1. Saving-investment process analysis

Perhaps the most pervasive structure used by flow-of-funds analysts is the saving-investment process. This is the process by which saving is transformed into ultimate lending, whence it passes through various financial channels to ultimate borrowing, and then into real investment. An important feature of the scheme is the insertion of financial institutions in the center between ultimate lending and ultimate borrowing in order to portray their role as financial intermediaries.

The way in which the details of the process are worked into the scheme will vary with the analyst. One such scheme is shown in Chart 1, which is designed to reveal the domestic financing process. ¹/ Private saving appears at the right of the chart and as the arrows indicate is either placed internally into real investment or is placed into ultimate lending (that is, used to acquire claims). This claims acquisition may take any of three major forms. They can be claims of financial institutions, thus placing funds with these institutions; they can be private credit instruments, thus passing funds directly through these markets to finance private ultimate borrowing; they can be federal securities, thus advancing funds in this market. In turn, financial institutions (bank or nonbank), in lending out the funds placed with them, must acquire either federal securities or private claims. Finally, private ultimate borrowing assembles the borrowing from banks, nonbanks, and ultimate lenders, which together with internal financing provides the funds to finance real investment.

View Full Size

Saving-Investment Process Scheme

Citation: IMF Working Papers 1989, 095; 10.5089/9781451950267.001.A001

Note: Codes for all flows refer to cells in Exhibit IIIB1/ (C 1) + (D 1) + (E 1)2/ (A 2) - (C 1) - (D 1) - (El)3/ (E 4) - (C 3) - (D 3)

• Download Figure
• Download figure as PowerPoint slide

Federal ultimate borrowing in Chart 1 also assembles the lending of the various sectors and provides the financing for the federal deficit. Here, however, there is also a “feedback” arrow at the top of the chart. This is a somewhat awkward expression of the fact that governments often borrow not to finance the government deficit, narrowly defined, but to on-lend the funds. In developing countries this is a key form of finance for government enterprises. In this way general government becomes a kind of financial intermediary.

We note that, in effect, on Chart 1 the saving-investment account is split down the middle, its two halves separated to the right and left, and the financial system inserted between. As a result, we see the placement of saving and the financing of investment as two distinct activities. But they necessarily articulate; whatever saving is placed with the financial system necessarily provides the financing of investment. Further, because saving and real investment are both nonfinancial variables, the financial markets are linked to the real economy at each end of the scheme.

This scheme is tied closely to flow-of-funds data because the various flow arrows can be measured by the cells in a flow-of-funds matrix. In this case the corresponding matrix is presented in Table 3. The codes on the various Chart 1 arrows refer to the rows and columns of Table 3. We observe that each of the (underlined) major flows oh the matrix is represented in the scheme. The saving-investment process scheme thus provides a means of interpreting the flow movements in the matrix over time.

Table 3.

Condensed Flow-of-Funds Matrix

^1/Households, nonprofit, enterprises, provincial and local government, and rest-of-world.

^2/Central bank, commercial banks, treasury monetary funds.

^3/Currency and demand deposits, time and saving accounts, saving via life insurance and pension funds.

Table 3.

Condensed Flow-of-Funds Matrix

	Private Sector 1/		Federal Government		Banking Sector 2/		Nonbank Financial Institutions		All Sectors
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)
	u	s	u	a	u	s	u	s	u	s
A. Saving		142.7	3.8			1.3		1.5	3.8	145.5
B. Real Investment	141.0				.3		.4		141.7
C. Intermediary Claims 3/	42.2		2.1			19.1		25.2	44.3	44.3
D. Private Claims	4.6	51.7	1.9		16.8		28.4		51.7	51.7
E. Federal Securities	2.6			6.5	2.5		1.4		6.5	6.5
F. Misc.& Discrep., net	4.0			1.3	1.3	.5	2.8	6.3	8.1	8.1
G. Total	194.4	194.4	7.8	7.8	20.9	20.9	33.0	33.0	256.1	256.1

^1/Households, nonprofit, enterprises, provincial and local government, and rest-of-world.

^2/Central bank, commercial banks, treasury monetary funds.

^3/Currency and demand deposits, time and saving accounts, saving via life insurance and pension funds.

View Table

Table 3.

