669. This chapter covers compilation of the financial account and the IIP and reconciliation of these two accounts. The financial account and the IIP provide information on transactions in, and stock positions of, a country’s external financial assets and liabilities (financial instruments).143 Reconciliation of the IIP and the financial account is shown, in summary form, in illustration 1.1 (chapter 1) and in detail in table 10.4 (chapter 10). These reconciliations show that differences between stock positions at the beginnings and ends of periods are due both to financial account transactions and to other changes (such as changes in values resulting from exchange rate changes, price movements, and other adjustments). Because of their close relationship, the IIP and the financial account are dealt with together in the Guide. The two accounts share many sources and methods of compilation.


669. This chapter covers compilation of the financial account and the IIP and reconciliation of these two accounts. The financial account and the IIP provide information on transactions in, and stock positions of, a country’s external financial assets and liabilities (financial instruments).143 Reconciliation of the IIP and the financial account is shown, in summary form, in illustration 1.1 (chapter 1) and in detail in table 10.4 (chapter 10). These reconciliations show that differences between stock positions at the beginnings and ends of periods are due both to financial account transactions and to other changes (such as changes in values resulting from exchange rate changes, price movements, and other adjustments). Because of their close relationship, the IIP and the financial account are dealt with together in the Guide. The two accounts share many sources and methods of compilation.

670. As a reflection of this close relationship, classifications of financial account transactions and the IIP are almost identical in the BPM. These classifications are similar, as well, to the classification of investment income, which is also closely related to the financial account and the IIP.

671. The main classification in the BOP financial account (and an important classification in the IIP) is functional types of investment, namely, direct investment, portfolio investment, other investment, and reserve assets. Direct investment refers to a lasting interest of an entity resident in one economy (the direct investor) in an entity resident in another economy (the direct investment enterprise). That lasting interest usually gives the direct investor an effective voice, or the potential for an effective voice, in the management of a direct investment enterprise. In the BPM, evidence of this lasting interest is defined as ownership of 10 percent or more in the equity of a direct investment enterprise. The most common examples of direct investment enterprises are branches and subsidiaries of multinational enterprises. The concept and definition of direct investment are explained subsequently in this chapter.

672. Portfolio investment covers financial instruments (other than those included in direct investment and reserves) in the form of equity and debt securities. Debt instruments include bonds and notes, money market instruments, and financial derivatives. An important feature of portfolio investment is that the securities are usually issued and traded on organized financial markets.

673. Reserve assets are those available to monetary authorities for financing BOP imbalances and for managing exchange rates. Other investment covers all financial instruments other than those classified as direct investment, portfolio investment, or reserve assets. Other investment includes long- and short-term loans, currency and deposits, trade credits, and other accounts receivable and payable, including arrears.

674. Another distinction made in the financial account (and one of primary importance in the IIP) is that between external assets and liabilities. However, direct investment is classified by direction—that is, direct investment abroad and direct investment in the host country. These directions may be regarded as proxies for assets and liabilities, respectively. The corresponding classifications for investment income are investment income credits and debits; income credits represent income earned on external assets, and income debits represent income payable on external liabilities.

675. The instrument classification required by the BPM in respect of the IIP and the financial account consists of equity instruments (which include equity securities, equity in unincorporated enterprises, and reinvested earnings) and debt instruments (which include bonds and notes, short-term money market instruments, financial derivatives, trade credits, use of Fund credit and loans, other loans, currency and deposits, and other accounts such as arrears). Two other instruments—monetary gold and SDRs—are identified as part of reserve assets.

676. The classification of instruments facilitates reconciliation of BOP and IIP statistics with national accounts and with statistics on external debt.

677. The sector of the domestic (resident) creditor, for assets, and that of the domestic debtor, for liabilities, is often a factor that influences financial transactions. Accordingly, for portfolio investment and other investment, the BPM distinguishes four sectors in the list of standard components: general government, monetary authorities, banks, and other. For direct investment, however, the domestic sector is a less significant factor. For this reason, the list of standard components in the BPM does not classify direct investment by sector. Also, as it can be presumed that the monetary authorities are either directly or indirectly responsible for transactions in reserve assets, no sectoral classification is required for this item.

678. Classification of BOP transactions by sector also plays a significant role in linking balance of payments statistics with other statistical systems, such as the system of national accounts, money and banking statistics, and government finance statistics.

679. The BPM recommends that certain debt instruments be further classified by long- and short-term maturity. Long-term refers to instruments with original maturities of more than 12 months; short-term refers to those with maturities of 12 or fewer months.144

680. The BPM recommends, as a supplementary classification for a number of instruments, that data on gross flows be collected and made available to users. For example, for long-term loan transactions, separate data should be compiled on drawings and repayments as well as on net transactions (drawings minus repayments). Other supplementary classifications of financial activity include liabilities comprising foreign authorities’ reserves (LCFAR) and exceptional financing. These classifications are discussed in detail later in this chapter.

681. Other classifications that may be applied to the financial account and the IIP include partner country (as discussed in chapter 17), currency denomination of instrument, and sector of nonresident party.

Direct Investment

Concept of Direct Investment

682. Direct investment is a category of international investment in which a resident entity in one economy (the direct investor) acquires a lasting interest in an enterprise resident in another economy (the direct investment enterprise). Direct investment implies a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence (or the potential for such influence) by the investor on the management of the direct investment enterprise.

683. The same concept of direct investment is used in the OECD’s Detailed Benchmark Definition of Foreign Direct Investment (BMD). The purpose of the BMD is to provide a detailed operational definition of direct investment; in doing so, the BMD provides an extension of the information in the BPM.

Motivation for Direct Investment

684. The benefits that direct investors expect to derive from having a voice in management are different from those derived by portfolio investors who cannot exercise significant influence over the enterprises in which they invest. From the viewpoint of direct investors, direct investment enterprises often represent units in multinational operations. The overall profitability of these depends on advantages gained by deploying resources available to each unit in the group in ways that best enhance group synergy. For example, direct investors may be able to obtain access to resources or markets that would otherwise be unavailable to them. Direct investors may also be able to increase enterprise profitability and value through management skills and other expertise. Therefore, direct investors are in a position to derive benefits in addition to the income that would, without their participation, accrue on invested capital. In contrast, portfolio investors are primarily concerned about return on capital and the likelihood of appreciation. Portfolio investors generally evaluate separately the prospects of each independent unit in which they might invest and often shift their capital with changes in these prospects.

Defining the Direct Investment Relationship

685. The direct investor may be an individual; an incorporated or unincorporated private or public enterprise; an associated group of individuals or enterprises; a government or government agency; or another organization, such as the International Finance Corporation (IFC) or European Bank for Reconstruction and Development (EBRD), that owns a direct investment enterprise in an economy other than the one in which the direct investor resides. A direct investment enterprise is an incorporated or unincorporated enterprise in which a direct investor owns 10 percent or more of the ordinary shares or voting power (for an incorporated enterprise) or the equivalent (for an unincorporated enterprise). Direct investment enterprises comprise branches (unincorporated enterprises), subsidiaries (incorporated enterprises that are more than 50 percent owned by the direct investor), and associates (incorporated enterprises that are between 10 and 50 percent owned by the direct investor). The direct investment relationship extends to the direct investment enterprise’s subsidiaries, sub-subsidiaries, and associates (unless the direct investment enterprise itself is an associate).

686. In the BOP and the national accounts, enterprises that have significant long-term operations in more than one economy are divided into separate entities in each economy. These entities are always in a direct investment relationship; the head office constitutes the direct investor, and the branches constitute the direct investment enterprises.

