not recommended. For instance, the face value of deep-discount bonds and zero-coupon bonds includes interest costs that have not yet accrued, which is counter to the accrual principle.
2.34 The market value of a traded debt instrument should be determined by the market price for that instrument prevailing on the reference date to which the position relates. The ideal source of a market price for a traded debt instrument is an organized or other financial market in which the instrument is traded in considerable volume and the market price is listed at regular intervals. In the absence of such a source, market value can be estimated by discounting future payment(s) at an appropriate market rate of interest. If the financial markets are closed on the reference date, the market price that should be used is that prevailing on the closest preceding date when the market was open. In some markets the market price quoted for traded debt securities does not take account of interest costs that have accrued but are not yet payable, but in determining market value these interest costs need to be included.
Nontraded debt instruments
2.35 As does BPM5, the Guide recommends that debt instruments that are not traded (or tradable) in organized or other financial markets—such as loans, currency and deposits, and trade credit—be valued at nominal value only.14 The nominal value of a debt instrument could be less than originally advanced if there have been repayments of principal, debt forgiveness, or other economic flows, such as arising from indexation, that affect the value of the amount outstanding. The nominal value of a debt instrument could be more than originally advanced because, for example, of the accrual of interest costs, or other economic flows.
2.36 For debt instruments that accrue no interest—for example, liabilities arising because dividends are declared but not yet payable—the nominal value is the amount owed. If there is an unusually long time15 before payment is due on an outstanding debt liability on which no interest costs accrue, then the value of the principal should be reduced by an amount that reflects the time to maturity and an appropriate existing contractual rate, and interest costs should accrue until actual payment is made.
2.37 For some debt, such as a loan, repayment may be specified in a contract in terms of quantities of commodities or other goods to be paid in installments over a period of time. At inception the value of the debt is equal to the principal advanced. The rate of interest, which will accrue on the principal, is that which equates the present value of the required future provision of the commodity or other good, given its current market price, to the principal outstanding. Conceptually, this type of contract is equivalent to the indexation of a loan, and so the initial rate of interest that accrues will change as the market price of the specified item changes, subject to any contractual arrangement (for example, limits in monetary terms on the maximum and minimum value that is to be paid by the debtor). When payments are made in the form of the good or commodity, the value of the principal outstanding will be reduced by the market value of the good or commodity at the time the payment is made.
2.38 In contrast, the value of the commodities, other goods, or services to be provided to extinguish a trade credit liability, including under barter arrangements, is that established at the creation of the debt; that is, when the exchange of value occurred. However, as noted above, if there is an unusually long time before payment, the value of the principal should be reduced by an amount that reflects the time to maturity and an appropriate existing contractual rate, and interest costs should accrue until actual payment is made.
2.39 The Guide recognizes the debt liabilities of pension funds and insurance companies to their nonresident participants and policyholders. The debt liability for a defined-benefit pension scheme is the present value of the promised benefits to nonresidents; while for a defined-contribution scheme the debt liability is the current market value of the fund’s assets prorated for the share of nonresidents’ claims vis-à-vis total claims.16 For life insurance, the debt liability is the value of the reserves held against the outstanding life insurance policies issued to nonresidents. The debt liability to nonresidents of nonlife insurance companies is the value of any prepayments of premiums by nonresidents, and the present value of amounts expected to be paid out to nonresidents in settlements of claims, including disputed, but valid, claims.
2.40 For arrears, the nominal value is equal to the value of the payments—interest and principal—missed, and any subsequent economic flows, such as the accrual of additional interest costs.
2.41 For nontraded debt instruments where the nominal value is uncertain, the nominal value can be calculated by discounting future interest and principal payments at an appropriate existing contractual rate of interest.
Traded debt instruments
2.42 The Guide recommends that debt instruments traded (or tradable) in organized and other financial markets be valued at both nominal and market value.17 For a traded debt instrument, both nominal and market value can be determined from the value of the debt at creation and subsequent economic flows, except that market valuation takes account of any changes in the market price of the instrument, whereas nominal value does not.
