445. Previous chapters of the Textbook have covered transactions recorded in the BOP current account and in the capital account portion of the capital and financial account. This chapter is concerned with concepts pertaining to the financial account. Topics such as the definition of financial account transactions, coverage, time of recording, valuation, and classification are examined. In subsequent chapters, individual components of the financial account are discussed in greater detail.

445. Previous chapters of the Textbook have covered transactions recorded in the BOP current account and in the capital account portion of the capital and financial account. This chapter is concerned with concepts pertaining to the financial account. Topics such as the definition of financial account transactions, coverage, time of recording, valuation, and classification are examined. In subsequent chapters, individual components of the financial account are discussed in greater detail.

Definition and Coverage

446. In the BPM, the financial account is defined as comprising all transactions (actual and imputed) in the external financial assets and liabilities of an economy. In this chapter, use of the term transactions is restricted to exchanges involving changes of ownership, including the creation and liquidation of claims. For convenience, the BPM practice of referring to external financial assets and liabilities as “external assets” or “assets,” and “external liabilities” or “liabilities” is continued in this and subsequent Textbook chapters.

447. Three criteria must be met for a transaction to be included in the financial account. These criteria are:

A transaction involves a change of ownership, including the creation or liquidation of an asset or liability. The pledging, authorization, commitment, or setting aside of funds for the purchase of an asset or repayment of an obligation does not alter the ownership of an asset or liquidate a claim.

An asset or liability must represent actual claims that are legally in existence. Therefore, the authorization of a loan or the incurrence of a contingent liability is not sufficient to establish, respectively, a claim or liability.

A transaction involves an external financial asset or liability. The external financial assets of an economy are comprised of holdings of monetary gold, special drawing rights (SDRs), and claims on nonresidents. The external liabilities of an economy are comprised of indebtedness to nonresidents. Therefore, with the exception of SDRs and monetary gold, each external financial asset of one economy is matched by an external liability of another economy, and vice versa. The important determinants for classifying financial items (assets or liabilities) as external are the identities of the creditor and debtor. The creditor and debtor must be residents of two different economies. The denomination of a financial item—whether in national currency, foreign currency, or any other unit of account (such as the SDR)—is not relevant for classification of the item as an external asset or liability. For example, a resident bank purchases a security that is denominated in national currency and issued by a nonresident. The security constitutes a claim on a nonresident, and the purchase of the security is therefore included in the BOP statement as a financial transaction.

448. Transactions are not the only cause of changes in the values of financial items. Changes that do not result from transactions are excluded from the balance of payments, although such changes may be reflected in the IIP statement. These exclusions are discussed in more detail in paragraphs 464–470.

449. Assets can take the form of financial items (such as securities, loans, and trade credits) or nonfinancial assets (such as stocks of grain or machinery held abroad by resident enterprises and real estate consisting of vacation homes located abroad and owned by individual residents) or intangible assets (such as patents and copyrights). Financial assets may be imputed to some nonfinancial assets, such as land, by means of a convention described in the BPM. Land, by convention, must be owned by a resident entity. Therefore, if a nonresident legally owns land, the nonresident has a financial claim on a resident entity that owns the land. For example, if a resident of Pokolbin owns land in Cromania, ownership of this land is—for BOP purposes—attributed to an entity resident in Cromania. The resident of Pokolbin has a financial claim equal to his or her equity in the land on the entity resident in Cromania. All receipts and payments attributable to the land are allocated to the resident entity in Cromania; all profits are remitted to the legal owner residing in Pokolbin or reinvested to increase the value of the financial claim of Pokolbin on Cromania. (See paragraphs 550–551 of chapter 9 for an illustration of the treatment for land owned by nonresidents.)

450. The treatment outlined in the preceding paragraph applies to land owned by nonresident, nongovernment entities. When land located abroad is held abroad by governments for embassies or similar purposes, such land is considered part of the territory of the government holding the land and not part of the territory of the host economy. Therefore, there is no need to attribute ownership of such land to an entity resident in the host economy. Transactions in government land held abroad are recorded in the capital account under acquisition/disposal of non-produced, nonfinancial assets; only the financing associated with these transactions is shown in the financial account.