687. The illustration shows the investments of enterprise N.

Under the definition of direct investment:

A is a subsidiary of N.

B is a subsidiary of A and, therefore, a subsidiary of N, even though only 33 percent of B’s capital is indirectly attributable to N.

C is an associate of B and, therefore, an associate of N through its subsidiary B, even though only 4 percent of C’s capital is indirectly owned by N.

D is an associate of N.

E is a subsidiary of D and, therefore, an associate of N, even though only 6 percent of E’s capital is indirectly owned by N.

F is an associate of N.

G is an associate of F but not of N; F is only an associate of N.

H is neither a subsidiary nor an associate of N.

J is a subsidiary of H but neither a subsidiary nor an associate of N.

K is a subsidiary of N.

L is a branch of K and thus a branch of N.

688. Therefore, enterprises A, B, C, D, E, F, K, and L are considered to be in a direct investment relationship with N.

689. It is also important to note that these enterprises are considered to be in direct investment relationships with each other. Therefore, for example, transactions between company E and company K represent direct investment transactions.

690. Model form 12 in appendix 2 provides instructions for identification of direct investment relationships. The definition on the model form is less detailed than the definition stated previously. A less than complete definition will suffice for most collections. However, the definition outlined in this chapter should be regarded as the most detailed exposition and the one that should be used to decide borderline cases.

691. An investor need not control or be the largest shareholder in an enterprise for a direct investment relationship to exist between the enterprise and the investor. The concept of direct investment is fundamentally different from the concept of foreign-controlled resident enterprises. While all foreign-controlled enterprises will be direct investment enterprises, those that are not considered foreign-controlled enterprises may also be in direct investment relationships with nonresident direct investors.

692. While somewhat arbitrary, the rule of 10 percent has been chosen to ensure consistent classification of investor/investee relationships across all countries’ statistics. In the interests of practicality and comparability, an objective rule is considered preferable to subjective judgment. Furthermore, as most direct investment enterprises are either branches or subsidiaries that are wholly or majority owned by nonresidents, borderline cases are likely to be relatively insignificant.

Direct Investment Capital

693. Direct investment capital is capital provided by a direct investor—either directly or through other enterprises related to that investor—to a direct investment enterprise or capital received by a direct investor from a direct investment enterprise. Direct investment capital includes equity capital, reinvested earnings,145 and other capital that involves various intercompany debt transactions. Capital provided to a direct investment enterprise by economic units other than a direct investor and other enterprises related to a direct investor is not direct investment capital. Furthermore, in the case of investment between affiliated banks, only investment associated with equity and permanent debt—that is, subordinate loan capital—is considered direct investment.

694. The BPM requires that data be compiled on three forms of direct investment: equity, reinvested earnings, and other (debt). To meet data requirements for national accounts, the compiler should collect separate details for nonequity securities and other debt if nonequity security transactions between enterprises in direct investment relationships are important.

Direction of Investment

695. Unlike other financial investment, direct investment is not recorded in the BOP on a straight asset/liability basis. Instead, direct investment is recorded on a directional basis—resident direct investment abroad and nonresident direct investment in the reporting economy. Capital invested by a direct investment enterprise in its direct investor (reverse investment) is regarded as an offset to capital invested by a direct investor and by related enterprises in the direct investment enterprise. In other words, such capital is considered a “disinvestment” by the direct investor rather than an asset of the direct investment enterprise. However, for purposes of analysis, these investments are shown separately in BOP standard components. When a direct investment enterprise invests in an enterprise related to its direct investor, this investment is recorded as resident direct investment abroad for the economy of the direct investment enterprise. In some countries, such investment may be identified separately in national presentations. In some instances, two enterprises (or groups of related enterprises) hold 10 percent or more of each other’s voting shares. In these cases, two direct investment relationships are established, and investments between the two enterprises (or groups of enterprises) are recorded on a full asset/liability basis—that is, as direct investment in the reporting economy and direct investment abroad.

Data Sources

696. Table 16.1 provides a summary of the advantages and disadvantages of three primary data sources—an ITRS, ES, and information from government approvals of foreign investment—usually used to compile direct investment statistics.146 Other sources, such as information provided by stock exchanges or published in newspapers and journals and partner country statistics, could be used. However, sources of this nature will typically supplement the three primary sources rather than provide comprehensive information.

Table 16.1

Sources of Information on Direct Investment (DI)

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697. Generally, most countries that have significant direct investment transactions and well-developed BOP compilation systems use surveys of enterprises to obtain information on some or all elements of direct investment activity.

698. A clear understanding of the practical implications of the definition of direct investment and how to relate company accounting practices to the BOP treatment should facilitate the collection of information on direct investment. Often, the compiler will have to explain BOP concepts and treatments of certain transactions to staff of individual enterprises. In important cases, the compiler may have to prepare a set of enterprise accounts from partial data supplied by the company before BOP transactions can be determined.

Valuation of Direct Investment Stocks and Transactions

699. The BPM recommends that market values be used to value direct investment financial flows, income transactions, and stock positions. This recommendation is consistent with valuation principles recommended for recording other entries in the balance of payments and the international investment position. The recommendation on valuation of direct investment is made for two primary reasons. First, if inconsistent valuation bases were used, it would be very difficult to make comparisons between direct investment and other financial investment as shown in the BOP and the IIP. Second, market valuation provides the most meaningful measure of the economic value of resources available to, or transferred between, economies. However, because of the nature of the direct investment relationship, criteria for establishing market values will not always be satisfied. It may be particularly difficult to establish market values for equity positions and for goods transactions taking place between enterprises in a direct investment relationship (transfer pricing). In these instances, the BPM recommends that market value proxies be used. (The issue of transfer pricing is discussed in chapter 11, paragraphs 487-491)

700. If the shares of a direct investment enterprise are traded in an organized market, then the traded share price should be used to determine the value of a direct investor’s equity in an enterprise. The net worth, which should be calculated by using current market prices, of direct investment enterprises (typically subsidiaries or branches) with nontrading shares should be used to determine value. If net worth calculated on this basis is not available, a directors’ valuation of the enterprise may be an acceptable proxy. As a last resort, net worth could be calculated on a historical cost basis.

701. The net worth of an enterprise is derived from the balance sheet, which should show assets, liabilities, and residual net worth (assets minus liabilities). The net worth of an enterprise consists of the issued capital stock of the enterprise, reinvested earnings, and other reserves—all of which are owned by the shareholders or, in the case of a branch, by the parent enterprise. If the assets and liabilities of an enterprise are valued at current market values, net worth should be a good proxy for the market price of the enterprise.147

702. Another term for net worth is shareholder funds. Within a specified period, the value of shareholder funds may change as a result of: (a) issues less redemptions of shares, (b) reinvested earnings, (c) extraordinary items arising essentially from capital gains and losses on various transactions, and (d) revaluations of assets and liabilities The change. within a specified period, in the value of a direct investor’s equity is determined by all of these factors and by the ratio of the direct investor’s shares to total shares. Also, the value of a direct investor’s equity is affected by net share purchases (purchases less sales) made by the investor during the period.

