1. Balance of payments statistics are included in a broad set of economic statistics known as the national accounts. The System of National Accounts 1993 (1993 SNA) presents the conceptual framework for the national accounts, and the fifth edition (1993) of the Balance of Payments Manual (the BPM) presents the conceptual framework and the structure and classification of the balance of payments. The high level of concordance between the 1993 SNA and the BPM is extremely important.1 This first chapter of the Balance of Payments Textbook (the Textbook) presents the balance of payments conceptual framework and certain internationally agreed-upon accounting conventions that have influenced the shape of that framework. These concepts and specific aspects of methodology are elaborated in subsequent Textbook chapters.
Definition of the Balance of Payments
2. As defined in the BPM, the balance of payments (BOP) is a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. Transactions, for the most part between residents and nonresidents, consist of those involving goods, services, and income; those involving financial claims on, and liabilities to, the rest of the world; and those (such as gifts) classified as transfers, which involve offsetting entries to balance—in an accounting sense—one-sided transactions. Each component of this important definition is subsequently examined.
3. The balance of payments is concerned with transactions and thus deals with flows rather than with stocks. That is, the balance of payments deals with economic events that take place during a reference period and not with outstanding totals of economic assets and liabilities that exist at particular moments in time.
4. The initial focus of the Textbook is on transactions (between an economy and the rest of the world) in goods, services, and income. Under what circumstances does an international economic occurrence constitute a transaction in the BOP sense of the word? In the framework of the national accounts, transactions in goods, services, or income are the provision, by one party to another, of real resources of this kind. Thus defined, a transaction involves two parties or transactors. It is not always clear, however, that there are two parties. Real resources are often transferred internationally from one constituent unit to another within the same legal entity. (For example, real resources may be transferred between a branch and the head office of a multinational enterprise.) It is equally difficult to determine whether transactions take place when individuals migrate and transfer assets from their former to their new countries. How should real resources that accompany migrating individuals be regarded? Such movements of resources do not involve two parties although, in the process, the wealth of some economies is diminished (countries of emigration) and the wealth of other economies is increased (countries of immigration). When individuals migrate, the economic impact of the shifts in real resources is similar to that of flows of resources between two parties. It is therefore possible to regard these shifts as transactions in a restricted sense. The determination of what constitutes a transaction must not be made strictly on the basis of logic but through adoption of generally agreed-upon conventions. For the sake of convenience, the term transaction is often used broadly in the BPM to refer to any sort of flow or change that is, by convention, shown in the balance of payments.
5. The BPM definition (see paragraph 2 on this page) of the balance of payments also includes transactions in an economy’s external financial assets and liabilities. These transactions arise from (a) the creation or extinction of an external financial asset or liability or (b) from a change in the ownership of an existing external financial asset and liability. Transactions that involve external financial assets and two resident parties and transactions that involve external financial liabilities and two nonresident parties are, theoretically, included in the balance of payments.2 Often, these transactions are transparent in the BOP presentation. However, some BOP presentations explicitly reflect these transactions if (for transactions in external financial assets) the two residents are in different sectors of the economy or if (for transactions involving external financial liabilities) the two nonresidents are residents of different countries.
6. An issue of frequent debate is whether BOP coverage should be restricted to transactions or whether, at the other extreme, the BOP statement should show all changes in the value of an economy’s holdings of external financial items. Opinions have differed, and conventions reflecting different analytic approaches have been suggested. The conventions recommended in the fifth edition of the BPM generally require a narrow view of BOP coverage.
7. This narrow view of BOP coverage should be considered in relation to the closely connected, stock-oriented international investment position. The international investment position (IIP) is a statistical statement (compiled as of a specific date such as year end) of the value and composition of an economy’s claims on the rest of the world and the value of that economy’s financial liabilities to the rest of the world. The difference between an economy’s stock of international financial assets and financial liabilities is that part of an economy’s net worth attributable to, or derived from, its external sector.
8. Those who are more interested in changes in an economy’s holdings of external financial items than in transactions in these items can obtain the necessary information by calculating the difference between IIP statements compiled for different periods. In addition to changes in BOP transactions, the difference will reflect valuation changes (such as those associated with movements in exchange rates or in prices of financial items) and other adjustments (such as uncompensated seizures and debt write-offs).
Double Entry System
9. The balance of payments is a statistical statement structured in systematic fashion; data in the statement are presented according to specific accounting rules. The basic accounting convention for a BOP statement is that every recorded transaction is represented by two entries with exactly equal values. In a BOP statement, the two entries are used to recognize the giving and receiving sides of every transaction. Therefore, the BOP statement is analogous to a typical financial statement prepared in accordance with the double entry system regularly used for business accounting.