451. According to the BPM, the following types of nonfinancial external assets require the imputation of financial assets:

immovable assets such as land and structures (except when such assets are owned by foreign government entities)

mobile equipment such as ships, aircraft, highway vehicles, rolling stock, fishing vessels, and drilling rigs that operate within an economy for at least one year, have separate records kept in respect of operation, and are recognized by tax and licensing authorities as part of the host economy’s capital stock (These assets are considered to be owned by an entity residing in the economy in which the assets are located.)

nonfinancial, as well as financial assets, of an unincorporated enterprise operating in an economy other than the one in which the owner resides (These assets are considered to be the assets of an unincorporated entity residing in the host economy rather than assets of the economy of the entity’s owner.)

goods transferred under a financial leasing arrangement and presumed to have undergone a change of ownership (imputation of a financial asset for the lessor and a liability for the lessee)

goods sent abroad for processing and subsequently returned to the original country. Such goods are recorded in the balance of payments as if ownership has changed—both when the goods were originally exported and again when the goods are re-imported. Offsetting the first imputed change of ownership is the creation of an imputed financial claim that is recorded in the financial account. This claim is extinguished as an offset to the second imputed change of ownership.

452. Up to this point, an asset has been described as a resident claim with a counterpart nonresident liability. Certain assets do not have this characteristic but are nevertheless treated, in the BPM, as external financial assets. These assets are monetary gold and special drawing rights (SDRs) in the IMF. These assets are treated as external financial assets because such assets are widely accepted as a means of international payment.

Transactions in Financial Assets

Kinds of Transactions

453. Transactions in financial assets can be classified as:

exchanges of real resources for financial items One side of the transaction is recorded in the current account; the other is recorded in the financial account.

exchanges of non-produced, nonfinancial assets for financial items such as copyrights and patents One side of the transaction is recorded in the capital account; the other is recorded in the financial account.

exchanges of financial items for other financial items Both sides of the transaction are recorded in the financial account.

exchanges of financial items without a quid pro quo In such transactions, cash or other financial items are provided by one party to another party but no economic value is provided in return. Offsetting the financial transactions are transfers classified as current or capital transfers and entered in either the current account or the capital account component of the capital and financial account.

Parties to Transactions

454. Information on the identity of both parties to a financial transaction may not be available to BOP compilers. For example, a compiler may not know whether a resident who purchased a transferable security issued by a nonresident conducted this transaction with another resident or with a nonresident. Similarly, a compiler may not know whether a nonresident who withdrew funds from a domestic bank account used the funds to settle a transaction with another nonresident or with a resident. The BPM recommendation for dealing with this problem is that the balance of payments cover all transactions in external assets and liabilities. Coverage includes (1) transactions that take place between two residents of the reporting economy and involve that economy’s external assets and (2) transactions that take place between two nonresidents of the reporting economy and involve the external liabilities of that economy.

455. BOP coverage of all transactions in external assets and liabilities is also relevant to economic analysis. For example, if the household or nonfinancial corporate sector sells an external financial asset to the banking sector, the sale has an impact on the money supply of the economy. Any analysis that relates BOP developments to those in money supply must take account of such transactions.

456. According to the BPM, credit and debit entries for each component of the financial account are generally netted in a BOP statement. As a result, most transactions between residents and nearly all transactions between nonresidents will cancel; therefore, such transactions do not appear as entries in the statement. However, transactions that involve assets and take place between resident creditors with different sector classifications will be net only at higher level balances and not at balances for particular items. For transactions involving liabilities, the identity of the nonresident creditor is used in differentiating between direct investment and other types of investment, between liabilities constituting foreign authorities’ reserves and other transactions (supplementary financial account classifications), and between liabilities owed to different countries in regional BOP presentations. When transactions in the financial liabilities of an economy involve two nonresidents who are classified in different nonresident creditor categories, the transactions will not be net for each individual item in the financial account.

457. For example, a resident nonbank enterprise of Madornia uses foreign exchange to purchase short-term commercial paper issued by a resident of Nostaw. This transaction is recorded in the BOP statement of Madornia (1) as a debit entry representing an increase in the portfolio debt assets of other sectors and (2) as a credit entry representing a decrease in reserve assets-foreign exchange. The commercial paper is then sold by the resident enterprise of Madornia to another resident enterprise of Madornia. If the sector classification for these two transactors is the same, the BOP entries are net, and no entry appears in Madornia’s BOP statement for the resident-resident transaction. However, if the commercial paper is sold by the resident nonbank enterprise to a resident bank, the transaction is reflected in the BOP statement (1) as a credit entry representing a reduction in the portfolio debt assets of other sectors and (2) as a debit entry representing an increase in portfolio debt assets of banks.