703. In ascertaining the value of a direct investor’s equity, the compiler may find that companies report details of nonresident ownership by using book values based on historical cost, current value, or anything in between. To obtain a market value, compilers in some countries (in particular, Australia) encourage companies to report market values and instruct enterprises to use (a) current share prices (if enterprise shares are traded) or a recent relevant transactions value (if one exists) or (b) net worth/net assets (valuation of assets and liabilities at current values with adjustments for intangibles). These countries consider the approach to be successful. The United States publishes direct investment equity valuations based on both market and net asset values; the market values are determined by using ratios of market values to historical cost estimates of net asset values.148

704. Model form 12 provides for the collection of information on the market value of direct investment equity. The form describes the collection of equity valued at share market values or net asset values based upon current accounting principles. (This instruction could be modified to reflect the compiler’s preference.) Part F of model form 12 provides for reporting of corresponding book values. Compilers who publish market value or current net asset value estimates should consider providing corresponding book value statistics as memorandum items.

Nonoperating Direct Investment Enterprises

705. While compilers should identify and collect information from all legal entities that fall within the definition of direct investment enterprises, adequate data may be unavailable. Of particular concern are brass plate companies, such as those established to register ownership of shipping vessels or to raise capital through the issuance of securities.

706. To take advantage of various legislation, certain companies may register in a country but, for all practical purposes, have no operational presence in that country. (Some security markets—for example, those in the United States—permit securities to be issued only by locally registered companies.) That is, the companies do not carry out production, have no employees, and do not pay income tax. Many companies established for the purpose of issuing securities may have no other presence in a host country. Brass plate companies may pay a fee to register in a host country and may share an office or directors with similar enterprises. However, books or accounts may be maintained elsewhere and, thus, be unavailable to the host country compiler.

707. Despite the difficulties caused by these arrangements, compilers should make every effort to compile complete sets of accounts for these enterprises. Countries that permit registration of these enterprises may also exempt them from supplying information that compilers require. However, some suitable data may be available from tax or other authorities. Alternatively, compilers may approach partner country compilers for information. In the country of the direct investor, the collection of data should be somewhat easier, and it is desirable that information on certain categories of enterprises be compiled separately so that relevant data can be provided (subject, of course, to any confidentiality constraints) to partner countries to assist them in compiling complete accounts.

708. According to the BPM, compilers should record the complete BOP entries of these enterprises. However, some compilers may prefer not to record transactions considered to be of no relevance to the domestic economy. Nevertheless, compilers should, for purposes of reporting to the IMF, prepare the gross entries as supplementary data.

709. The following example illustrates alternative methods of recording. A brass plate company is established in one country for the purpose of owning a shipping vessel operated by a nonresident parent enterprise located elsewhere.149 In the relevant period, the cost of registering the vessel is 25, and incidental expenses in the country are 5. The operator pays 110 to lease the vessel, and this amount is immediately remitted by the enterprise to the nonresident owner. If this brass plate enterprise is essentially ignored, BOP entries for the country of registration would be:

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710. However, the treatment required by the BPM requires the gathering of additional information. The value of the vessel at the time of acquisition by the brass plate company is 1,000, and the vessel depreciates by 75 during the period. According to recommendations of the BPM, BOP accounts for the country of registration should be:

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711. In this case, the direct investment inflow is 1,030, which is equal to the value of the vessel plus the cost of registration and incidental expenses. The operating profit of the enterprise is the difference between revenue of 110 and expenses (registration, incidental, and depreciation) of 105. All of this profit is remitted to the direct investor. A further 105 is remitted and, as the enterprise has no retained profits from previous periods, this remittance therefore represents a withdrawal of investment by the direct investor.

Construction Enterprises

712. According to the discussion in paragraphs 452-455 of chapter 10, when an enterprise undertakes construction activity in an economy other than the one in which the enterprise is resident, it may be necessary to classify the activity as construction undertaken by an enterprise residing in the host economy. This enterprise is regarded as a branch (direct investment enterprise) of a nonresident entity (the direct investor). (Chapter 10 discusses issues that may have to be addressed to determine the residency of construction enterprises.)

713. An example should help clarify the recording in the BOP of construction activity associated with direct investment enterprises. An enterprise in country B establishes a branch in country A to undertake, during a two-year period, a construction project with a total value of 100,000. The parent enterprise sends a machine valued at 20,000 to country A at the commencement of the project; the machine is returned to country B at the end of the project. At the beginning of the project, the parent enterprise places 30,000 into a bank account, from which all payments are made, in country A. At the end of the first year, the construction enterprise values work-in-progress at 50,000 and receives a progress payment of 25,000, which is paid into the bank account in country A. The remaining 75,000 is paid at the end of the second year. At this time, any outstanding accounts are settled, and the remaining amount is remitted to country B. The construction enterprise incurs the following costs:

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714. The following transactions should be recorded in the BOP of country A:

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715. At the beginning of the first year, the parent enterprise provided a machine (an import of country A) and cash. Both of these represent an investment in the branch by the parent. In the first year, production is 50,000 (as valued by the enterprise), and operating expenses plus taxes are 32,000. Therefore, net profit after tax is 18,000. No money is remitted, so the profit is reinvested in the enterprise. Also in the first year, country A’s foreign exchange assets initially rise as a result of cash investment by the parent enterprise and subsequently fall somewhat as a result of payment for materials from country B. The net outcome is an increase of 19,000.

716. In the second year, net profit after tax is again 18,000. A total of 36,000 is remitted to cover profits for both years. Negative reinvested earnings are recorded in the second year because reinvested earnings are calculated after remittances of profits. After all payments are settled, the final cash position of the enterprise is 70,000.150 Of this amount, 36,000 is accounted for as a remittance of income. The remaining 34,000 is added to the written-down value of the returned machinery (16,000) in order to calculate the parent’s withdrawal of investment from the branch. The external assets of country A’s banks fall by 11,000 as a result of payments for imports from country B and by an additional 70,000 as a result of the remittance of cash to country B.

717. The recording of transactions in this way is reasonably complex, and table 10.15 (in chapter 10) is provided to help compilers understand the recording in the BOP of construction activity. To collect some or all of the required data, it is likely that compilers will have to approach enterprises involved in construction activity.

Transactions in Land

718. According to the BPM and the SNA, land cannot be owned by nonresidents. However, in practice, land is legally owned by persons and enterprises that are not residents of the countries in which the land is located. In the balance of payments, these situations are treated as if the land is owned by a resident enterprise that is, in turn, a direct investment enterprise of the nonresident legal owner.

719. For this reason, the recording in the BOP of transactions involving land (including any buildings, etc. that may be on the land) may initially appear to be difficult However. as table 16.2 (on page 158) shows, all transactions involving land can be recorded in the BOP in a straightforward manner. Table 16.2 is presented from the point of view of the BOP compiler in the country in which the land is located.

Table 16.2

BOP Recording of Transactions Associated with Land

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720. The compiler should ensure that questions asked to obtain information on land and related transactions are meaningful to data providers. Data providers will certainly be unaware of the BOP treatment of land, and questions using terms such as direct investment may not be understood.

721. Countries using ES to measure direct investment may encounter unique problems with measurement of transactions in land—particularly transactions involving nonresidents who invest in the compiling country’s land. These transactions tend to be relatively small on a case-by-case basis, but they are numerous enough to be significant in total and costly to measure. Also, it is difficult for the compiler to approach the principal entities involved in these transactions as they are nonresidents. To overcome these problems, some countries have adopted a method whereby resident intermediaries, such as law firms, are approached for information (to be recorded in the BOP) on nonresident purchases and sales of land.151 For large purchases, the nonresident’s local representative is approached for details on income and stocks of investment. For smaller investments, data models are used to estimate income and stocks. Stock data are typically estimated by using a perpetual inventory approach based on formulae such as:

ESV = (SSV * (PIE/PIS)) + (NT * (((PIE + PIS)/2)/PIS))

in which

ESV = stock value at the end of the period;

SSV = stock value at the start of the period;

PIE = value of a relevant price index at the end of the period;

PIS = value of a relevant price index at the start of the period;

NT = net transactions (purchases less sales) during the period.