10. The dual entry system underlying BOP accounting is governed by certain rules. Thus, in conformity with business and national accounting, in the balance of payments, the term credit is used to denote a reduction in assets or an increase in liabilities, and the term debit is used to denote a reduction in liabilities or an increase in assets. This usage has been supplemented by the rule that every recording of a debit movement shall be matched by the recording of a credit movement and vice versa. For example, Dromesia borrows 200,000 units in Cromanian currency from the government of Cromania and deposits the money with a Cromanian commercial bank. Dromesia then acquires an asset (the bank balance) as well as incurring a liability (the debt to the government of Cromania). The asset account is debited, and the liability account is credited. The Dromesian BOP entries to record the transaction are:
| Credit | Debit | |
|---|---|---|
| Liabilities (obligation to Cromania) | 200,000 | |
| Assets (bank balance in Cromania) | 200,000 |
| Credit | Debit | |
|---|---|---|
| Liabilities (obligation to Cromania) | 200,000 | |
| Assets (bank balance in Cromania) | 200,000 |
11. In the preceding (and in succeeding) statements, credits are entered on the left-hand side, and debits are entered on the right-hand side. This traditional practice in BOP accounting differs from commercial accounting procedure in some countries.
12. Changes in assets are, of course, associated with many other types of change besides changes in liabilities. An increase in one asset may be associated with a decrease in another. For example, Mr. Jones in Cromania purchases goods from Mrs. Smith in Dromesia but does not pay for them. Mrs. Smith’s claim against Mr. Jones is a trade credit and an asset of Dromesia. When Mr. Jones pays this debt in Cromanian currency, Dromesia’s trade credit assets are decreased and its foreign currency assets are increased. According to the rule stated in paragraph 10, the increase in one asset (foreign currency) is recorded as a debit, and the decrease in the other asset (trade credit) is recorded as a credit. As always, the debit is offset by an equal credit. If the goods purchased by Mr. Jones are worth 1,000 units, the two entries in Dromesia’s balance of payments would be:
| Credit | Debit | |
|---|---|---|
| Assets (trade credit) | 1,000 | |
| Assets (foreign currency) | 1,000 |
| Credit | Debit | |
|---|---|---|
| Assets (trade credit) | 1,000 | |
| Assets (foreign currency) | 1,000 |
13. An increase in one liability may be associated with a decrease in another. If the example in paragraph 12 is viewed from Cromania’s perspective, the trade credit owed to Mrs. Smith is a liability. When Mr. Jones pays for the goods in Cromanian currency, the trade credit liability ceases to exist. In its place, the Cromanian banking system incurs a liability (in the form of a deposit in Cromanian currency) to a resident of Dromesia. The increase in the bank’s liability is recorded as a credit, and the decrease in Cromanian trade credit liability is shown as a debit. The balance of payments entries are:
| Credit | Debit | |
|---|---|---|
| Liability (bank deposit) | 1,000 | |
| Liability (trade credit) | 1,000 |
| Credit | Debit | |
|---|---|---|
| Liability (bank deposit) | 1,000 | |
| Liability (trade credit) | 1,000 |
14. On the basis of rules stating that an increase in assets is recorded as a debit, that an increase in liabilities is recorded as a credit, and that every credit entry is matched by a corresponding debit entry, accounting conventions can be formulated for credits and debits in the balance of payments. Under the conventions of the system, the compiling economy records credit entries for (a) exports of goods, provision of services, provision of the factors of production to another economy and (b) financial items reflecting a reduction in the economy’s external assets or an increase in external liabilities. Conversely, the compiling economy records debit entries for (a) imports of goods, acquisition of services, use of production factors provided by another economy and (b) financial items reflecting an increase in assets or a decrease in liabilities. In other words, for real or financial assets, a positive figure (credit) indicates a decrease in holdings, and a negative figure (debit) indicates an increase. For liabilities in the form of financial instruments, the rule is reversed; a positive figure indicates an increase and a negative one, a decrease.
15. Most entries in the balance of payments pertain to transactions in which economic values are provided or acquired in exchange for other economic values. Offsetting credit and debit entries required by the recording system are often the automatic result of two entries of equal amount being made for two items that have been exchanged. For example, a commodity import is recorded in the statistics for goods, and payment for that import is recorded in the banking statistics for changes in assets or liabilities. When items are donated or when recordings are one-sided for other reasons, only one aspect of the transaction is recorded automatically in source data. Special types of entries called transfers are made in the balance of payments to provide the required offsets. Transfers are shown as credits when the entries for which the transfers provide offsets are debits and as debits when those entries are credits.