Condensed Flow-of-Funds Matrix

	Private Sector 1/		Federal Government		Banking Sector 2/		Nonbank Financial Institutions		All Sectors
	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)	(9)	(10)
	u	s	u	a	u	s	u	s	u	s
A. Saving		142.7	3.8			1.3		1.5	3.8	145.5
B. Real Investment	141.0				.3		.4		141.7
C. Intermediary Claims 3/	42.2		2.1			19.1		25.2	44.3	44.3
D. Private Claims	4.6	51.7	1.9		16.8		28.4		51.7	51.7
E. Federal Securities	2.6			6.5	2.5		1.4		6.5	6.5
F. Misc.& Discrep., net	4.0			1.3	1.3	.5	2.8	6.3	8.1	8.1
G. Total	194.4	194.4	7.8	7.8	20.9	20.9	33.0	33.0	256.1	256.1

^1/Households, nonprofit, enterprises, provincial and local government, and rest-of-world.

^2/Central bank, commercial banks, treasury monetary funds.

^3/Currency and demand deposits, time and saving accounts, saving via life insurance and pension funds.

In using the scheme we often find the causation moving from left to right, counter to the arrows. For example, it is often the case that fluctuations in real investment or the federal deficit will result in fluctuations in various forms of borrowing. Chart 1 indicates how the impact of these borrowing fluctuations on financial institutions and markets can be traced. We see the advantage of having available in the flow-of-funds accounts the immediate forms of borrowing by each sector and not just the ultimate “financing” of the saving figures. With added detail the scheme can become a very effective vehicle for our understanding of how capital formation or the federal deficit is financed.

2. Policy problem analysis in developing countries

We shall here pose some key financial planning problems regularly faced by developing countries and shall briefly indicate their relationship to the flow-of-funds accounts. (1) Will there be an adequate amount of foreign exchange? In the first instance, of course, this question implies an analysis of the rest-of-world account. Given the balance of payments current deficit (rest-of-world saving), the foreign exchange balance is protected by foreign borrowing. To judge its extent an analysis of the domestic borrowers’ financing is needed (private and public enterprises, financial institutions, and general government). (2) How will the central government deficit be financed? The government deficit (gross capital formation less gross saving) plus its lending will be financed by the issue of government debt. The placement of these issues is analyzed by moving horizontally across the flow-of-funds matrix. Estimating the other sectors’ capacities to absorb the issues requires sector analysis of the major debt buyers. And the absorption by the banking system may imply further money supply expansion or the crowding out of private borrowers. (3) How will the major government enterprises be financed and by whom? Government enterprise capital formation will be financed first by the enterprises’ own saving (that is, their operating surpluses). Beyond this their major sources of funds will be government loans, borrowing from abroad, and borrowing from commercial banks. The volume of this last is of special interest because of the possibility again of crowding out private borrowers.

In all three of these policy questions we note that answers require an impact analysis on various sectors and/or types of transaction. It is the articulation of the accounts within the flow-of-funds matrix that enables us to seek and judge the answers.

3. Financial projections and programming

The essence of a flow-of-funds projection is a matrix for some future time period. Such projections can be used for a variety of purposes. One would be to test the consistency of a number of separately prepared sector or market forecasts. Another would be to develop a consistent view of the financial flow implications of a particular set of assumptions about future events. A third might be used by the planners in a developing country to examine the implications of parts of an economic plan.

For example, consider a projection of Table 1. A developing country might have sector capital formation and saving data from a tentative plan formulation. It might then impose certain constraining balance of payments estimates. The interior of the matrix could be projected under these constraints in order to work out the implications for domestic finance. The projection might well be able to identify certain types of credit shortages or the amount of necessary monetary expansion.

The projection of a more elaborate matrix—of some 10 sectors and 20 or more financial transaction types—has for many years been a regular part of monetary and credit policymaking at the central bank in the United States. In a series of iterations, the judgmental forecasts of numerous financial market and national account specialists in the research division are used to modify an extrapolated matrix. At the same time, monetary policy implementation and impact are gradually worked into the projection. In the end the exercise provides a detailed statistical picture of future financial flows that is closely integrated with the prepared policy position to be placed before the governing board.

A sophisticated illustration can be drawn from the type of financial programming engaged in by the Fund in the design of adjustment programs. The policy packages of these programs aim primarily at establishing a viable balance of payments position over the medium term. An important element of this type of programming is an analysis that traces major credit demands to a focus on the banking system, even on the central bank itself. First, a balance of payments target is established and the implications of projected imports, exports, and foreign borrowing for foreign exchange reserves are calculated. The pathway of balance of payments impact is via the movement in the foreign exchange reserves to the banking system. And because the central bank is assumed to be the residual buyer of government debt, public finance needs can ultimately also be traced to the banking system. Given an independent estimate of the appropriate currency and deposit expansion, the credit extension available to the private domestic sector can be calculated residually and its adequacy can be judged in the light of financing needs. Iterations of this analysis lead to the firming of the various policy objectives. Until now, financial programming has generally been done without the help of formal flow-of-funds projections, but it is evident that they would be a useful complement to the analysis.