Reinvested Earnings

458. One type of asset or liability shown in the financial account is reinvested direct investment income. Related transactions are discussed in chapters 6 and 7. If the reinvested earnings of a direct investment enterprise accrue to a nonresident direct investor, these earnings are treated as a BOP transaction. The reinvested earnings are viewed as income paid to the nonresident direct investor by the direct investment enterprise and simultaneously reinvested by the investor.

Migrants’ Financial Transfers

459. Migrants’ financial assets and liabilities are recorded in the financial account of the balance of payments when migrants change their countries of residence. For example, land owned by migrants in their former countries, enterprises owned by migrants and located in the former countries, and migrants’ deposits with banks in their former countries become, at the time of migration, financial assets of the countries to which the migrants are moving. Migrants’ liabilities to their new countries become, at the time of migration, claims between residents of the same country. From the point of view of the new country, the recording of migrants’ financial transfers is achieved by creating or extinguishing assets and liabilities. The offset to a change, which results from the migration, in an economy’s financial items is entered as a capital transfer in the capital account. Chapter 7 contains additional information on the treatment of migrants’ transfers.

Borderline Cases

460. Changes in maturities or terms of contracts for existing assets or liabilities may or may not constitute transactions that should be recorded in the balance of payments. The BPM states that changes in the original terms of a contract normally require formal agreement between the parties involved in the contract. The agreement reflecting the changes constitutes a transaction that is recorded in the balance of payments. For example, a resident private enterprise borrows 200 units from a nonresident bank. In the period in which the loan becomes due for repayment, the resident enterprise negotiates with the bank to extend the loan for another six months. As the contractual terms of the loan are altered, the following transaction would be recorded in the balance of payments:

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However, if a loan contract originally provides the borrower with an option to extend the loan, the extension does not represent a change in the contractual agreement between the creditor and debtor. In such cases, the extension is not recorded as a transaction in the balance of payments.

461. Changes that occur in contractual terms when the government negotiates to take over liabilities incurred by the private sector may or may not constitute transactions that should be recorded in the balance of payments. For example, the central bank of Hughesavia encourages resident companies to borrow funds, on a short-term basis, from nonresident banks. The resident companies are scheduled to pay interest and repay principal in national currency, which is not convertible, but the central bank has agreed to transfer to nonresident creditors the equivalent amount in foreign exchange. However, the country subsequently experiences BOP problems and the central bank does not allocate the necessary foreign exchange for these payments. The outstanding principal (before scheduled repayments) is 700 units. Scheduled repayments of principal and interest due amount to 100 units and 18 units, respectively. After lengthy negotiation with the creditors, the outstanding balances on these short-term loans are converted to seven-year loans, and the central bank replaces the resident companies as the debtor. The following entries would be recorded in the BOP statement of Hughesavia:

Before loan conversion agreement

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If, however, the monetary authorities simply assume responsibility for the arrears and do not renegotiate the contract, no BOP transactions are recorded. In such cases, the changed sector of the liability would be reflected only in the IIP statement.

462. Another type of borderline case occurs when a transactor intends to dispose of a certain asset at virtually the same moment that ownership of the asset is nominally acquired. The most common examples of such closely linked pairs of transactions are arbitrage and certain other dealings, such as forward contracts, in foreign exchange. Arbitrage seeks to exploit price differentials that may exist in different markets; forward contracts are concluded to exploit price differentials that exist over time in the same markets. It is recommended in the BPM that two changes of ownership be recorded—no matter how briefly an asset is owned—when pairs of transactions are closely linked. The rationale for this recommendation is the recognition that a profit or loss in an arbitrage transaction or a forward contract reflects the realization of a capital gain or loss that should be entered in the financial account.

463. Yet another kind of borderline case occurs with the redefinition, at a later period, of a country’s transactions with the International Monetary Fund. For example, if a member country makes a reserve tranche drawing from the IMF, the country’s reserve position in the IMF decreases (credit) by the same amount that its reserve of foreign exchange assets increases (debit). At a later period, the IMF may determine, on the basis of more up-to-date information, that the member country qualified for use of Fund credit for compensatory financing of export fluctuations at the time of its reserve tranche drawing. In such instances, it is recommended that entries showing an increase in the use of Fund credit (credit) and an increase of an equal amount in the reserve position in the Fund (debit) be recorded in the period in which the redefinition took place. For example, a country makes a reserve tranche purchase of 200 units from the Fund. This purchase is subsequently redefined as the use of Fund credit. The following entries would be recorded in the country’s balance of payments:

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This treatment, which relates to transactions that rarely occur in practice, is recommended in order to align BOP entries with statistics published by the IMF on its own activities. Because the exchange of instruments imposes different obligations on the debtor, the transaction is more akin to the renegotiation of a loan than to a reclassification.