16. In summary form, double entry accounting conventions used in the balance of payments consist of:
Credit (CR) entries
Exports of goods and services
Income receivable
Offsets to real or financial resources received without a quid pro quo (transfers)
Increases in liabilities
Decreases in financial assets
Debit (DR) entries
Imports of goods and services
Income payable
Offsets to real or financial resources provided without a quid pro quo (transfers)
Increases in financial assets
Decreases in liabilities
17. Techniques of BOP analysis are largely based on the double entry recording system of BOP statements. BOP analysis identifies and groups transactions that are autonomous (undertaken for their own sake) and all other transactions that can be characterized as flows induced to finance autonomous transactions. When entries are divided—on the basis of these or any other characteristics—into two groups, the sums of the two groups will (in theory) be numerically equal and have opposite signs.3 The principal focus of BOP analysis is on the selection of characteristics to be isolated and the subsequent examination of relationships between the resultant partial balances that can be constructed.
Concept of an Economy
18. In general, the balance of payments is a record of economic flows occurring between residents of one economy and residents of the rest of the world. An economy is defined as an economic entity having a center of economic interest within a specific territory. Economy is thus nearly synonymous with country as the balance of payments (in practice) usually deals with transactions between nations. In theory, an economy can represent a small portion of a large national territory. An economy may also consist of more than one country—for example, the Economic Union of Belgium and Luxembourg. In addition, it is possible to consider the balance of payments of such regional groups as the European Union (EU) and the balance of payments of each group member. (See chapter 4 of the BPM and chapter 2 of this Textbook for the definition of resident economic entities and guidelines for distinguishing them from nonresident economic entities.)
Principles for Valuation of Recording; Unit of Account and Procedures for Conversion
19. As BOP transactions are diverse, the BPM provides clear guidance on how to value transactions and in which periods the transactions should be recorded. In addition, because transactions may be denominated in many currencies, BOP statisticians should be sure to select the most appropriate unit of account in which to express the statement and the best procedures for converting flows from transaction currencies into the unit of account.
Valuation
20. The application of a uniform principle of valuation to all transactions recorded in the balance of payments is necessary for three reasons. First, as each transaction has two aspects, the double entry accounting rule would be violated if credit and debit entries did not possess the same values. Second, the absence of a uniform valuation principle would make it impossible to compare the BOP statement of one country with the BOP statements of other countries because the valuation of entries made by partner countries would lack symmetry. Third, were a uniform valuation system not used, items recorded in the balance of payments could not be compared with one another, and serious problems of interpretation would be created for data users. Questions concerning the valuation of transactions are not limited to BOP statistics; similar problems arise for compilers of national accounts. For both BOP and national accounting systems, the solution has been to adopt a uniform basis for pricing.
21. The assignment of value to an economic transaction on the basis of price is by no means straightforward. A range of prices may exist for any asset. For example, for commodities, there may be quoted prices or list prices at both wholesale and retail levels. The same commodity may be priced differently in geographically separated markets. Customs authorities of various countries may compile price lists for use in assessing duties to be paid. The balance sheets of enterprises may carry real assets valued in terms of production costs (if the enterprises produced the articles), in terms of acquisition or historical costs, in terms of depreciated replacement costs, or in terms of market values. In transactions conducted between affiliated enterprises, transfer pricing may be utilized. In general, however, transactions between such enterprises will be valued at the purchase or sales prices that would be realized in commercial exchanges made under “arm’s length” conditions.
22. Market prices are widely used in the general field of economics as a means to measure the deployment of resources. The use of market prices for valuing transactions is therefore recommended in the BPM and is consistent with the 1993 SNA. Admittedly, there may be some practical problems in implementing this recommendation. Adjustments may be required for the reported values of a large number of individual transactions, and it may be difficult to determine suitable market price proxies for transactions that have not actually taken place in a market. Nevertheless, no other principle of valuation can measure the economic value of resources transferred between economies in an equally meaningful way.
23. Market price is defined, for both the balance of payments and the national accounts, as the amount of money that a willing buyer pays to acquire something from a willing seller when both are independent parties and when all considerations are solely commercial. A market price is the price paid in one specific exchange made under the previously stated conditions. A second exchange that involves an identical unit and is completed under exactly or nearly the same circumstances could be made at a different market price. Defined in this way, a market price is clearly distinguished from a price quoted in the market, a world market price, a going price, a fair market price, or any price intended to express the generality of prices for a class of supposedly identical exchanges rather than the one price that the goods actually fetch. Furthermore, a market price should not necessarily be considered equivalent to a free market price. That is, a market transaction should not be interpreted as occurring exclusively in a purely competitive market. In fact, a market price could be determined in a monopolistic or monopsonistic market or in any other market that is not wholly free. Indeed, the market may be so narrowly defined that it consists of a sole transaction of the kind between independent parties.