2.43 For debt securities that are usually tradable but for which the market price is not readily observable, by using a market rate of interest the present value of the expected stream of future payments associated with the security can be used to estimate market value. This and other methods of estimating market value are explained in Box 2.2. For unlisted securities, the price reported for accounting or regulatory purposes might be used, although this method is less preferable than those mentioned above. Similarly, for deep-discount or zero-coupon bonds, the issue price plus amortization of the discount could be used in the absence of a market price.
Box 2.2.General Methods for Estimating Market Value
When market-price data are unavailable for tradable instruments, there are two general methods for estimating market value or, as it is sometimes called, fair value:
Discounting future cash flows to the present value using a market rate of interest; and
Using market prices of financial assets and liabilities that are similar.
The first general method is to value financial assets and liabilities by basing market value on the present, or time-discounted, value of future cash flows. This is a well-established approach to valuation in both theory and practice. It calculates the market value of a financial asset or liability as the sum of the present values of all future cash flows. Market value is given by the following equation:
The method is relatively easy to apply in valuing any financial asset or liability if the future cash flows are known with certainty or can be estimated, and if a market interest rate (or series of market interest rates) is observable.
Directly basing market value on the market price of a similar financial instrument is a well-used technique when a market price is not directly observable. For example, the market price of a bond with five-year remaining maturity might be given by the market price of a publicly traded five-year bond having comparable default risk. In other cases, it may be appropriate to use the market price of a similar financial instrument, but with some adjustment in the market value to account for differences in liquidity and/or risk level between the instruments.
In some cases, the financial asset or liability may possess some characteristics of each of several other financial instruments, even though its characteristics are not generally similar to any one of these instruments. In such cases, information on the market prices and other characteristics (for example, type of instrument, issuing sector, maturity, credit rating, etc.) of the traded instruments can be used in estimating the market value of the instrument.
2.44 If arrears are traded on secondary markets, as sometimes occurs, then a separate market value could be established.
2.45 Positions in financial derivatives, equity securities, and equity capital and reinvested earnings on foreign direct investment are not included in the gross external debt position because they are not debt instruments, but they are recognized by the Guide as memorandum items to the position. These instruments are to be valued at market value.
2.46 The market value of a forward financial derivatives contract is derived from the difference between the agreed-upon contract price of an underlying item and the prevailing market price (or market price expected to prevail) of that item, times the notional amount, appropriately discounted. The notional amount—sometimes described as the nominal amount—is the amount underlying a financial derivatives contract that is necessary for calculating payments or receipts on the contract. This amount may or may not be exchanged. In the specific case of a swap contract, the market value is derived from the difference between the expected gross receipts and gross payments, appropriately discounted; that is, its net present value. The market value for a forward contract can therefore be calculated using available information—market and contract prices for the underlying item, time to maturity of the contract, the notional value, and market interest rates. From the viewpoint of the counterparties, the value of a forward contract may become negative (liability) or positive (asset) and may change both in magnitude and direction over time, depending on the movement in the market price for the underlying item. Forward contracts settled on a daily basis, such as those traded on organized exchanges—and known as futures—have a market value, but because of daily settlement it is likely to be zero value at each end-period.
2.47 The price of an option depends on the potential price volatility of the price of the underlying item, the time to maturity, interest rates, and the difference between the contract price and the market price of the underlying item. For traded options, whether they are traded on an exchange or not, the valuation should be based on the observable price. At inception the market value of a nontraded option is the amount of the premium paid or received. Subsequently nontraded options can be valued with the use of mathematical models, such as the Black-Scholes formulas, that take account of the factors mentioned above that determine option prices. In the absence of a pricing model, the price reported for accounting or regulatory purposes might be used. Unlike forwards, options cannot switch from negative to positive value, or vice versa, but they remain an asset for the owner and a liability for the writer of the option.