722. The use of this approach requires the establishment of a benchmark stock position for deriving future estimates. This benchmark could be obtained from a comprehensive, occasional survey, or the compiler could determine a point in time when such investment was nil or insignificant. Price indexes required for use in the model may be produced by the compiling country’s statistical agency, or such indexes may be available from organizations involved in the real estate industry. Rent and expenses can be derived by applying appropriate ratios to the stock positions. These ratios are regularly produced by firms involved in real estate research.

Portfolio Investment

Description and Classification

723. Portfolio investment covers external claims in equity and debt securities, other than those included in direct investment and reserve assets. Debt instruments include long-term bonds and notes, short-term money market instruments, and financial derivatives such as options, warrants, traded financial futures, and currency (but not interest rate) swaps.152

724. The BPM classifies portfolio investment by:

(1) assets and liabilities; (2) type of instrument—namely, equity, bonds and notes (long-term debt securities), money market instruments, and financial derivatives; and (3) resident sector—namely, monetary authorities, general government, banks, and other sectors. The compiler could classify the various instruments of investment in greater detail by sector if this information is necessary to satisfy national accounts or other statistical requirements.

725. For countries that have well-developed capital markets, it may be analytically useful to distinguish between debt securities issued in the domestic market and those issued abroad. Also, classification by currency of debt may be useful for analytical purposes and for estimating related items, such as investment income, in the absence of data.153

Data Sources

726. Data on the stock positions, financial flows, and non-flow changes could come from an ITRS, from ES, or from official sources. For countries with well-developed capital markets, special surveys of international activity associated with securities (see chapter 6) may be required. Stock positions should, in principle, be valued at market values.154 Data on stock positions, financial flows, and non-transaction changes should be reconciled to ensure consistent reporting. For non-transaction changes, market price, exchange rate, and other changes in the values of stocks should be recorded as separate series. Table 16.3 summarizes data sources that could be used to compile portfolio investment items.

Table 16.3

Compilation of the Financial Account and the IIP: Portfolio Investment Items

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727. Care should be taken to ensure that transactions in securities are measured separately from any financial fees that may relate to the transactions.155 Alternatively, when data sources provide information on transactions that include financial fees, the fees should be estimated and the transactions data adjusted to the correct basis.

Data on Securities Issued in Foreign Financial Markets by Residents

728. Data on positions, flows, and non-transaction changes in positions can be collected from issuers of the securities by using an ITRS, ES, or official sources, such as the debt office. However, as described in chapter 6, paragraph 280, some adjustments may be necessary to deduct resident holdings of these securities—particularly when bearer securities are involved. This information could be obtained from resident holders of these securities or from security brokers.

Data on Securities Issued in Domestic Financial Market by Residents and Held by Nonresidents

729. Data on stock positions often must come from a survey of intermediaries (such as banks) responsible for maintaining shareholder and other security registers.156 Staff of these institutions should know, to varying degrees, who holds the securities. In addition, the survey should cover resident nominees (custodians) holding securities on behalf of nonresidents. Alternatively, as described in paragraphs 740-743, data on positions could be derived from a periodic benchmark survey that could be updated by using flow data and making allowance for changes in security prices. Data on financial flows would probably have to be obtained from security registers (including nominees) or from security brokers, and adjustments would be necessary for off-market transactions. For analytical reasons, it may be desirable for data on financial flows to distinguish among issues, redemptions, and secondary market transactions.

730. Clear reporting rules are necessary to prevent errors. The compiler may consider collecting data on individual securities. In practice, it may be difficult to give intermediaries appropriate guidelines to report aggregate data, and collating data (from different sources) on investments in individual enterprises is a good way to overcome reporting errors. For additional information on surveys of intermediaries, see chapter 6.

Data on Securities Issued by Nonresidents

731. Data on stocks and transactions could come either from an ITRS or from ES of resident holders. Alternatively, for securities issued by nonresidents in domestic capital markets, surveys of security registers (for stocks) and security brokers (for transactions) could be used. (See chapter 6, paragraph 279) For securities issued by nonresidents in foreign capital markets and acquired by residents, a useful alternative source (particularly for securities held by the household sector) for some data may be surveys of resident portfolio managers who manage securities on behalf of resident principals. Paragraph 281 of chapter 6 provides further details on this approach.

Deriving Transactions from Stocks Data

732. The reconciliation statement shows that, for an external financial asset or liability, the difference between the stock position at the beginning and end of a period is due to financial transactions that are included in the BOP and to other changes that are excluded from the BOP. Consequently, to derive transactions from stocks, it is necessary to separate these two elements. In principle, this separation is accomplished by: (1) eliminating, from stock positions in currencies of denomination, the effects of price changes and other adjustments (such as write-offs) in order to determine the transactions in those currencies; and (2) using period average exchange rates to convert the transaction estimates into the unit of account.157

733. For equity securities, the best way to eliminate the impact of price changes on changes in stocks is to work with underlying units. (An underlying unit is determined by dividing the value of a financial instrument by its price.) If there are no other adjustments, a change in the number of underlying units should be attributable to transactions. This change could then be multiplied by the period average price of the instrument to derive a value for transactions (in the currency in which the instrument is denominated).

734. For example, at the start of a period, a resident of country A owns $100 of equity in company Z, which is a nonresident enterprise. At the end of the period, the value of the investment by a resident of country A in company Z rises to $156. At the start of the period, company Z’s shares were trading at $10 and, at the end of the period, they had risen to $12. As the resident of country A had 10 underlying units (shares) in company Z at the start of the period ($100/$10) and 13 underlying units at the end of the period ($156/$12), it can be assumed that the resident of country A purchased 3 shares during the period. The amount actually paid for the shares is unknown, but it could be estimated at $11, which was the period average share price. Multiplying the 3 shares by $11 gives a transactions estimate of $33. Therefore, of the $56 increase in the value of the investment by a resident of country A in company Z during the period, $33 was attributable to transactions and $23 ($56 less $33) to price changes.

735. The formula for deriving transactions is:

TV = ((ESV/EP) - (SSV/SP)) * ((SP + EP)/2)

in which

TV = the transactions value;

SSV = the value of the stock at the start of the period;

ESV = the value of the stock at the end of the period;

SP = the price of the stock at the start of the period; and

EP = the price of the stock at the end of the period.

736. This formula is based on the assumption that there are no bonus issues through which the number of shares owned by an investor could increase without transactions. Consequently, the impact of bonus issues should be taken into account when compilers calculate numbers of shares acquired (or disposed of) through transactions. One method is to divide, for purposes of the BOP calculation, the share price at the start of the period by the bonus factor plus one.158 Therefore, the previous equation would be modified to:

TV = ((ESV/(EP) - (SSV/SP/(BF + 1))) *(((SP/(BF+1)) + EP)/2)

in which

BF = the bonus factor.

737. Often, however, working on a security-by-security basis and using the actual prices of securities is not possible. An alternative is to work with groups of securities and to use an appropriate price index to determine underlying units. (In such cases, underlying units will have no real world equivalents.) Most stock exchanges publish prices indexes for shares traded. For example, nonresidents may hold shares issued by resident enterprises on domestic stock exchanges. At the start of the period, the value of nonresident equity holdings is $2,400 and the stock exchange index is 120. At the end of the period, the value of nonresident equity holdings is $2,200 and the stock exchange index has fallen to 100. In this example, the nonresident underlying units move from 20 (2400/120) to 22 (2200/100), an increase of 2. Multiplying 2 by the average index of 110 produces a transaction estimate of $220. In this example, therefore, the impact of falling share prices on the value of nonresident investments is a decrease of $420. The value of the investment does not fall by this amount during the period because the decrease in prices is offset by the net purchase of additional shares by nonresidents.