24. The essential characteristic of the market in which prices used in the balance of payments are found is the absence of any relationship between the parties to a particular transaction. That is, the transactors are independent. If this condition exists, a particular transaction can be described as a market-oriented transaction. The criterion of independence between transactors is the opposite of this definition of associated transactors:
Two persons shall be deemed to be associated in business with one another if, whether directly or indirectly, either of them has any interest in the business or property of the other or some third person has an interest in the business or property of both of them. (Customs Cooperation Council, Brussels Definition of Value, Article 11)
25. In concept, all stocks of assets and liabilities comprising a country’s international investment position are recorded on the basis of market value. The underlying assumption is that such stocks are continuously (regularly) revalued at current prices by, for example, reference to actual market prices for financial assets such as shares and bonds or, in the case of some direct investments, by revalued enterprise balance sheets reflecting market value.
26. Chapter 5 of the BPM contains a complete discussion of problems related to the use of market prices for valuation of flows and stocks as well as proposed solutions to be effected through use of proxy measures when the conditions of a market transaction are absent.
Time of Recording
27. As previously stated, a BOP statement is constructed on the double entry system; every transaction is represented by a credit and a debit. Both sides of a transaction—each credit and corresponding debit—should be recorded simultaneously, and the same time or date of occurrence should be recorded by both parties to a transaction. To ensure uniformity, a principle is required to determine the time at which a transaction is entered in the balance of payments. The requirement for a uniform time of recording is analogous to that for a uniform basis of valuation.
28. Each economic transaction proceeds through a succession of stages to which specific dates can be assigned. For example, two transactors agree to conduct a set of transactions. A specific date, the time of contract or commitment, can be assigned to the time that the formal agreement is executed. Contract provisions are subsequently implemented. Commodities are delivered to the purchaser or services are rendered. Claims for payment then devolve. When payment is made, the financial claim—which was created when the seller provided real resources to the buyer—is settled. Specific dates can be assigned to all these events. The two most important events, which are usually relevant for any contract, are (1) the time of contract and (2) the time when legal ownership of the assets changes. While the change in ownership is effected by the delivery of an asset, the ensuing financial claim may not be settled until a later period.
29. Each successive stage of a contract has significance from an economic standpoint. At the time of commitment, the price—or the basis for determining the price—is generally fixed for each transaction covered under the contract. The risk is thereby assigned for any price changes that may subsequently occur. The date when the ownership of assets changes is of prime significance in economic analyses based on the national accounts and the balance of payments because both are mainly concerned with recording exchanges of economic values. By definition, such exchanges occur when ownership of assets changes. Usually, change of ownership is also, in the accounting records of enterprises, the most meaningful stage in contract fulfillment. Such records are often the source of BOP data. Thus, for many reasons, the BPM states that the time at which ownership changes is the time at which a transaction is recorded. The BOP principle for uniform time of recording conforms with that of the national accounts.
30. A common transaction consists of an exchange, which is made between two enterprises, of goods for financial assets. Entries for such an exchange are made in each company’s accounting records. The entries show dates for, in the accounting records of one company, the acquisition of goods and the relinquishment of a financial asset and, in the accounting records of the other, the acquisition of a financial asset and the relinquishment of goods. Ideally, both parties record their entries as of the same date. This method of recording provides a fixed point of time to which a BOP transaction may be related.
31. Under the change of ownership criterion and the conventions for implementing it, rules can be formulated to produce consistent times of recording for most other types of transactions. For further discussion of these rules and practical application of the change of ownership concept, see chapter 6 of the BPM.
Unit of Account and Procedures for Conversion
32. The numerous individual transactions that make up the balance of payments of any country are likely to be denominated in a variety of currencies (for example, the domestic currency, internationally used currencies such as the U.S. dollar, and currencies of trading partners). Transactions in diverse currencies must be converted to a single unit of account before being summed and combined under the headings of a single statement. A country’s BOP statistics are normally expressed in domestic currency as the data are used in conjunction with other national statistics. However, if the domestic currency undergoes major changes in relationship to other currencies, it may also be necessary to compile the national balance of payments in a more stable currency. Compilation of a country’s balance of payments in a non-domestic currency may be useful, as well, for international comparisons. Discussed in subsequent paragraphs are the selection of a currency or some other unit of account for the BOP statement and procedures for converting data expressed in transaction currencies to domestic currency or some other unit of account.
33. It is preferable that the balance of payments be expressed in a stable unit of account. Stability in this context is specifically defined. A unit of account is considered stable when the prices of international transactions expressed in that unit are not affected by changes (relative to the unit) in the values of the transaction currencies. For example, if there were—as a result of a general realignment of currency relationships—a decrease of 10 percent in the value of transactions conducted in deutsche marks, an increase of 5 percent in the value of transactions conducted in U.S. dollars, and little or no change in the value of transactions conducted in special drawing rights (SDRs), the latter could be described as a relatively stable unit of account. Transactions expressed in a unit that is stable in the defined sense may nevertheless reflect price changes attributable to factors other than exchange rate changes. That is, a series expressed in a stable unit of account is not the equivalent of a volume or constant price series from which all price variations have been isolated. A completely stable unit of account does not exist. Nor is it possible, especially during a period of marked fluctuation in relative exchange rates of transaction currencies, to construct an artificial unit of account that is completely stable.