4. Long-run development of financial institutions

Flow-of-funds projections need not be merely short-run; they can cover 5-year plan periods or even 15- to 20-year financial developments. In this latter case the projection may reveal, or be required to take into account, various institutional developments in the financial system. Thus, shifts in the main sectors carrying out capital formation will be accompanied by changes in the types and composition of claims that the financial system will be asked to absorb. Similarly, as some households become more affluent and sophisticated, the supply of funds moving into the various financial markets will alter. Wealthy households may wish to deal regularly in equity share markets or to place funds into life insurance and pension saving. These changing borrower and lender needs will be pressures for change in the financial institutions and the markets that are their financial channels. An efficient group of financial institutions is one that can comfortably absorb the varieties of instruments offered to it by borrowers and can offer a suitable variety of claims to meet the needs of lenders. The long-run changes in these borrower and lender needs will thus suggest appropriate institutional growth, and policies can be designed for its promotion.

One or two examples from developing countries may provide illustrations. We should keep it in mind that well-organized open markets for financial instruments may not be common in developing circumstances. A country may wish to place more of its government debt issues domestically and/or less with its banking system. The situation may be appropriate for the design of a small-saver instrument that can be widely distributed and that would carry a very high rate of return in the interest of saving mobilization. Or we might consider a country in which liquid business deposits are stored in foreign assets. Such accumulation represents lending to the rest-of-world and may be part of a pattern in which the rest-of-world is being treated as a financial intermediary, accepting short-term funds and lending back long-term funds. It may be desirable to attract the short-term flow to the domestic economy. What is suggested is the need for a secure, liquid financial instrument—for example, a treasury bill—with an attractive enough return to compete with foreign instruments. The flow-of-funds projection can incorporate such new growth patterns into its flows and can help us to judge their impact on other markets and sectors.

In concluding this section, it is only fair that we raise a question. Given all these promising applications, why has flow-of-funds analysis not become more prominent during the past 30 years? We can only speculate. On the academic side, for some reason, flow-of-funds analysis—unlike input/output analysis—seems not to have developed a strong tradition. And, on the other hand, many applied economists have apparently not sensed how they might make use of the system. Or, perhaps, much flow-of-funds analysis is so informal as to remain hidden, as in much of the Fund’s work. Nevertheless, given the growing importance of financial problems for most of the countries of the world, we believe the system’s potential remains great.

We turn, in the next section, to an examination of the relation of flow-of-funds accounts to the SNA, and, finally, in Section IV, to a demonstration that flow-of-funds matrices such as Tables 1 and 2 are within easy grasp of the nations of the world.

1. Finance and the evolution of the SNA

As background to a consideration of the relationship between the flow-of-funds accounts and the SNA, it will be useful to briefly review the evolution of the SNA itself over the last 35 years. For this purpose we propose to comment on the so-called standard accounts as they first appear in the 1953 version (SNA 1953), ²/ then as they appear in the 1968 version (SNA 1968), ^3/ and finally as they might appear in the revision under consideration which we label SNA 1990. We shall discuss several key features of each phase of the evolution.

c. Types of national accounts data presently submitted

It is time to pause in our evolutionary survey of the standard SNA systems—before we project forward to SNA 1990—and address a somewhat different question. We have been tracing the UN schemes of what was desirable in social accounting data. We need also to observe what has been happening in practice over the past 35 years. One way of doing this is to look at what types of data the countries of the world are able to submit for the UN’s compendium of national accounts. ^7/ Table 4 summarizes a recent such survey.

Table 4.

Major Types of National Accounts Data Reported in United Nations Compilation for 1983 ^1/

(146 Countries Reporting in accordance with UN-SNA.)

^1/From United Nations, National Accounts Statistics: Main Aggregates and Detailed Tables, 1983. All tables for which more than 50% of the countries reported either current or back data are included here.

Table 4.

Major Types of National Accounts Data Reported in United Nations Compilation for 1983 ^1/

(146 Countries Reporting in accordance with UN-SNA.)