738. One advantage of using indexes is that the compiler need not be concerned about bonus issues, the impact of which is typically factored into calculation of the index. The compiler should not, however, use accumulation indexes, which are a mixture of price changes and income yields. The compiler should also ensure that the index used in calculations of transactions from stocks is the most appropriate one available. For example, for measuring equity investment in the United States, the Dow Jones index would probably be suitable, whereas the Nikkei index from Japan would almost certainly be unsuitable.

739. For debt securities, techniques similar to those previously described could be used. The compiler will generally have to use indexes, and suitable indexes should be available in most major security centers. However, for financial derivatives, it is almost impossible to derive transactions from stocks, so the compiler should seek ways of directly measuring transactions in these instruments.

Deriving Stocks from Transaction Data

740. The process of deriving stocks from transaction data is known as the perpetual inventory method. Via this method, for which a stock estimate for some base point in time is required, the compiler may calculate the value of a stock at the end of a period as being equal to the value of the stock at the beginning of the period plus the impact of transactions and non-transaction changes in the value of the stock during the period. The required base estimate may be obtained from an occasional collection of stock data, or a point in time when the stock position of the instrument being measured was known or assumed to be nil or negligible can be used as the base.

741. As with the derivation of transactions from stocks, calculation of stocks from transactions should initially be made in currencies in which instruments are denominated. The stock estimates should then be converted, by using prevailing exchange rates, to the unit of account.

742. Perpetual inventory models for portfolio securities typically involve use of appropriate financial market indices to determine the impact of non- transaction changes in levels. These models are based on formulae similar to:

ESV = ((SSV/SI) + (TV/((SI + EI)/2))) * EI

in which

ESV = the value of the stock at the end of the period;

SSV = the value of the stock at the start of the period;

TV = the transactions value during the period;

SI = the value of an appropriate index at the start of the period; and

EI = the value of an appropriate index at the end of the period.

743. More detailed perpetual inventory models produce better quality results. For example, if such a model were used to estimate a country’s stock of portfolio investment made abroad in the form of equities, the best results would be achieved if the model were constructed on a market-by-market basis.159 The compiler should then chose the index appropriate to each market. (See the discussion of indexes in paragraph 738 of this chapter.)

Treatment of Financial Derivatives

744. Options are financial instruments that provide one party (the holder) with the right, but not the obligation, to buy (call option) or sell (put option) a specified financial or real asset for a predetermined price (the strike price) from another party (the option writer).160 If the option holder exercises his or her right, then he or she is said to exercise the option. Exercise can take one of two forms: (1) actual delivery of the underlying asset for the strike price or (2) cash settlement based on the difference between the prevailing market price of the underlying asset and the strike price.

745. If the option holder and writer are residents of different countries, creation and exercise of option contracts constitute transactions that should be recorded in the BOP of the relevant countries. Also, trading of options between residents of different countries will result in BOP transactions for the countries concerned.

746. An example should help explain the BOP treatment of options. A resident of country A writes a tradable three-month call option on 10 shares in an enterprise located in country X; the strike price is $15 per share. The option is purchased from the writer by a resident of country B for 820. The following transactions would be recorded in the BOP of country A:

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747. After three months, the price of shares in the enterprise in country X rises to $18 per share, and the option holder in country B decides to exercise the option. The resident of country B acquires ownership of 10 shares, with a market value of $180, in the enterprise located in country X. However, only $150 (10 x $15) is actually paid. The remaining $30 represents extinguishment of the option contract at the time it is exercised. The following transactions would be recorded in the BOP of country A:161

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748. In this example, the underlying asset is delivered when the option is exercised. However, the option holder in country B could, instead, accept a cash settlement of $30, in which case the following entries would be recorded in the BOP of country A:

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749. Table 16.4 provides an extensive list of transactions associated with options and the BOP treatment of such transactions.

Table 16.4

Treatment of Typical Transactions in Options—BOP of Country A

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Options written on real assets must be tradable to be considered financial instruments.

750. An ITRS or ES could, for BOP purposes, be used to collect information on transactions involving options. However, if an ITRS is used, care should be taken to ensure correct recording of transactions resulting in deliveries of underlying assets. Unless supplementary information is sought, an ITRS respondent is likely to (1) record the transaction in the underlying asset at the option strike price rather than at the market value at the time of transaction and (2) fail to record extinguishment of the option contract.

751. To measure options for the IIP, compilers should probably approach option holders and writers through ES to obtain the necessary information. For the IIP, options should be valued on the basis of market prices prevailing on the dates on which the IIP statement is prepared. If no market exists for a particular type of option, market value can be approximated by using a financial formula known as the Black-Scholes formula. (This formula is quite complex; however, compilers need not understand its exact nature.) Most organizations with significant options operations use (for preparation of balance sheets or supplementary accounts) this or similar formulas to value their positions. Therefore, in practice, the compiler should accept the valuation of option positions provided by principals unless there is serious doubt as to their validity in terms of market valuation principles.

752. Derivatives other than options typically involve contracts in which two parties agree to exchange specified assets, either real or financial, at some future point or points in time. Such contracts are either (1) tradable or (2) settled, on a net basis, for cash rather than an actual exchange of underlying assets. Such derivatives are considered to be financial instruments and include forward foreign exchange contracts, futures, and currency swaps. If transactions in these instruments involve residents of different countries, the transactions should be recorded in the BOP financial account.162 Transactions that should be recorded against derivative instruments include any trading in contracts and the net value of settlements made. It may also be necessary to record transactions associated with the establishment of derivative contracts. Frequently, however, two parties will enter into a derivative contract without any payment by one party to the other; in these cases, the value of the transaction establishing the contract is nil, and no entry is actually required in the BOP.

753. Fees paid to financial intermediaries (such as banks and brokers) to establish derivative contracts do not represent transactions in the derivatives themselves. Rather, these fees should be classified as financial services and recorded in the services component of the current account. Likewise, margin payments provided by one party to another as securities against future obligations do not represent transactions in derivatives. These margin payments should, instead, be reflected in the currency and deposits item in the other investment component of the financial account.

754. Two examples should further illustrate the BOP treatment of derivatives. In the first example, a resident of country A purchases a tradable futures contract from a broker in country B for 100 and pays brokerage fees of 12. The resident of country A is also asked to make a margin payment of 250 to the broker as security against adverse market movements. The following transactions should be recorded in the BOP of country A:

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755. When the futures contract expires after three months, the market has moved against the resident of country A, and he is required to pay 180 as settlement. This settlement is deducted from the margin payment previously made, and the balance of 70 is returned to the resident of country A. The following transactions should be recorded in the BOP of country A:

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756. In the example, the financial derivative contract has, as a result of adverse market movements, “flipped” from being an asset to being a liability of the resident of country A. Such “flipping” can occur with derivative contracts other than options. Movements in underlying asset prices or exchange rates, which are reflected in the price change and exchange rate components of the reconciliation statement for stocks and flows, can cause such changes in the value of derivatives.