34. To remain consistent with principles that require transactions to be valued at market prices and recorded at the time of change in legal ownership, the exchange rate used in converting values expressed in a transaction currency to values expressed in the unit of account is the market rate prevailing when change of ownership occurs for a particular transaction. If this conversion method is not used, the market value—in terms of a unit other than the transaction currency—is not a single, determinate value but one that varies as the relationship between transactors changes.
35. Actual dates may not be available for some transactions that must be converted from one currency to another. These cases require the use of market rates prevailing during the periods in which the transactions are recorded in the balance of payments. By applying these averages for limited periods (months are preferred to quarters and quarters are preferred to years) to data aggregated for use in the balance of payments, statisticians can obtain approximate equivalents in which a certain degree of distortion must be accepted.
36. The exchange rate prevailing on the statement date of the international investment position is recommended for use in converting data on stocks of external financial assets and liabilities.
37. The existence of multiple official exchange rates indicates implicit taxes and government subsidies of economic units involved in transactions. The imputed tax or subsidy can be estimated from the difference between the actual exchange rate applicable to a specific transaction and a rate calculated as a weighted average of all official rates used for foreign exchange transactions. It is suggested that compilers use a single rate for the balance of payments; otherwise, transactions would be expressed at values that include elements of transfers—most of which involve two resident parties. For practical reasons, this rate may be the official exchange rate predominant in the economy rather than the weighted average of all official rates. For transactions involving parallel (black) market rates, actual transaction rates should be used to value both flows and stocks as there are no official taxes or subsidies implicit in these transactions. The use of actual exchange rates applicable to specific assets or liabilities is recommended, in the BPM, for conversions in the international investment position.
Coverage of the Balance of Payments
38. Many international transactions recorded in the balance of payments do not involve payments of money. To provide a comprehensive record of an economy’s transactions with the rest of the world, the balance of payments includes some transactions that do not give rise to immediate money payments and some transactions that do not elicit any such payments. The inclusion of transactions other than those involving money payments constitutes the principal difference between a BOP statement and an exchange record.
39. In the following paragraphs, categories of transactions are discussed in the context of limits that should be set for BOP coverage.
Exchanges
40. Most transactions likely to be recorded in the balance of payments may be characterized as exchanges in which one transactor provides an economic value to another transactor and receives an equal value in return. Economic values are goods and services; incomes receivable for use of the factors of production; non-produced, nonfinancial assets (such as patents and copyrights); and financial resources. Within such exchanges, four types of economic transactions may be distinguished.
Exchanges of Goods and Services for Financial Items
41. For example, an exporter in Coonawarra sells commodities worth 10 units to an importer in Pokolbin and receives payment in foreign exchange. The exporter (one transactor) thus provides economic value in the form of commodities to an importer (the other transactor) and, in return, receives an equivalent amount of economic value in the form of foreign exchange. BOP entries for the economies of the two transactors are:
| Coonawarra | Pokolbin | |||
|---|---|---|---|---|
| Credit | Debit | Credit | Debit | |
| Commodities | 10 | 10 | ||
| Financial claims | 10 | 10 | ||
| Coonawarra | Pokolbin | |||
|---|---|---|---|---|
| Credit | Debit | Credit | Debit | |
| Commodities | 10 | 10 | ||
| Financial claims | 10 | 10 | ||
42. A convention is applied for transactions involving exchanges of real resources by two parties that constitute a single legal entity. When a single legal entity is divided, according to the BOP definition of residence, into a domestic and a nonresident enterprise (i.e., a parent company and its branch), a change of ownership is imputed even when the same legal entity is both buyer and seller.
Payment for, or Receipt of Income on, the Factors of Production
43. These flows are included in the balance of payments if one of the transactors supplies economic value in the form of factors of production (e.g., labor and financial capital) and receives, in return, economic value in the form of financial resources.
Barter (Exchange of Goods and Services for Other Goods and Services)
44. BOP entries for both transactors are made in the current account.
Exchanges of Financial Items for Other Financial Items
45. Such exchanges may consist, for example, of securities sold for money or commercial debts repaid with money. In the first case, one transactor (the seller of the securities) provides economic value to the other transactor (the buyer) in the form of a financial instrument representing a claim payable in money, which is a financial instrument as well. In the second case, the transactors also exchange economic value in the form of financial instruments. The composition of the creditor’s asset portfolio is affected as a result of the exchange of economic values, and the debtor’s indebtedness is reduced.