Financial Item Changes to Be Excluded from the Balance of Payments

Allocation or Cancellation of SDRs

464. The holding of special drawing rights (SDRs) is discussed in detail in chapter 12, although allocations and cancellations of SDRs are no longer recorded in the balance of payments. In the fourth edition of the BPM, such changes were regarded as transactions offset by counterpart entries to the allocations or cancellations. The impact of allocations or cancellations of SDRs on a country’s reserves can be determined from an analysis of the reserve assets component of the IIP statement rather than from the balance of payments.

Monetization or Demonetization of Gold

465. The same stock of gold held by monetary authorities may, at different times, be classified as a commodity (nonmonetary gold) or as a financial asset (monetary gold). Changes, which result from reclassification of gold stocks, in holdings of monetary gold are not recorded in the balance of payments. Instead, the impact of these changes is reflected in the reserve assets component of the IIP statement. The treatment of monetization or demonetization of gold recommended in the fifth edition of the BPM is different from that recommended in the previous edition.

Valuation Changes

466. The BPM recommendation is to omit from the balance of payments all unrealized valuation changes in the external financial assets and liabilities of an economy. Valuation changes can occur for a number of reasons. One is a change in the price of the unit in which an asset is denominated. For example, a resident of Namdarb purchases, in Clintonstan currency, a security issued by Clintonstan at a price of 500 units. The exchange rate at the time of the purchase is l unit of Namdarb currency for 5 units of Clintonstan currency, so the resident of Namdarb pays 100 units to purchase this security. When the value of the security subsequently increases to 550 units in Clintonstan currency, the price—expressed in Namdarb currency—is 110 units. The increase of 10 units—in Namdarb currency—in the value of the security represents one type of valuation change.

467. Another type of valuation change occurs when the monetary unit in which an asset is denominated changes in terms of the unit of account used for recording BOP statistics. For example, Clintonstan currency depreciates (in terms of Namdarb currency) from an exchange rate of 1 unit of Namdarb currency for 5 units of Clintonstan currency to a rate of 1 unit of Namdarb currency for 6 units of Clintonstan currency. The value, in terms of Namdarb currency, of a security worth 500 units of Clintonstan currency decreases from 100 units to 83.3 units.

468. Valuation changes like those described in the foregoing paragraphs are omitted from the balance of payments as such changes do not represent transactions. (However, transactions may take place for which valuation changes are realized. Resulting capital gains or losses are reflected implicitly in the balance of payments as part of the value of the transactions that gave rise to realization of the capital gains or losses.) In the previous edition of the BPM, valuation changes in reserves—as well as counterpart entries to these valuation changes—were reflected in the balance of payments. However, as the IIP statement provides a framework for analyzing changes, there is no longer a need to show the total change in the level of reserves in the balance of payments.


469. A valuation change occurs as a result of a write-off if a debtor is unable or unwilling to make partial or full repayment of a claim. In such cases, the creditor may choose to regard a part or the full amount of the claim as canceled. As opposed to the contractual rescheduling of debts discussed previously, write-offs do not involve contractual agreements and thus are unrealized capital losses that should not be recorded in the balance of payments. However, forgiveness by a creditor of all or part of the debt owed by the debtor does constitute a transaction that should be recorded in the balance of payments. In such cases, the reduction in debt recorded in the financial account is offset by an entry in the debt forgiveness item in the capital transfers component of the capital account.

Classification Changes

470. Classification changes in an economy’s external assets or liabilities are not recorded in the balance of payments. Classification changes arising from territorial changes (other than those associated with government purchases of foreign land for embassy and similar uses); reclassifications between portfolio investment and direct investment; and reclassifications related to assumption or relinquishment of control, by monetary authorities, of the foreign exchange assets of banks are examples of reclassification changes that are not shown in the balance of payments.