757. In the second example, an enterprise in economy X enters into a currency swap with an enterprise in country Y. No money changes hands at the start of the contract. In six months, because of favorable movements in exchange rates, the enterprise in country X receives a net settlement of 80 from the swap partner in country Y. The following transactions should be recorded in the BOP of country X:

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758. One or both parties to a derivative contract may enter into the contract to hedge against adverse movements in some other position. For example, an enterprise borrowing in U.S. dollars but preferring liabilities in Japanese yen may enter into a currency swap in which the enterprise receives U.S. dollars for Japanese yen. In BOP recording, it is important that transactions in derivative contracts be recorded separately from any transactions involving the position that is being hedged. Were this not the case, serious asymmetries could arise in the recording of BOP transactions, and distortions could occur in analysis of BOP items. If compilers wish to provide users with information on the impact of hedges, such data could be shown in satellite BOP tables.

759. In the IIP, financial derivatives other than options should be valued by reference to market prices of similar instruments. If derivatives being valued are traded infrequently, they could be valued by calculating the net present value (NPV) of future payments and receipts expected under the contract. If the NPV of future transactions is positive—that is, net receipts are expected—the derivative contract should be shown as an asset in the IIP. On the other hand, if net payments are expected, the contract should be shown as a liability. Enterprises with significant positions in derivative contracts will probably value their derivative positions and options in a similar manner (at least in their management reports).

Securities Issued at Discounts or Premiums

760. Many debt securities are issued at discounts or premiums. Most short-term securities are issued at prices that are less than the amounts issuers will repay to redeem them, and the discounts represent income earned. Long-term bonds are usually issued with interest payments being made every 6 to 12 months. A bond may be issued at a discount or a premium if the market rate of interest differs from the interest rate assumed in the bond issue. For example, plans may be made to issue a bond bearing a 4.5 percent interest coupon to reflect the market rate of interest at the time. However, before the bond is issued, the market rate of interest changes, and the bond is therefore issued at a slight discount or premium to align the actual interest rate with the market rate. Some long-term bonds are issued without any actual interest payments (zero coupon bonds) or with interest payments that are small in relation to prevailing rates of interest. Such bonds must be issued with significant discounts (deep discounted bonds) to attract investment.

761. According to the BPM, when a resident of one economy issues a security that is purchased by a resident of another economy, the transaction should be valued at the issue price and not at the security’s redemption (face) value. Any discount (or premium) should be recorded as interest (or negative interest) income accrued over the life of the security.163 The offset to accrual of interest should be recorded as a transaction in the security because accrued interest is implicitly being reinvested in the security. At maturity, the transaction extinguishing the security should be valued by using the redemption value.

762. Table 16.5 on page 168 shows the BOP treatment of a zero coupon bond that was issued to a nonresident at 38.554 on December 31, 1992; the bond is to be redeemed in 10 years at 100. The implicit (compound) rate of interest on the security is 10 percent, and it is assumed that the interest rate will remain unchanged over the life of the security. The 3 years presented in the table show that, in each of the years from 1993 to 2001, accrued interest is recorded and offset by an increase in bond liabilities. By the year 2002, annual interest is calculated as 9.091. In that year, the bond is redeemed, and the BOP transaction in bonds of 90.909 represents the reduction (from liabilities of 100) that results from the redemption, less the increase in liabilities of 9.091, associated with accrued interest.

Table 16.5

BOP Treatment of a Zero Coupon Bond

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Other Investment

Description and Classification

763. Other investment, which is a residual category, covers financial instruments not included in direct investment, portfolio investment, or reserve assets. Other investment includes loans from the Fund and the use of Fund credit, financial leases, other long- and short-term loans, trade credits, currency and deposits, household investments in life insurance funds, capital subscriptions to nonmonetary international organizations, prepayments of insurance premiums, and other accounts receivable and payable (such as interest and principal arrears).164

764. The BPM classifies other investment by: (1) assets and liabilities; (2) type of instrument—namely, trade credits, loans, currency and deposits, and “other assets and liabilities”; and (3) resident sector—namely, monetary authorities, general government, banks, and other sectors. Trade credits, loans and “other assets and liabilities” are also classified by original maturities.

Data Sources and Methods

765. Data on stock positions, financial transactions, and non-transaction changes in stock positions could come from an ITRS, ES, official sources, or partner countries and international institutions. The same source does not have to be used to measure all activity. For example, an enterprise survey could be used to measure trade credits; official sources could be used to measure official sector assets and liabilities; and an ITRS could be used to measure other activity. Stock positions should be valued at market values.165 Data on stocks and flows should be collated to ensure consistency and accuracy of reporting. Table 16.6 on page 169 provides an overview of data sources that could be used to measure other investment items.

Table 16.6

Compilation of the BOP Financial Account and the IIP: Other Investment Items

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766. An ITRS can serve as a suitable data source for the measurement of other investment flows and stock positions. ITRS procedures should ensure the inclusion of data on transactions that, for reasons of offsetting, do not give rise to cash transactions or that pass through bank accounts held abroad. For example, if a resident importer finances trade with a loan from a nonresident bank and payments are made directly to the exporter, a transaction in loans should be recorded even though there were no transactions involving the banking system of the compiling country.

767. Transactions involving trade credits are often difficult to measure in an ITRS. To achieve more accurate measurement, parties involved in trade with nonresidents could provide details on delivery dates as well as information on payments. However, trade credits will only be known when payments are actually made, and payments may be made sometime after trade credits are originally extended. This factor could lead to delays in providing estimates or to revisions in data for previous periods. An alternative means of measuring trade credits would be to match customs records with bank records. However, this process could be fairly laborious, and sophisticated systems would be necessary to facilitate the matching process. Another alternative would be to compare total trade, as measured in international trade statistics, with payments for imports and receipts for exports, as measured in the ITRS. The differences could be assumed to represent transactions in trade credits.166 Adjustments would have to be made for goods transactions financed by other means, such as loans, and goods transactions, such as barter trade and gifts, that do not involve financial settlements.

768. ES can provide suitable data for the measurement of other investment flows and stock positions. An enterprise survey should cover the population of enterprises with external assets and liabilities that are classified as other investment.

769. The compiler may also collect data on other investment from the official sector. The reporting entity may be the national debt office or some other official institution that has data on official and other sectors.

770. Partner countries or international institutions could also serve as data sources (see chapter 9). International banking statistics compiled by the IMF or the BIS may be particularly useful for transactions of the nonbank sector with nonresident banks. These statistics are described in detail in paragraphs 396-401 of chapter 9.

771. An example illustrates one method of using such information. In the example, BOP compilers in Essendonia know that small Essendonian enterprises and Essendonian households maintain deposit accounts (in foreign currency) with nonresident banks. However, Essendonia’s BOP collections only cover transactions in the nonresident bank accounts of banks, government enterprises, and large private enterprises.

772. For the first quarter of 1992, Essendonian BOP collections show that net transactions in the nonresident bank accounts of government and large private enterprises were $E 440 CR and $E 820 DR, respectively. Furthermore, government enterprises earned interest of $E 6 and private enterprises earned interest of $E 15 on these accounts in 1992.

773. IBS information published in International Financial Statistics (IFS) show that, at the end of 1991, Essendonian nonbank claims on banks in countries reporting to IBS were $US 800. At the end of the first quarter of 1992, the value of the claims was JUS 1000.167 Essendonian BOP compilers know that Essendonian residents hold, with nonresident banks, accounts in currencies other than the United States dollar. The compilers suspect that the currency mix closely parallels the currency mix used to determine the value of the SDR.