46. Provision of a financial item may result, not only in a change in the ownership of an existing claim, but also in the creation of a new claim or the cancellation of an existing claim. For instance, an existing loan may be refinanced. This act is recorded in the balance of payments as the settlement of an old debt and the creation of a new one. The entries are:
| Repayment of an existing loan | debit |
| Drawing on a new loan | credit |
| Repayment of an existing loan | debit |
| Drawing on a new loan | credit |
In this case, contract terms pertaining to the maturity date of a financial item are altered by agreement between the parties; the refinancing extinguishes the claim under the original contract and replaces it with a different one.
47. The four types of exchanges discussed in preceding paragraphs are covered by the balance of payments if the transactors are residents of different economies or if both transactors are not residents of the economy that is the debtor for the financial item in which the transactors are dealing. The balance of payments primarily registers changes in economic relationships between transactors residing in different countries or economies. The structure of the BOP financial account provides for certain financial flows to be differentiated by economic sectors. If two resident transactors from different sectors in the reporting economy enter into an exchange involving financial claims on a nonresident, this intra-residential transaction in external financial assets would be recorded in the balance of payments. For example, banks of a reporting economy could acquire treasury bills of foreign governments from the private sector of the economy. This strictly domestic exchange nonetheless requires a BOP entry because of the way the financial account is structured. The entries are:
| Short-term assets of private sector | credit |
| Short-term assets of banks | debit |
| Short-term assets of private sector | credit |
| Short-term assets of banks | debit |
48. The possibility of two resident transactors engaging in an exchange of liabilities is very slim; it is not likely that the debtor would be able to transfer his debt to another entity without the express consent of the creditor. The acquisition, by one resident entity, of the liabilities of another resident is therefore viewed as two separate transactions. The first resident redeems his indebtedness to the nonresident party who, in turn, re-lends to the second resident entity. For the debtor economy, the BOP entry is:
| First resident’s liabilities | debit |
| Second resident’s liabilities | credit |
| First resident’s liabilities | debit |
| Second resident’s liabilities | credit |
Transfers
49. When, from the points of view of both transactors, the provision and acquisition of economic values is two-sided, the transaction is characterized as an exchange. However, one transactor sometimes provides an economic value to another transactor and does not receive an equivalent value in return. The lack of economic value on the one side must be balanced by an entry referred to in BOP and national accounts as a transfer. A transfer is simply a contra entry to the one-sided provision or acquisition of economic values.
50. For instance, if Coonawarra furnishes free clothing and food to alleviate the plight of earthquake victims of Nostaw, Coonawarra is not engaged in an exchange but in a one-sided provision of economic value. As a result of this action, Coonawarra’s resources are diminished while those of Nostaw are augmented. Coonawarra receives no economic value in return, and Nostaw gives up no economic value in payment. Coonawarra might, of course, be said to receive an intangible return (gratitude or good will) for the real resources provided to Nostaw, but such intangibles are not tradable as economic values are.
51. Funds or goods recorded as transfers are not provided in exchange for specified amounts of goods, or services purchased voluntarily, or payment of loans or contractual obligations. Transfers between private parties are voluntary, but those to or from governments usually arise from legal obligations to, or legal commitments of, those governments. Whether voluntary or under commitment, the provision and receipt of an economic value without a quid pro quo is shown, by means of a contra entry, as a transfer in the balance of payments.
Territorial Change and Migration
52. The balance of payments deals primarily with transactions between residents of an economy and residents of other economies. As, for BOP purposes, an economy comprises the economic entities associated with its territory, the scope of an economy could be affected by changes in its territory or by changes in the status of entities associated with the economy.
53. A change in the territory of an economy results in a change in the status of any entities associated with that territory. That is, with respect to the former economy, residents become nonresidents and, with respect to the new economy, nonresidents become residents. For example, the economy of Clintonstan extends its territory into area X, which is part of the economy of Bushland. Entities resident in area X become part of Clintonstan. With the change in territory, former domestic claims on area X are classified, from the perspective of Bushland, as external claims. Clintonstan acquires additional productive facilities, as well as the claims of area X on Bushland. In effect, the net worth of entities associated with area X is transferred from Bushland to Clintonstan. Therefore, if the real resources and capital that an economy provides to or receives from the rest of the world as a result of a change in territory are recorded in the balance of payments, a counterpart entry reflecting the transfer of net worth is also required, from the perspective of the new economy, to balance the statement.