Net Recording

471. In general, financial movements are recorded on a net basis. That is, each item in the financial account is presented—depending on whether total debits exceed total credits or vice versa—as a net debit or net credit entry. The net change in claims on nonresidents by residents and the net change in claims on residents by nonresidents during a period is considered to be of more interest than the total value of financial claims that changed hands during the period. Therefore, most categories in the financial account are shown on a net basis.16 The only exception specified in the BPM to net recording in the financial account is for drawings and repayments on long-term loans and trade credits, which are shown as supplementary classifications.

Valuation and Timing

472. Transactions in financial items are recorded in the financial account at market values when changes of ownership occur. The concepts of market value and time of recording are discussed in detail in chapters 5 and 6 of the BPM. These concepts and the application thereof to financial transactions are further elaborated in chapters 9, 10, 11, and 12 (which deal with the various items in the financial account) of the Textbook. Financial items are recorded in the balance of payments when the creditor and debtor enter, respectively, the claim and the liability in their books.


473. In the development of a BOP classification scheme for financial items, emphasis was given to distinguishing categories of transactions that exhibit different patterns of behavior. On this basis, five main approaches are used to classify financial items.

Functional Types of Investment

474. In the BPM, three broad categories of investment exhibiting different behaviors and a fourth residual category are distinguished. The following discussion focuses on the salient features of these categories. A more detailed discussion on each of the categories is provided in chapters 9-12.

Reserve Assets

475. Reserve assets are instruments available to governmental authorities for financing or regulating payment imbalances. Reserve assets are comprised of monetary gold, special drawing rights (SDRs) in the IMF, reserve positions in the IMF, and claims on nonresidents (such as foreign exchange) available to the central authorities. Under a fixed exchange rate system, changes in holdings of reserves usually reflect a response to an aggregate surplus or deficit resulting from transactions undertaken for their own sake. These transactions are called autonomous transactions. For example, if the sum of all autonomous transactions between residents and nonresidents of an economy produces an overall deficit, this deficit may be financed by drawing down on reserves.

476. In flexible exchange rate systems, changes in reserves may also reflect actions (such as intervention in the foreign exchange market to affect the exchange rate for the national currency) taken by the authorities to influence autonomous transactions. For instance, if the currency of a country is under pressure in foreign exchange markets, the authorities may decide to prevent depreciation in their country’s currency by selling foreign exchange assets in support of the currency. This policy would result in a reduction of the country’s reserves.

Direct Investment

477. The direct investor is usually different from other investors because the direct investor seeks to have, on a lasting basis, an effective voice in the management of an enterprise (the direct investment enterprise) in which the direct investor’s investment is made. To achieve this purpose, the investor normally owns a significant percentage of the equity capital invested in the direct investment enterprise. In addition, the direct investor may provide other types of capital (such as loans and trade credits) and technical expertise to the direct investment enterprise. Because of this special relationship between the direct investor and the direct investment enterprise, direct investment capital flows often show characteristic behavior that differs from the flows of portfolio investment and other investment. For this reason, direct investment flows are recorded separately in the balance of payments.

Portfolio Investment

478. The portfolio investment category covers investment—other than investment classified as reserve assets or direct investment—in equities, other securities, and financial derivatives. Nonequity securities include bonds, bills, negotiable certificates of deposit, preference shares (except participating preference shares), bankers’ acceptances, and marketable promissory notes. Stocks and shares are examples of equities. Financial derivatives are secondary market instruments that give the holder a qualified right to receive an economic benefit in the form of cash or another primary financial instrument at some future point in time.

479. Portfolio investors are primarily concerned with the safety of their investment, the likelihood of an appreciation in the value of that investment, and the return they will obtain from their investment. If circumstances change, the portfolio investor—unlike the direct investor—can often easily shift the investment to another area.

Other Investment

480. Other investment is a residual category comprising all other kinds of financial transactions, including loans, trade credits, and bank deposits. The transactions included here are diverse and, for this reason, it is difficult to make further meaningful distinctions along functional lines.

Assets and Liabilities

481. There is no doubt that a distinction between assets and liabilities is important for analyzing a country’s international investment position. This distinction is important even for financial intermediaries that borrow and re-lend abroad the same funds because conditions (such as rates of interest and maturity) for the borrowing and lending are usually different. Therefore, these ostensibly offsetting flows may have different implications for the BOP. A strict distinction between assets and liabilities is less important for direct investment capital because of the related nature of the transactors. However, even within direct investment, the standard BOP classification allows for a distinction between assets and liabilities.