2.48 For equity securities that are listed in organized markets or are readily tradable, the value of outstanding stocks should be based on market prices. The value of equity securities not quoted on stock exchanges or not traded regularly should be estimated by using prices of comparable quoted shares as regards past, current, and prospective attributes such as earnings and dividends. Alternatively, the net asset values of enterprises to which the equities relate could be used to estimate market values if the balance sheets of the enterprises are available on a current-value basis, but this is not a preferred method given the possibly large difference between balance sheet and equity market valuations.
2.49 For equity capital and reinvested earnings related to foreign direct investment, it is recognized that, in practice, balance sheet values of direct investment enterprises or direct investors are generally utilized to determine their value. If these balance sheet values are on a current market value basis, this valuation would be in accordance with the market value principle, but if these values are based on historical cost and not current revaluation, they would not conform to the principle. If historical cost from the balance sheets of direct investment enterprises (or investors) is used to determine the value of equity capital and reinvested earnings, compilers are also encouraged to collect data from enterprises on a current market value basis. In instances where the shares of direct investment enterprises are listed on stock exchanges, the listed prices should be used to calculate the market value of shares in those enterprises.
Unit of Account and Exchange Rate Conversion
2.50 The compilation of the gross external debt position statement is complicated by the fact that the liabilities may be expressed initially in a variety of currencies or in other standards of value, such as SDRs. The conversion of these liabilities into a reference unit of account is a requisite for the construction of consistent and analytically meaningful gross external debt statistics.
2.51 From the perspective of the national compiler, the domestic currency unit is the obvious choice for measuring the gross external debt position. Such a position so denominated is compatible with the national accounts and most of the economy’s other economic and monetary statistics expressed in that unit. However, if the currency is subject to significant fluctuation relative to other currencies, a statement denominated in domestic currency could be of diminished analytical value because valuation changes could dominate interperiod comparisons.
2.52 The most appropriate exchange rate to be used for conversion of external debt (and assets) denominated in foreign currencies into the unit of account is the market (spot) rate prevailing on the reference date to which the position relates. The midpoint between buying and selling rates should be used. For conversion of debt in a multiple rate system,18 the rate on the reference date for the actual exchange rate applicable to specific liabilities (and assets) should be used.
2.53 For debt liabilities, it is recommended that the traditional distinction between long- and short-term maturity, based on the formal criterion of original maturity, be retained. Long-term debt is defined as debt with an original maturity of more than one year or with no stated maturity. Short-term debt, which includes currency, is defined as debt repayable on demand or with an original maturity of one year or less. If an instrument has an original maturity of one year or less it should be classified as short-term, even if the instrument is issued under an arrangement that is long-term in nature.
Appendix: Accrual of Interest Costs—How Should This Be Implemented?
2.54 The Guide introduces the idea of including interest costs that have accrued and are not yet payable in the gross external debt position. This annex presents the theoretical framework for the accrual of interest costs, and a more detailed discussion on how to apply the accrual principle, by type of instrument.
2.55 Because the focus of the Guide is on position statistics, the debate about whether the rate at which interest should accrue on market-traded instruments should be based on the current market value of the debt (the so-called creditor approach) or as stipulated in the original contract (the so-called debtor approach) is not relevant. This is because the market value position to be reported is based on the market price of the instrument, and that value should include any interest costs that have accrued and are not yet payable.19 Given this, unless otherwise stated, this annex focuses on nominal value.
2.56 At the outset, it is worth noting some key principles for applying the accrual of interest costs principle in both the nominal and market value presentations of external debt:
All financial instruments bearing interest are included;
The accrual of interest costs can be calculated by the straightline or compound interest method;
All instruments issued at a discount are treated in a similar manner; and
The accrual of interest costs also applies to variable-rate and index-linked instruments.
Theoretical Framework for the Accrual of Interest Costs
2.57 Three examples, drawn from work undertaken by Statistics Canada (see Laliberté and Tremblay, 1996), are provided to illustrate the theoretical framework for the accrual of interest costs. These examples, and the discussion on accruing interest costs on a straightline or compound basis that immediately follows, provide an explanation of the basic principles.