54. The effect of the change in territory can be illustrated by the balance sheet of an enterprise located in area X.
| Assets | Liabilities | |
|---|---|---|
| Fixed assets | 1,000 | |
| Deposits in a commercial bank in Bushland | 500 | |
| Net worth of owner | 1,500 |
| Assets | Liabilities | |
|---|---|---|
| Fixed assets | 1,000 | |
| Deposits in a commercial bank in Bushland | 500 | |
| Net worth of owner | 1,500 |
Were it considered desirable to portray in the balance of payments the shift in resources stemming from a territorial change, these entries would be made in the BOP statement of Clintonstan:
| Credit | Debit | |
|---|---|---|
| Goods | 1,000 | |
| Financial assets | 500 | |
| Counterpart to territorial change | 1,500 |
| Credit | Debit | |
|---|---|---|
| Goods | 1,000 | |
| Financial assets | 500 | |
| Counterpart to territorial change | 1,500 |
55. However, it is recommended in the BPM that changes occurring in an economy’s real and financial assets as a result of territorial changes be excluded from BOP coverage. The rationale for the exclusion is that territorial changes occur infrequently and can be appropriately viewed as changes in the coverage of reporting economies. Such changes will, however, be reflected in the reporting economy’s IIP statistics. The BPM treatment of territorial change extends to the creation of new economies from the territory of existing economies (for example, Slovenia, which was created from the former Yugoslavia) or the full absorption of one economy by another (for example, East and West Germany).
56. In contrast to infrequent territorial changes, changes in the residence of individuals are commonplace. The impact of migrating individuals is, however, somewhat similar to that of the cession or acquisition of territory because international creditor or debtor positions are affected by a change in the coverage of individuals comprising an economy. Movable property owned by a migrant is, in effect, imported into the new economy. Fixed assets owned by the migrant and located in the former economy become claims of the new economy on the former economy. The migrant’s claims on, or liabilities to, residents (including those of the former economy) of an economy other than the new economy become external claims or liabilities of the new economy, and the migrant’s claims on, or liabilities to, residents of the new economy cease to be claims on, or liabilities to, the rest of the world for any economy. The net sum of all these shifts is equal to the net worth of the migrant.
57. The following example illustrates changes resulting from the migration of an individual. Prior to migration, a resident producer in Daniherland operated a business.
Balance Sheet of a Resident Enterprise of Daniherland
Balance Sheet of a Resident Enterprise of Daniherland
| Domestic Assets | Domestic Liabilities | ||
| Machinery and equipment | 5,000 | Bank loans | 2,000 |
| Inventories | 1,500 | Trade credits | 1,500 |
| Cash | 200 | ||
| Securities | 500 | ||
| 7,200 | 3,500 | ||
| External Assets | External Liabilities | ||
| Claims on residents of Essendonia | 800 | Trade credits due to residents of Essendonia | 1,200 |
| Claims on residents of Nostaw | 1,200 | Funds borrowed from residents of Nostaw | 800 |
| 2,000 | 2,000 | ||
| Net worth of proprietor | 3,700 | ||
| Total assets | 9,200 | Total liabilities and net worth | 9,200 |
Balance Sheet of a Resident Enterprise of Daniherland
| Domestic Assets | Domestic Liabilities | ||
| Machinery and equipment | 5,000 | Bank loans | 2,000 |
| Inventories | 1,500 | Trade credits | 1,500 |
| Cash | 200 | ||
| Securities | 500 | ||
| 7,200 | 3,500 | ||
| External Assets | External Liabilities | ||
| Claims on residents of Essendonia | 800 | Trade credits due to residents of Essendonia | 1,200 |
| Claims on residents of Nostaw | 1,200 | Funds borrowed from residents of Nostaw | 800 |
| 2,000 | 2,000 | ||
| Net worth of proprietor | 3,700 | ||
| Total assets | 9,200 | Total liabilities and net worth | 9,200 |
58. The producer ceases business activity in Daniherland and migrates to Essendonia with the intention of engaging in a similar line of economic activity there. The migrating producer takes the capital goods (machinery, equipment, and inventories) used by the enterprise in Daniherland and converts holdings of domestic financial assets into foreign exchange. The producer also transfers her indebtedness and external financial claims to the new enterprise in Essendonia. As a result, the international investment position of both the country of emigration and the country of immigration are affected. Daniherland, the country of emigration, loses real resources in the form of capital goods and foreign exchange and no longer has 2,000 units of external assets in the form of migrant claims on residents of Essendonia and Nostaw. Simultaneously, Daniherland ceases to have external liabilities to Essendonia and Nostaw. However, Daniherland now has new external assets, in the form of claims on the migrant, of 3,500 units. Essendonia, the country of immigration, acquires real resources of 6,500 units, foreign exchange of 700 units, and external assets (claims on Nostaw) of 1,200 units. Essendonia also assumes external liabilities of 4,300 units (the migrant’s debts to residents of Daniherland and Nostaw) and ceases to have external liabilities that were due to amounts (800 units) owed by Essendonian residents to the migrant and external assets (1,200 units) that other residents of Essendonia had extended in trade credits to the migrant. To record these shifts in the balance of payments, the following entries are required:
| Daniherland | Essendonia | |||
|---|---|---|---|---|
| Credit | Debit | Credit | Debit | |
| Goods | 6,500 | 6,500 | ||
| Financial assets | 800 | 700 | ||
| Financial liabilities | 2,000 | 3,500 | ||
| Transfer of net worth | 3,700 | 3,700 | ||
| Daniherland | Essendonia | |||
|---|---|---|---|---|
| Credit | Debit | Credit | Debit | |
| Goods | 6,500 | 6,500 | ||
| Financial assets | 800 | 700 | ||
| Financial liabilities | 2,000 | 3,500 | ||
| Transfer of net worth | 3,700 | 3,700 | ||
59. In the BPM, it is suggested that all such changes be recorded in the balance of payments. Thus, changes in assets and liabilities that are due to the migration of individuals from one economy to another are covered by the balance of payments. The net sum of all these shifts is equal to the net worth of the migrant, which must be recorded as an offset if the other shifts are recorded. This offset is conventionally included with transfers in the balance of payments.