Type of Instrument

482. The method by which an investor chooses to make an investment—that is, the instrument of investment—is often important in BOP analysis. The many instruments available for investment may be divided into two broad categories: equity and debt. Equity instruments are those that entitle the holder to a share in the profits of the issuing enterprise or a claim on the residual value of the enterprise after all of the other liabilities of the enterprise have been met. Debt instruments, on the other hand, entitle the holder to a return that is not related to the profitability or net worth of the issuing enterprise.

483. The three main equity instruments are shares in incorporated enterprises, equity in unincorporated enterprises, and direct investors’ shares of the reinvested earnings of direct investment enterprises. Within debt instruments, the major subcategories are loans (including use of Fund credit), trade credits, currency and deposits, bonds and notes, money market instruments, and financial derivatives. While not debt instruments in the strictest sense (because there is no debtor associated with these instruments), monetary gold and SDRs are generally grouped with debt instruments in presentations of BOP and other related statistics.

Domestic Sector

484. The institutional sector of the domestic (resident) creditor is often a factor that influences financial transactions in assets. Likewise, the institutional sector of the debtor often influences financial transactions in liabilities. Accordingly, for portfolio investment and other investment, four sectors are distinguished in the BOP standard components: general government, monetary authorities, banks, and other. For direct investment, however, the domestic institutional sector is not particularly important for explaining the behavior of investments. Accordingly, direct investment transactions are not classified by sector in the standard components of the balance of payments. Monetary authorities can be presumed to be either directly or indirectly responsible for reserve asset transactions; therefore, sectoral classification is not required for these transactions.

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

486. The principle of classification by sector, which is specified in the BPM, is to identify the domestic creditor for assets and the domestic debtor for liabilities. The identification of assets by domestic creditor does not present any problems because the creditor is always the owner of an asset and thus one of the parties to transactions involving the asset. Therefore, for assets, sector attribution by creditor and by transactor coincides. However, this coincidence does not always apply in the case of liabilities. For example, a resident of Coonawarra purchases 40 units worth of 90-day government notes in the financial market of Hughesavia. Subsequently, a resident of Hughesavia purchases these notes from the resident of Coonawarra. The following transactions would be recorded in the balance of payments of Hughesavia:

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487. Entries appearing in the previous example show that a claim on a domestic debtor (the Hughesavian government) changes ownership from a nonresident creditor to a domestic creditor. The domestic debtor (the Hughesavian government) is not a party to the subsequent transaction between the nonresident investor and the resident of Hughesavia who acquires the claim. Nevertheless, according to the BPM, the sector of the debtor determines the classification of the transaction. The original nature of the liability is generally considered more significant than the identity of the present claim-holder. The second transaction in the example is attributed to the debtor in Hughesavia who issues the notes and not to the resident who acquires these securities from the nonresident investor.

488. Sectoral attribution of transactions in financial items should be interpreted quite strictly. Guarantees and financial intermediation (when the intermediary is not actually the legal creditor or debtor) undoutedly have an influence on investors. However, such factors do not constitute the primary motivation of those engaging in the transactions. A government guarantee for repayment of a loan to an enterprise may have a favorable impact on a lender. Nonetheless, the basic motivation for the transaction is the decision of the enterprise to borrow.

Long- and Short-Term Investments

489. The criterion used in the BPM for distinguishing between long- and short-term investments is the original contractual maturity. Long-term investment is defined as investment with an original contractual maturity of more than one year or an investment with no stated maturity (such as corporate equities). Short-term investment is defined as investment payable on demand or with an original contractual maturity of one year or less; short-term investment includes currency. The definitions of long- and short-term investments are not sufficient or satisfactory for distinguishing between long- and short-term movements. Often, the original maturity does not have much influence on the length of time a financial asset will be held. Nevertheless, it appears to be one of the factors that investors take into account with regard to certain instruments.

490. While a number of the innovations in financial markets have somewhat diminished the usefulness of classifying many of the BOP financial transactions by maturity, it is still seen as an important classification for the trade credit, loans, and other assets and liabilities components of other investment. Accordingly, it is recommended in the BPM that transactions in these instruments be classified in this way. However, for investment in other instruments, the maturity classification is not viewed as particularly useful and is not recommended.