2.58 The first example is that of a simple instrument that is issued and redeemed at the same price and pays fixed annual interest at the end of each year; the second example is of an instrument issued at a price that is at a discount to the redemption price, and that also makes annual interest payments; and the third example is of an instrument issued at a discount that has no interest payments. These examples have general applicability throughout the Guide, in that they explain how future payments can be discounted to produce the stock of external debt at any moment in time.
Example 1: Present Value and the Accrual of Interest Costs—Simple Case
2.59 In this simple example, a debt instrument is issued with a five-year maturity, a principal amount of $100, and annual payments of $10 each year as interest. That is, the interest rate on the instrument is fixed at 10 percent a year. Given this, as seen in Table 2.1, in present value terms the payment of $10 in a year’s time is worth 10/(1 + 0.1), or 9.09; the payment of $10 in two years’ time is worth 10/(1 + 0.1)2, or 8.26; and so on. In present value terms, the principal amount advanced to be repaid at maturity is worth 100/(1 + 0.1)5, or 62.09. The present value for each payment is provided in the left-hand column, and it can be seen that the present value of all future payments equals the issue price of $100.
|Present Value in 2001||2002||2003||2004||2005||2006|
2.60 Because interest costs accrue at 10 percent a year on a continuous basis, and are added to the principal amount, after six months of the first year the principal amount has increased. It equals the $100 principal amount due to be paid at maturity, plus half of the year’s interest payment, $5 (calculated on a straightline basis), or plus just under half, $4.88 (calculated on a compound basis). Any payments of interest, or principal, would reduce the amount outstanding.
2.61 Alternatively, the principal amount outstanding after six months could be calculated by discounting all future payments. The present value of each payment after six months is presented in parentheses in the left-hand column. After six months, each of the values in the left-hand column has increased because the payments are closer to being made, and time is being discounted at a rate of 10 percent a year. The discounted value of each payment after six months can be seen to sum to $104.88, the same amount outstanding as with the compound approach to accruing interest costs. One practical advantage of maintaining a system that discounts each payment to its present value is that if the instrument is stripped (see below)—that is, all payments traded separately—the compilation system will already be prepared for such a situation.
2.62 Unless there are early repayments that reduce the amount of principal outstanding—for instance, with certain types of asset-backed securities, partial repayments of principal could occur at any time—the amounts described above would be recorded in the gross external debt position; that is, after six months with a contractual interest rate of ten percent per annum, the amount outstanding would be $104.88 (or $105 on a straightline basis).
2.63 The rate relevant for discounting all the payments to a market value would be implicit in the market price, or to put it another way, the market value amount would equal future payments discounted at the current market rate of interest for that debt instrument. The market value of external debt should include any interest costs that have accrued and are not yet payable.
Example 2: Present Value and the Accrual of Interest Costs—Discounted Principal
2.64 The second example concerns the more complex case of instruments issued at a discount to the redemption value. These instruments will include securities, and any other instruments where the issue price is less than the redemption price.20 In this instance, both the coupon payments and the difference between the issue price and the redemption price determine the rate at which interest costs accrue. Table 2.2 presents the calculations involving an instrument similar to that in the first example above—that is, issued with the same 10 percent yield, but “only” having annual interest payments of $8. The difference between the 10 percent yield and the yield implied by coupon payments is reflected in the discount between the issue price and redemption price. Once again, from the left-hand column of the table it can be seen that discounting all the future payments by 10 percent, including the principal amount, provides the issue price of $92.40.
|Present Value in 2001||2002||2003||2004||2005||2006|
2.65 How is the accrual of interest costs calculated? Simply, interest costs accrue at a yield of 10 percent each year, of which $8 is paid out in interest payments and the rest is reinvested (or capitalized) into the original principal amount. The principal amount grows from year to year, due to the continued reinvestment of interest costs that have accrued, and as a consequence, so does the absolute amount of interest costs that accrue each year. As with the first example, the present value of each payment after six months is presented in parentheses in the left-hand column. In the position data, the amount outstanding can be seen to be $96.91 after six months.