60. Should transfers that are associated with migration and involve the movement of real and financial resources from one economy to another be considered transactions? In a national accounting sense, a transaction consists of the provision of economic value by one party to another. In this sense, migrants’ transfers can be deemed transactions if the migrant is theoretically divided into two persons—one of whom is a resident of the former country and the other, a resident of the new country. Any transfer of real and financial resources from one of these persons to the other is considered a transaction as there is both a provision and an acquisition of economic value. Assigning the migrant dual status as a resident and a nonresident is a device by which migrants’ transfers can be included in the balance of payments.
61. The effect of territorial changes on a country’s creditor/debtor position and the effect of changes resulting from the migration of individuals are treated differently. Territorial changes occur infrequently and can be viewed as changing the coverage of the reporting economy; the migration of individuals occurs continually. Over a long period, wealth in the form of financial items or real capital brought into a country by immigrants may be a significant source of foreign exchange for the country’s monetary authorities or may contribute substantially to the country’s domestic capital formation. Conversely, wealth taken out of a country by emigrants may be a substantial drain on the resources of that country. It is therefore useful and appropriate to account, in the balance of payments, for international transfers of wealth accompanying migration.
Reclassification of Claims and Liabilities
62. The classification scheme used in the BOP financial account accentuates characteristics that reflect the motivation of the investor. The underlying intentions of the investor may vary over time and thereby affect the character of the investment and its classification—as can be seen from the distinctions made among direct investment, portfolio investment, other investment, and reserve assets. For example, several independent holders of equity capital in an enterprise located abroad decide to associate to acquire entrepreneurial control over the enterprise. As a result, the character of the investment changes from portfolio investment to direct investment. According to the BPM, reclassifications of this type are not reflected in the balance of payments but are recorded in IIP statements at the ends of the periods in which the reclassifications occur. Similarly, central monetary authorities may relinquish or assume effective control over the foreign exchange holdings of deposit money banks, and reclassification from reserve assets to other investment-assets-currency and deposits-banks (or vice versa) are therefore recorded in the international investment position but not in the balance of payments.
Valuation Changes
63. The values of real resources and financial items are constantly subject to variation. Alterations in values may be due to either or both of two factors. One factor is price changes. The price at which a commodity transaction (or any other transaction) takes place may be subject to change in terms of the currency in which the transaction is quoted. The other factor is exchange rate changes. There may be a change in the exchange rate between the transaction currency and the unit of account in which the balance of payments is recorded. Valuation changes are included in the international investment position but not in the balance of payments. Realized capital gains and losses are, however, indirectly recorded in the balance of payments.
64. The following example illustrates the difference between realized capital gains and losses, which are recorded in the balance of payments, and unrealized valuation changes, which are excluded. During the course of a year, a financial asset (such as a security issued by a nonresident enterprise) is acquired from abroad for 50 units. At the end of the reporting period, the purchaser still holds this asset, the value of which has risen to 80 units. In accordance with the BPM, the security purchase should be recorded in the balance of payments as a debit of 50 units. The total change in holdings of financial assets is 80 units, of which 30 units constitute a valuation gain. This valuation gain is excluded from the balance of payments but reflected in the international investment position where the level of the investment at the end of the reporting period is recorded at the market value of 80 units. The difference between the level at the beginning of the period, which is nil, and the level at the end of the period comprises a transaction of 50 units and a valuation change of 30 units. Had the purchaser sold the asset for 80 units before the end of the reporting period, the balance of payments would show a net credit transaction in securities of 30 units (purchase, 50 units; sale, 80 units). The net entry relates to the realization of capital gains but is nevertheless included in the statistics as it is the net result of two transactions (a purchase and a sale) recorded at market values.
65. In the BPM, it is recommended that write-offs of bad debts be regarded as valuation changes and consequently excluded from BOP coverage. The write-off, by the creditor, of a bad debt is presumably prompted by the unwillingness or inability of the debtor to redeem his debt. The expropriation of property without compensation is analogous to a write-off of a bad debt; the former should be thought of as a valuation adjustment and excluded from the balance of payments.