Supplementary Classifications

491. In addition to the five primary classifications of financial transactions, there are—according to the BPM—two other classifications that can be used to analyze financial account transactions: liabilities constituting foreign authorities’ reserves (LCFAR) and exceptional financing transactions. However, as the BOP analysis that uses these classifications tends to be more specialized than analysis undertaken on the basis of other classifications, LCFAR and exceptional financing are not included in the BOP standard components. Instead, these classifications are shown as supplementary classifications.

Liabilities Constituting Foreign Authorities’ Reserves

492. A BOP analyst may wish to group certain liabilities with reserve assets if he or she considers these liabilities to perform a function similar to that of reserve assets. The relationship between most liabilities and reserve assets is, however, not always straightforward. Reserve assets may be used to perform more than one function, and the liabilities related to each of the functions may be different. It may also be difficult to identify the underlying causes of changes in certain liabilities. Therefore, the BPM recommendation is to identify any liability that constitutes a reserve asset from the point of view of the nonresident creditor. In certain cases, it may be very difficult—from the debtor’s point of view—to determine whether a creditor will classify a claim as part of reserve assets. For example, the central bank of Nostaw could purchase, through a broker, securities issued by a resident of Namdarb and place these securities in the reserve assets of Nostaw. It would be difficult for the BOP compiler of Namdarb to determine whether these securities are held as reserve assets by Nostaw. As a practical matter, BOP compilers in debtor countries can follow a rule of thumb to identify liabilities that constitute foreign authorities’ reserves.

493. The rule of thumb is based on the assumption that a nonresident creditor will probably classify as reserve assets any liability of the compiling economy that is:

repayable on demand or in the short-term (i.e., marketable) or that the debtor is prepared to redeem on short notice;

repayable in a form that the debtor regards as a reserve asset;

owed to a central bank, central government, or other agency (except a public nonmonetary enterprise) of the central authority.

All of these conditions need not be met or be simultaneously applicable. One of the following two rules is sometimes applied. The overwhelming majority of monetary assets (that is, assets that can be used to make payments) owned by governmental authorities will be reserve assets. Therefore, in the absence of information to the contrary, the debtor economy could consider any liabilities to foreign central authorities to be classified as liabilities constituting foreign authorities’ reserves. Alternatively, the debtor economy could decide to classify as LCFAR only its liabilities to foreign monetary authorities. This decision could be made if the the available evidence suggests that a significant portion of the debtor economy’s liabilities to other foreign central authorities is comprised of types of assets that are not likely to constitute part of the reserve assets of the creditor economies.17

494. According to the BPM, liabilities that constitute reserve assets of the creditor economy are shown as a supplementary classification, even though the compiling country itself (the debtor) may not, in fact, regard some or any of the liabilities as an additional means of financing its BOP deficit or as an offset to its reserve assets.

Exceptional Financing

495. Exceptional financing transactions consist of any arrangements (other than the use of reserve assets, Fund credit and loans from the Fund, and LCFARs) made by the authorities of an economy to finance BOP imbalances. The category of exceptional financing transactions therefore covers BOP financing items not included in categories for reserve assets and liabilities constituting foreign authorities’ reserves. There are three main forms of exceptional financing: external borrowing, repayment of arrears, and forgiveness of debt.

External Borrowing

496. Instead of using reserve assets to finance a BOP deficit, authorities may engage in external borrowing for that purpose. For example, to bolster foreign exchange reserves, the central bank of a country borrows 100 units on a short-term basis. The BOP entries would be:

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In this and other examples of the recording of exceptional financing transactions, the exceptional financing element of the transaction is classified according to the supplementary exceptional financing classification rather than the BOP standard components classification.

Both entries are shown “below the line” because the borrowing is not an autonomous transaction affecting the BOP deficit of the country but a means of financing the deficit.

497. The main practical problem in classifying official borrowing is the necessity of distinguishing between BOP financing and project financing. (The latter is always shown “above the line” as a factor contributing to the overall BOP position of the country.) No objective criterion, such as original maturity or sector of transactor, can be depended upon to provide the desired distinction. Rather, the purpose of the borrowing must be determined on the basis of available information.

498. Some borrowings that are encouraged or inspired by governmental authorities but do not constitute official liabilities may nonetheless be regarded as exceptional financing transactions. For example, authorities may use commercial banks to conduct external borrowing operations. When the proceeds of commercial bank borrowings are effectively subject to the control of the authorities, the borrowings should be categorized as exceptional financing. (Such proceeds are analogous to reserve assets legally owned by commercial banks but under the effective control of authorities and therefore considered part of official reserves.) Compilers must determine whether authorities are exercising control over proceeds and whether the borrowings were undertaken for the purpose of BOP financing. The determination may be very difficult to make and, in some situations, quite important because of the large movements that sometimes occur in commercial banking funds.