Example 3: Present Value and the Accrual of Interest—Zero-Coupon Instrument
2.66 The third example covers zero-coupon instruments. If the instrument is issued at discount and has no coupon, then the principal amount increases in value over time by the implicit yield on the security at issuance, derived from the difference between the issue price and the redemption price. In the example below, the zero-coupon instrument is issued at $62.09 and is to be redeemed at $100; the difference implies a 10 percent yield. As can be seen in Table 2.3, the principal amount grows each year because of the continued reinvestment of interest costs that accrue, and so after the first year the amount outstanding has increased by 10 percent to $68.30, by a further 10 percent in year two to $75.13, and so on until redemption at $100 at the end of year five.21
|Present Value in 2001||2002||2003||2004||2005||2006|
|100/(1 + 0.1)||62.09 (1 + 0.1)||62.09 (1 + 0.1)2||62.09 (1 + 0.1)3||62.09 (1 + 0.1)4||62.09 (1 + 0.1)5|
|= 62.09||= 68.30||= 75.13||= 82.64||= 90.90||= 100|
Straightline or compound interest
2.67 In calculating the accrual of interest costs by a straightline approach, an equal amount of the interest costs to be paid is attributed to each period—for example, $5 for the first six months in the first example above. For bonds with interest payments (that is, annual or more frequent), on secondary markets the buyer of the bond pays to the seller the amount accrued since the last payment, according to a very simple arithmetic proportionality. For many international loans, debt-monitoring systems record the accrual of interest costs on a straightline basis.
2.68 However, the accrual of interest costs can also be calculated on a compound basis—that is, continuously adding the accrued interest costs not yet payable to the principal amount each period, and applying to that amount the interest yield on the debt in order to calculate the interest costs for the next period. This method is the theoretically preferred approach because it relates the cost to the provision of capital and allows reconciliation between amounts accrued and the discounted value of future payments. Such an approach is commonly used when information on individual instruments owned by nonresidents is unknown, and so to calculate the accrual of interest costs an average yield is applied to positions. Of course, in such instances the theoretical benefit of using a yield is offset by the approximation of applying an average yield to a range of instruments.
2.69 Differences in methods may well have a small effect on the gross external debt position. However, as is evident from the first example, for each instrument the straightline approach will overestimate the position in the short term. For fixed-rate instruments, this will be gradually “unwound” as the time of the interest payment approaches.
2.70 For loans (except interest-free loans) interest costs are recorded as accruing continuously, increasing the value of the loan outstanding, until paid. When loans have been rescheduled and a new (moratorium) interest rate agreed between the debtor and creditor, interest costs should accrue on the rescheduled debt at the new moratorium interest rate. It is recognized that interest costs that accrue on loans may have to follow national practices and be classified under other debt liabilities.
2.71 For deposits, interest may be credited to the account (reinvested) at certain times, such as the end of a given period. In the Guide, interest costs accrue continuously and become part of principal on a continuous basis. It is recognized that interest costs that accrue on deposits may have to follow national practices and be classified under other debt liabilities.
2.72 For some deposits, such as time or savings deposits, a given rate of interest may be paid only under the condition of a minimum holding period. An early liquidation, if contractually allowed, is balanced by a reduction in the rate of interest paid to the holder. For recording the accrual of interest costs, the rate of interest to use is the maximum rate that the depositor could receive in the normal course of the contract (that is, respecting the arrangements about maturity or notice). In the event, if the arrangements are not fully respected, the amount of interest costs that accrued previously are corrected in line with the rate the depositor actually received. As the revised amount is in all likelihood globally very small compared with the total interest costs for deposits, for practical reasons the correction could be included in the last period of compilation (as opposed to revising back data).