774. IFS also compares the values of country currencies in terms of the United States dollar and the SDR. Essendonian BOP compilers obtain the following exchange rates from IFS:

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Calculated by using IFS data

775. The compilers calculate the value of Essendonian nonbank claims on nonresident banks in terms of SDRs because SDRs best reflect the currency mix of these deposits. In SDRs, the level of claims at the end of 1991 was 533 (800/1.5) and, at the end of the first quarter of 1992, 714 (1000/1.4). For this exercise, the compilers use end-of-period rates. Next, the compilers subtract the level of claims (in SDRs) at the end of 1991 from the level at the end of the first quarter of 1992 in order to derive estimated transactions of SDR 181.168 They then convert the transactions in SDRs to Essendonian dollars by using the period average $E/SDR exchange rate. The result is an estimate of transactions in $E of 588. As this estimate represents an increase in assets, the appropriate BOP entry must be a debit. Essendonia’s balance of payments collections have already accounted for a net debit of $E 380 for transactions in nonresident bank accounts of nonbanks (820 debit for the large private enterprises less 440 credit for the government enterprises). Therefore, the $E 208 difference (588 less 380) is assumed to represent transactions in accounts with nonresident banks not covered by balance of payments collections.169

776. Essendonian BOP compilers also estimate interest income on accounts not covered by their collections. From IFS, they learn that LIBOR interest rates on SDRs were 5 percent at the end of 1991 and 6 percent at the end of the first quarter of 1992. They calculate that the average rate during the first quarter of 1992 was 55 percent, or 1.4 percent per quarter. They decide that this rate is appropriate for estimating interest on deposits with nonresident banks and apply this rate to the average level of Essendonian nonbank deposits (SDR 624) with nonresident banks during the first quarter of 1992. They calculate that interest accrued on nonbank deposits with nonresident banks in the first quarter of 1992 was SDR 9 (0.014 x 624) or $E 28 when the interest is converted by using period average exchange rates. As BOP collections have already measured interest of $E 21 ($6 earned by government enterprises and $15 earned by large private enterprises), the compilers deduce that the difference of $E 7 represents interest credits earned by households and small private enterprises on bank accounts abroad.

777. The Essendonian compilers add the two estimates for undercoverage—$E 208 DR in financial transactions and $E 7 CR in investment income—to their balance of payments. They then consider possible offsets to the net $E 201 debit that they have added. Upon reflection, they decide that approximately half is attributable to exports of goods. As customs statistics are used to measure this item in Essendonia’s balance of payments, it is thought that these goods would have already been covered. The remaining $E 100 is thought to represent workers’ remittances that have been sent to Essendonian residents, deposited with nonresident banks, and thus have by-passed the Essendonian banking system, which is the main source of information for this item in Essendonia’s balance of payments. Accordingly, the compilers add a credit of $E 100 to the worker remittance item in current transfers in the first quarter 1992 balance of payments.170

Calculating Transactions from Data on Stocks

778. When data on stocks are denominated in foreign currencies, the calculation of transactions in the unit of account can be undertaken by using the following methodology.

779. Stock position data must be recorded in currency of denomination. Changes in stock position data (recorded in currency of denomination) reflect transactions after allowance is made for write-offs and price changes in market values of instruments.171 Transactions should be converted to the unit of account by use of period average exchange rates. Price changes, if any, should also be converted to the unit of account by use of period average exchange rates. If there are write-offs, it should be possible to identify times of occurrence. A write-off should be converted to the unit of account by use of the exchange rate prevailing on the date of the write-off; otherwise, a period average exchange rate could be used.

780. For instruments denominated in each currency, opening and closing stock position figures (recorded in currency of denomination) should be converted to the unit of account by using midpoint rates applicable at the beginning and end of the period, respectively. The estimate for the opening position should be subtracted from the estimate for the closing position to calculate the stock position change in terms of the unit of account.

781. As a result of these calculations, transactions, price changes, write-offs, and the change in stock are now measured in the unit of account. The difference between the change in stock and the sum of transactions, price changes, and write-offs can be attributed to exchange rate changes.

782. Table 16.7 illustrates the derivation of transactions from stocks via the method described. In the example, it is assumed that there are no price changes applicable to the asset under consideration. This would be a reasonable assumption for most deposits, loans, trade credits and other non-tradable instruments.

Table 16.7

Calculating Financial Transactions from Data on Stocks

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A reduction, or increase, in the value of an asset could also arise from a change in its market value.

783. If turnover of a particular asset is high, net movement in the stock low, and relevant exchange rates volatile, there could be a large difference between the result obtained by this method and the true result—which would be obtained if underlying gross transaction flows were converted via the midpoint of rates prevailing on dates of transactions. Therefore, the compiler should interpret with some care the results achieved by using this method. When possible, compilers who use this method should undertake calculations at frequent intervals (for example, monthly, rather than quarterly) to obtain more accurate results.

Financial Leases and Similar Arrangements

784. Financial leases and similar arrangements represent a form of financing akin to a secured loan. They are usually evidenced by: (a) a long-term agreement; (b) the lessor being a financial institution; (c) the lessee being responsible for operation, repair, and maintenance of the item being financed and having first option on disposal of the item at termination of the agreement; and (d) penalties for cancellation of the agreement. Taxation or other advantages, which may not be available from other forms of financing, are usually associated with these arrangements. The BPM includes financial leases with loans in the BOP classification.

785. Information required for the BOP is usually readily available from principals who know the value of the good initially leased and are able to distinguish principal and interest components of lease payments. It is especially important that interest and principal components be separately identified, and necessary data could be collected via a well-designed ITRS or ES.

786. Table 16.8 shows BOP entries for a resident of country A, who leases an aircraft from a resident of country B, who purchased the aircraft from a resident of country C. The value of the aircraft is 100. Annual rental payments, which commence in the second year, are 10; in the second year, 4 of these are the interest component. The table shows that country B is not at any time regarded as the owner of the aircraft.

Table 16.8

BOP Treatment of Financial Leasing

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Capital Subscriptions to Nonmonetary International Institutions

787. Information on capital subscriptions is typically available to nonmonetary institutions from official sources. Such capital subscriptions should be recorded in other assets under the other investment component of the financial account. For example, suppose a country makes a capital subscription of 100 to a regional development bank. The subscription is provided in the form of a non-negotiable promissory note denominated in national currency. The following transactions should be recorded in the BOP:

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The promissory note is regarded as a loan, rather than as a portfolio security, as it is non-negotiable.

788. If the promissory note is subsequently redeemed by the development bank to provide financing to another country, the following transactions should be recorded in the BOP:

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Reserve Assets

Description and Classification

789. Reserve assets are financial instruments such as monetary gold, special drawing rights, reserve position in the Fund, foreign exchange (which includes liquid assets such as currency, deposits, and securities), and other assets available to central monetary authorities for BOP management purposes, such as financing imbalances and managing exchange rates.172

790. The presentation of BOP standard components in the BPM contains a subclassification of reserve assets by instrument—monetary gold, special drawings rights, reserve position in the Fund, foreign exchange [split between (a) currency and deposits and (b) securities], and other claims. As can be seen from table 10.6 (in chapter 10), the SNA provides a more detailed breakdown of the other claims component.

Data Sources and Methods

791. Data on stock positions, financial flows, and non-transaction changes in positions could come from an ITRS. However, it would be preferable in most circumstances to obtain the information from actual records of monetary authorities (see chapter 8, paragraphs 350-352). Stock positions, including monetary gold, should be valued on the basis of prevailing market values. Data on positions, financial flows, and non-flow changes should be reconciled to ensure consistent reporting. Data on flows may be derived from stock positions, as described in paragraphs 778-783. In this case, relevant authorities should be encouraged to change their reporting practices to provide transactions data.