499. Without becoming the legal debtors, governmental authorities may also encourage borrowing abroad by offering exchange rate guarantees or other inducements to public enterprises, local governments, or the private sector. The authorities may even state that their purpose is the improvement of the country’s BOP position. The existence of such a policy is certainly a relevant fact to be noted in appraising a country’s position. Nevertheless, official inducement is rarely the only reason that such borrowing takes place. Therefore, treating this debt as official financing exaggerates the influence that authorities can exert in an indirect manner. Moreover, most financial flows are likely to be affected by actions of the authorities, and those actions are no doubt taken with the BOP impact in mind. However, the indirect BOP effects cannot be quantified, and cases do arise in which an inducement offered by authorities seems the most reasonable explanation for a certain financial inflow. In that circumstance, the borrowing should undoubtedly be shown “below the line” in measuring the balance of payments.

500. The repayment of a loan is not usually a discretionary act on the part of the debtor. Therefore, with one exception, only original drawings on loans constitute exceptional financing transactions. The exception occurs when, for balance of payments reasons, loan repayments are made on schedules that differ from predetermined schedules. If authorities choose, with or without the consent of the creditor, not to make a loan repayment on schedule, the obligation is treated as if it had in fact been satisfied and a new, replacement obligation is created. Specifically, a debit entry for reduction of the liability is made “above the line,” and an offsetting credit entry for an increase in official borrowing is made in exceptional financing. Similarly, a loan repayment made by authorities in advance of the due date is sometimes shown as exceptional financing. If the loan prepayment is made for other than BOP purposes (to improve the debtor’s standing in the credit market, for example), the prepayment is not included in exceptional financing transactions.

501. If the short-term borrowing described in paragraph 496 were repaid on time and if interest of 10 units were charged, entries for the repayment would be:

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Thus, even though the drawing of the loan was shown “below the line” as an exceptional financing transaction, repayment of the loan is shown “above the line.”

Payments in Arrears

502. Payments in arrears are simply payments that are not made when due. According to the BPM, such payments are recorded as if the payments were made, and new liabilities are created for the outstanding debts. Payments in arrears are included in exceptional financing transactions if monetary authorities fail to provide the necessary foreign exchange but not if the payments are in arrears because a debtor refuses or is unable to pay in national currency.

503. For example, in period 1, a manufacturer imports some materials on credit. In period 2, when the debt falls due, the manufacturer tries to convert his national currency into foreign exchange to make the payment. The country is experiencing BOP difficulties, and the central bank cannot allocate the necessary foreign exchange. The payment, therefore, is not made. Principal and interest due amount to 150 units and 10 units, respectively. Entries in the balance of payments would be:

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504. As with external borrowing, debt repayments are included in exceptional financing transactions only if the repayments are unscheduled. Such is usually the case for payments in arrears. To extend the previous example—in period 3, the exchange restrictions are lifted and the repayment is made. The entries would be:

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505. When payments are in arrears, debts are often renegotiated and new contracts arranged. Under such circumstances, changes in the nature of the exceptional financing are recorded as repayments of the payments in arrears and drawings of new loans. If the debt were rescheduled for payment over two years, the entries would be:

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New loan repayments, if made according to schedule, are shown “above the line” in the periods in which the repayments are made.

506. If repayments other than those scheduled for the current period are rescheduled, only the rescheduling of the repayment for the current period is shown as exceptional financing. The remainder of the rescheduled repayments are shown “above the line” as the repayment of the old liability and the creation of a new one.

Debt Forgiveness

507. Occasionally, a creditor will forgive all, or part, of the debt of a debtor in a country experiencing BOP problems. This debt forgiveness will also affect the exceptional financing category. The liability is reduced “above the line” for the amount forgiven. That part of the offsetting capital transfer relating to the scheduled repayment for the current period is shown as part of exceptional financing transactions. The remainder of the transfer is shown “above the line.”

Other Exceptional Financing Transactions

508. In addition to the three types discussed in previous paragraphs, there are other types of transactions (such as debt-equity swaps and grants received from Fund subsidy accounts) that could be considered exceptional financing transactions. Additional details on these transactions may be found in chapter 22 of the BPM.