2.73 For securities for which the issue and redemption prices are the same, interest costs accrue in the same manner as for loans.
Instruments issued at a discount
2.74 Instruments for which the issue price is less than the redemption price are all treated in the same way. This includes nontraded instruments where the amount to be paid is greater than the economic value provided at inception of the debt. The method of accrual for instruments issued at a discount or premium was described in paragraph 2.28 above.
2.75 For short-term negotiable instruments,23 issuance at a discount is very frequent. Generally these instruments are akin to zero-coupon bonds (example 3 above), and so the treatment of such instruments is the same. Without information on individual securities, one practical approach is to base estimates of the accrual of interest costs on average maturities and average rates of interest at issuance.
2.76 External debt, particularly general government debt, could be issued in the form of fungible bonds (also named linear bonds). In this case, securities are issued under one similar “line” (in terms of coupon amounts and payment dates, and final redemption price and maturity date) in tranches, generally issued during a rather short period but sometimes over a longer one. Each tranche is issued at a specific issue price according to the prevailing market conditions. Fungible bonds may be seen as a good example of instruments with two interest components: the coupon (representing the interest payment), and the difference between the issue price and redemption price. Thus, in principle each tranche should be identified separately because the nominal interest rate might well differ from tranche to tranche given the different market conditions that existed when they were issued. Once issued, however, the tranches may mix and so may not trade separately on secondary markets, nor be identified separately in portfolios. If so, it is necessary to estimate a weighted-average interest rate resulting from issuing different tranches, updated at each new issue, and apply this to the amount owed to nonresidents.24
2.77 Stripped securities are securities that have been transformed from a principal amount with interest payments into a series of zero-coupon bonds, with a range of maturities matching the interest payment dates and the redemption date of the principal amount. The essence of stripping was described in the first example above: the coupon payment amounts are separately traded. In itself, the act of stripping does not affect the nominal value of the debt outstanding for the issuer of the securities that have been stripped.
2.78 There are two types of stripping. First, if the stripped securities are issued by a third party, who has acquired the original securities and is using them to “back” the issue of the stripped securities, then new funds have been raised by the third party, with the interest rate determined at the time of issuance.
2.79 On the other hand, if the owner of the original security has asked the settlement house or clearing house in which the security is registered to “issue” strips from the original security, the strips replace the original security and remain the direct obligation of the issuer of the original security. In the gross external debt position on a nominal value basis, it is unrealistic from a practical point of view to take into account the rate prevailing at the issuance of each strip. Rather, since stripping provides no additional funding to the issuer and there is no impact on the original cost of borrowing, fully determined at the issuance time (in the case of fixed-rate) or following rules that cannot be changed (in the case of variable-rate), it is assumed that stripping does not change the cost of borrowing. So, unlike other zero-coupon bonds, the interest rate used for calculating the accrual of interest costs for strips is not the rate prevailing at the time of stripping, but rather the original cost of borrowing—that is, on the underlying security.
2.80 In some countries, strips of interest payments may refer to coupons of several bonds, with different nominal amounts but paid at the same date. In this case, best efforts should be made to use the weighted-average nominal interest rate of the different underlying bonds to calculate the accrual of interest costs on the stripped securities.
2.81 Interest that accrues on arrears (both principal and interest arrears) is known as late interest. For arrears arising from a debt contract, interest costs should accrue at the same interest rate as on the original debt, unless the interest rate for arrears was stipulated in the original debt contract, in which case this stipulated interest rate should be used. The stipulated rate may include a penalty rate in addition to the interest rate on the original debt. For other arrears, in the absence of other information, interest costs accrue on these arrears at the market rate of interest for overnight borrowing. Also, any additional charges relating to past arrears, agreed by the debtor and creditor at the time the arrears are rescheduled, and to be paid by the debtor to the creditor, should be regarded as an interest cost of the debtor at the time the agreement is implemented. If an item is purchased on credit and the debtor fails to pay within the period stated at the time the purchase was made, any extra charges incurred should be regarded as an interest cost and accrue until the debt is extinguished.