792. Central banks are sometimes reluctant to release details of reserve asset transactions and stock positions. Concerns of the central bank and requirements of users of BOP data must be carefully weighed by the compiler. In deference to the former, it may—with skillful combining of data—be possible to meet requirements of the conceptual framework without publishing a detailed breakdown of reserve asset transactions and stock positions.

Extrapolation and Projection

793. If the compiler is using an ITRS, ES, or an official source to measure various components of the financial account and the IIP, data should be available on a fairly timely basis. However, when timely data are not available, the compiler may not—in view of the volatile nature of certain financial account transactions—wish to extrapolate particular financial items. If the compiler prefers to wait until data are available, he or she would include the unavailable financial flows as part of a residual item, which would also include net errors and omissions from other parts of the BOP. (If this approach is adopted, it should be clearly explained to users of the statistics.) Conversely, the compiler may consider it preferable to extrapolate particular financial flows. For example, if investment income estimates are derived from yield analysis (as described in chapter 13, paragraphs 598-599), it may be necessary to extrapolate financial transactions in order to extrapolate the necessary stock positions. The impact of market price and exchange rate movements should also be considered when stock data are being extrapolated.

794. On occasion, data on financial flows may be available but data on stock positions may not. In these circumstances, the compiler may extrapolate stock estimates from the latest available stock data, but the extrapolation must take into account movements in market prices and exchange rates and the impact of transactions (see paragraphs 740-743). Alternatively, as discussed in paragraphs 778-783, it is possible to estimate financial flows from stock position data if the latter are available when the former are not.

Table 16.9

Compilation of the BOP Financial Account and the IIP: Reserve Assets

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795. If the compiler elects to extrapolate financial flows, he or she should take three broad factors into account. One factor that the compiler should consider is any available information on flows. For example, the compiler may have partial information on new loans, loan repayment schedules, large investment projects, or various press announcements by individual companies. Also, the compiler should consider past trends and the general economic climate. For example, a change in domestic interest rates may encourage investment (or disinvestment) in nonequity securities, and a change in government policies toward direct investment may have an impact on this component over time. A third factor to be considered is the size of unidentified transactions as financial flows in any category are likely to be affected by the overall size of such unidentified transactions. These unidentified transactions are derived as a residual by summing the current account and known financial account items. The residual flow may be distributed across items in the financial account and the net errors and omissions item. In making the distribution, the compiler should take into account the historical relationship between (a) initially unidentified transactions and subsequently identified financial flows and (b) changing economic circumstances. The compiler should also identify historical relationships between unidentified financial flows and net errors and omissions.

796. Projections require similar methodologies. However, there are additional variables that should be considered. Compilers may allow projected current account transactions and autonomous financial flows to determine the outcome for reserves and other BOP financing items. Alternatively, some target may be set for reserve transactions. For example, at the end of the projection period, the stock position of reserves may be targeted as a certain fraction of the value of imports. When considered with projections for autonomous financial flows, targeted reserves may produce a “financing gap” that has to be covered by borrowing or lending abroad. Should the financing gap be unsustainable, the compiler may have to reconsider the impact of assumptions related to underlying exchange rate, growth, and other economic policy variables on both financial and current account transactions and to revise projections accordingly. As the BOP projections process is an iterative one, it may take several rounds to establish financial account projections that are consistent with those for the current account.

797. Having projected financial flows, the compiler can project stock positions. In making these projections, the compiler should consider the expected impact of changes in exchange rates and market prices. However, in many cases, the compiler may assume a constant real exchange rate and no changes in other prices. The projection of stock positions is particularly useful for projecting investment income transactions.

Liabilities Constituting Foreign Authorities’ Reserves and Exceptional Financing

798. Liabilities constituting foreign authorities’ reserves and exceptional financing are two supplementary classifications important to an understanding of BOP statistics. LCFAR represent liabilities corresponding to reserve assets and should be identified by an analyst undertaking a global analysis of BOP official reserve flows and stock positions. Exceptional financing refers to non-autonomous BOP transactions, other than those involving reserve assets, that are undertaken by authorities in order to meet BOP financing requirements.173

799. LCFAR may take the form of securities, currency, and deposits held by other central monetary authorities. Data on securities could be obtained from issuers, those responsible for security management, or from financial intermediaries. Data on deposits could be collected from banks. Currency held by foreign central banks could be obtained through special inquiries to partner countries known to have significant holdings of the compiling country’s national currency. (However, this approach may meet some resistance from the central banks of partner countries.)

800. Exceptional financing includes arrears on both interest and principal, borrowing to meet BOP requirements, rescheduling of loans and other obligations that are either in arrears or due, debt swaps, grants from other governments for BOP support, and debt forgiveness. These instruments can all be regarded as new financing or as alternatives to raising funds. Two other categories are also included in exceptional financing. These are the early repayment of borrowings associated with BOP financing and reductions in BOP arrears. Data on exceptional financing transactions would typically be available from official sources on a timely basis.

801. Appendix 4 of the BPM provides a comprehensive description of the accounting for exceptional financing transactions. However, the recording of debt conversions is not always straightforward; consequently, this issue is examined in the Guide.

802. Debt-to-equity conversion and other forms of debt conversion undertaken for BOP purposes raise complex issues: What is the value of the liability being canceled? What is the value of the asset being acquired? Is there an element of debt forgiveness? Clear answers may not exist for these questions. If the debt is being traded, the traded price may be regarded as the value to be used (for determining both transactions and IIP value) of the liability.174 When the debt is exchanged for some other asset, it may be possible, unless there is some element of debt forgiveness involved, to value the other asset and use that value for the original liability. Debt forgiveness would not be associated with a purely commercial transaction but, if a foreign government purchases debt and immediately sells it at a lower price, the difference may be regarded as debt forgiveness.

803. An example illustrates some of these points. Debt that is issued by the compiling country’s government, denominated in U.S. dollars, and has a face value of 100 is held by a nonresident enterprise. The debt is converted at the official conversion rate (par value in this illustration) to direct investment equity in the compiler’s country. The compiler may record the transaction as shown in table 16.10.

Table 16.10

Converting Debt to Equity by Using Book Values and Official Rates

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804. However, there may be problems with this treatment. If, for example, the debt was acquired by the nonresident as the result of a secondary market transaction for US$70, the U.S. dollar value may, for BOP purposes, be considered 70 (market value) and not 100 (book value). Accordingly, it may be considered that the holder of the debt is being provided with a favorable exchange rate (1.43 units of domestic currency for US$1) as an inducement to undertake the debt conversion. As discussed in paragraphs 434-441 of chapter 10 of the Guide, the BPM recommends—in the case of multiple exchange rates—the use of a unitary rate (such as the predominant rate). By comparison with the domestic currency value of the equity investment, conversion of the market value of the U.S. dollar debt liability to domestic currency at the unitary rate—in this case, the official rate—produces a difference of 30. The 30 represents a transfer from the debtor country; the transfer is the result of the favorable exchange rate (akin to a subsidy) provided to a nonresident. Therefore, it may be appropriate to record the transactions shown in table 16.11 in the BOP of the debtor country:

Table 16.11

Converting Debt to Equity by Using Market Values

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805. In practice, however, the debtor country may be reluctant to record the transactions in this manner and prefer to value the transaction in debt at the (legal) value of 100 rather than at its market value.

Compilation of External Debt Statistics

806. Statistics on a country’s external debt can be compiled from the BOP financial account and IIP components provided in the listing of standard components in the BPM. Table 16.12 on page 176 shows the relationship between these components and external debt statistics.

Table 16.12

Relationship between BOP Standard Components and External Debt Statistics

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