2.82 For loans, deposits, and securities, the same principles as with fixed-rate instruments apply, except that in the absence of firm information, the accrual of interest costs should be estimated and added to the gross external debt position, using the most recent relevant observation(s) of the reference index. Revisions to back data should be undertaken when the amount of interest costs that have accrued is known with certainty.
2.83 In addition, if the interest rate can vary only under the condition of a minimum change in the index and/or within specific upward limits, any estimate of the accrual of interest costs should take account of any such conditions. If there is a link between the nature of the rate index and the frequency of interest payments—for example, interest is indexed on a quarterly basis and is normally paid every quarter with a delay of one quarter—then the exact amount paid to the owners of the securities may well be known in advance, and so can be accrued with certainty. This is known as interest being “predetermined.”
2.84 External debt might be indexed to indices other than interest rate indices. Examples include indexing to the price of a commodity, an exchange rate index, a stock exchange index, or the price of a specific security, and so on. Principal as well as interest payments may be indexed. The index can apply continuously over all or part of the life of the instrument. Any change in value related to indexation is recorded as an interest cost, and so affects the principal amount outstanding until paid. The impact of the indexation on the principal amount is recorded on a continuous basis for the period during which the indexing is operative.
2.85 The method of calculation is the same as that for variable-rate interest discussed above; that is, the accrued amount should be estimated using the most recent relevant observation(s) of the reference index and added to the gross external debt position. For instance, if in the first example above interest payments were indexed, and movement in the index after six months suggested that interest payments would increase to $12 a year, then the interest costs accrued to date would be $6 on a straightline basis (or $5.80 on a compound basis), and the amount outstanding $106 ($105.80). Revisions to back data are undertaken when the amount of interest costs that have accrued is known with certainty.
2.86 As mentioned above, a loan that is repayable in commodities or other goods in installments over a period of time (see paragraph 2.37) is conceptually equivalent to an indexed loan. At inception the principal amount outstanding is the value of principal advanced; as with other debt instruments, interest costs will accrue on this amount, increasing its value. At any moment in time, the interest rate that accrues is that which equates the market value of the commodities or other goods to be paid with the principal amount then outstanding; as the market price of the commodity or other good changes, so will the implicit interest rate.
2.87 Index-linked instruments may include a clause for a minimum guaranteed redemption value. Any estimate of the accrual of interest costs should take account of such conditions. For instance, if strict application of the index had the effect of reducing the amount outstanding to less than the minimum, it would not be relevant to record any reduction below the minimum guaranteed redemption value. Normally, the current market price of debt instruments takes into account such a clause.
Instruments with grace periods
2.88 Some debt instruments may have a grace period during which no interest payments are to be made. Provided that the debtor can repay, without penalty, the same amount of principal at the end of the grace period as at the beginning, no interest costs accrue during the grace period. This remains true even if the rate of interest applied in a second and/or subsequent time period is adjusted (for example, there is a step up), so that the final yield is roughly similar to normal conditions over the total life of the instrument.
Instruments with embedded derivatives
2.89 Some instruments may have embedded derivatives that could, if exercised, affect the rate of interest. For such instruments, interest costs should accrue, and be included in the gross external debt position, as “normal.” If the financial derivative is exercised and so affects the interest rate, this should be reflected in the rate at which interest accrues—for example, in a structured note with a maximum interest rate, when, and as long as, the maximum is reached and so the financial derivative is “exercised,” interest costs should accrue at the maximum rate and no more. The market price of debt instruments should reflect the likelihood of the financial derivative being exercised.
Foreign currency instruments
2.90 Interest costs should accrue (or not) in foreign currency on an instrument denominated in foreign currency, adding to the outstanding principal amount, until paid or in arrears. The principal amount in foreign currency should be converted into the unit of account at the midpoint between the buying and selling market (spot) rates on the reference date to which the position relates.
In many instances, such as cash purchases by households in shops, economic value is provided against immediate payment, in which instance no debt liability is created.
These liabilities could include those arising from taxes, penalties (including penalties arising from commercial contracts), and judicial awards at the time they are imposed. However, in some instances an issue will arise about whether a government has jurisdiction to impose such charges on nonresidents.
These include claims on nonlife insurance companies, claims for damages not involving nonlife insurance companies, and claims arising from lottery and gambling activity.
The exclusion of contingent liabilities does not mean that guaranteed debt is excluded, but rather that the guaranteed debt is attributed to the debtor not the guarantor (unless and until the guarantee is called).
See also BPM5, Chapter IV.
The classification of parent claims on unincorporated branches is discussed in more detail in Chapter 3, in the section on direct investment.
See also BPM5, Chapter VI.
Thus, the Guide does not recognize any unilateral repudiation of debt by the debtor.
In some instances arrears arise for operational reasons rather than from a reluctance or inability to pay. Nonetheless, in principle such arrears, when outstanding at the reference date, should be recorded as arrears.
See also BPM5, Chapter V.
In the HIPC Initiative (see Appendix V), a representative market rate is used to discount future payments. This provides another measure of opportunity cost and is specific to countries in that program.
A single rate is usually used to discount payments due in all future periods. In some circumstances, using different rates for the various future payments may be warranted. Even if a single rate of discount is used, dependent on the time until due, a different discount factor applies to each payment. For example, at a rate of discount of 10 percent, the discount factor for payments one year hence is 0.909 (or 1/(1 + 0.1)) and for payments two years hence is 0.826 (or 1/(1 + 0.1)2) and so on. See also the example in Table 2.1.
For a debt liability on which the interest rate steps up or down by contractually predetermined amounts over its life, the time profile of the discount factors to be applied to future payments would be nonlinear, reflecting these step changes.
International statistical manuals consider that for nontraded instruments, nominal value is an appropriate proxy for market value. Nonetheless, the development of markets, such as for credit derivatives linked to the credit risk of individual entities, is increasing the likelihood that market prices can be estimated even for nontraded instruments. As these markets extend, consideration might be given to compiling additional information on market values of nontraded debt.
What constitutes an unusually long time in this context will depend on the circumstances. For instance, for any given time period, the higher the level of interest rates, the greater is the opportunity cost of delayed payment.
In a defined-benefit scheme, the level of pension benefits promised by the employer to participating employees is guaranteed and usually determined by a formula based on participants’ length of service and salary. In a defined-contribution scheme, the level of contributions to the fund by the employer is guaranteed, but the benefits that will be paid depend on the assets of the fund.
A multiple exchange rate system is a scheme for which there are schedules of exchange rates, set by the authorities, used to apply separate exchange rates to various categories of transactions or transactors.
If an economy was disseminating a debt-service ratio with future interest and principal payments calculated using the current yield on debt, then if the market value of external debt rises, part of the future interest payments could become principal payments.
For instruments issued at a discount, issue price is a generic term that means the value of principal at inception of the debt; redemption price is similarly a generic term that means the amount of principal to be paid at maturity. This is because some instruments are “issued” without a price as such (for instance, trade credit). In such instances, the issue price equals the economic value provided (that is, of goods or services provided) and the redemption price equals the amount owed when the debt liability is due to be paid.
A worked example of accruing interest on a zero-coupon bond in the balance of payments is given in the IMF’s Balance of Payments Textbook (1996), paragraphs 400 and 401, p. 83.
This text has drawn upon that in Eurostat (2000), the ESA95 Manual on Government Deficit and Debt.
A negotiable financial instrument is one whose legal ownership is capable of being transferred from one unit to another unit by delivery or endorsement.
A creditor might focus on the prevailing market interest rate, or the rate prevailing when they purchased the security, and hence might record the claim at a value different from that recorded by the debtor.