	% of Countries Reporting:
	Current Data	Current or Back Data
1.1 Expenditures on the gross domestic product (current prices)	53%	98%
1.2 Expenditures on the gross domestic product (constant prices)	48%	73%
1.3 Cost components of the gross domestic product	46%	84%
1.4 General government current receipts and expenditures, summary	24%	58%
1.7 External transactions on current account, summary	38%	73%
1.8 Capital transactions of the nation, summary (saving and capital formation)	37%	62%
1.10 Gross domestic product by kind of activity (current prices)	49%	94%
1.11 Gross domestic product by kind of activity (constant prices)	49%	76%
1.12 Relations among national accounting aggregates	50%	82%

^1/From United Nations, National Accounts Statistics: Main Aggregates and Detailed Tables, 1983. All tables for which more than 50% of the countries reported either current or back data are included here.

View Table

Table 4.

Major Types of National Accounts Data Reported in United Nations Compilation for 1983 ^1/

(146 Countries Reporting in accordance with UN-SNA.)

	% of Countries Reporting:
	Current Data	Current or Back Data
1.1 Expenditures on the gross domestic product (current prices)	53%	98%
1.2 Expenditures on the gross domestic product (constant prices)	48%	73%
1.3 Cost components of the gross domestic product	46%	84%
1.4 General government current receipts and expenditures, summary	24%	58%
1.7 External transactions on current account, summary	38%	73%
1.8 Capital transactions of the nation, summary (saving and capital formation)	37%	62%
1.10 Gross domestic product by kind of activity (current prices)	49%	94%
1.11 Gross domestic product by kind of activity (constant prices)	49%	76%
1.12 Relations among national accounting aggregates	50%	82%

^1/From United Nations, National Accounts Statistics: Main Aggregates and Detailed Tables, 1983. All tables for which more than 50% of the countries reported either current or back data are included here.

We see in Table 4 strong evidence that the early SNA 1953 scheme has taken hold in practice. Almost all of the 146 reporting countries are producing a GDP account (GDP, 1.1, and income, 1.3), although it is true that for many countries these data are not yet current. Most also provide the GDP by industry (1.10) and in constant prices (1.2 and 1.11). More than half are able in time to add current accounts for general government (1.4) and the rest-of-world (1.7), and also a capital formation (saving-investment) account (1.8). These four accounts are four of the five needed for the closed SNA 1953 system referred to above in which the capital reconciliation accounts are merged with the domestic capital formation account to form a saving-investment account. About a quarter of the reporting countries are able to add a household income and outlay account (not shown in table) and form the complete system.

Table 4 reports 1983 data, but its source compendium was published in 1986—more than 15 years after the publication of SNA 1968. Do we find evidence of its impact? The reporting scheme does not include SNA 1968 Account 3: National Disposable Income and Its Appropriation (the consolidated income and outlay) or Account 5: Capital Finance (the consolidated capital finance). So, apparently, the four “Consolidated Accounts for the Nation” as a standard scheme did not take hold. If we inquire about the deconsolidated 12-sector scheme, we find that only a handful of countries—perhaps 10 percent and largely in Europe—are able to report sector income and outlay accounts at the level of detail of SNA 1968, and a still smaller handful—perhaps 5 percent—are able to report detailed sector capital finance accounts. We are thus forced to conclude that SNA 1968 is not widely used as a system of standard accounts.

2. The flow-of-funds representation in the SNA

What, then, is the upshot of our vision of the about-to-be-created SNA 1990 standard accounts? If we are right about the main lesson of SNA 1968, the new accounts should not be far ahead of the current statistical accomplishment of most countries. To be serviceable, the new accounts should be feasible next steps in statistical development. In addition, our analysis has stressed the need to maintain sector accounts in the standard central system. And for effective financial analysis we must have sector capital finance accounts and the separate sectoring of financial institutions. Are these objectives compatible? We believe so.

In sketching a suggested new system, let us begin where a good many countries presently are: they have a gross product and income account, income and outlay accounts for the rest-of-world, general government, and households (including within it nonprofit institutions), and a consolidated capital formation (saving-investment) account. Let us move toward the SNA 1968 12-account scheme but keep in mind, at the same time, the need for simplification.

First, we envision a vertical extension of the rest-of-world account to derive its capital finance account and a similar extension for general government. The development of full balance of payments and government finance data for most countries during the past few decades should make this a relatively easy step. ^8/

Three capital finance accounts remain: for nonfinancial enterprises, for financial institutions, and for households, etc. (including nonprofit institutions). Let us imagine them lumped together into a single residual capital finance account. For analytical purposes it is essential to estimate and break out an account for at least a large share of financial institutions. For many countries this can be done via an account for the monetary and banking system alone. And these basic data are available for almost all countries. As we shall note below, it is analytically less essential to break nonfinancial enterprises away from households, etc., but such a step would in any event have to await the compilation of balance sheet data for substantial groups of enterprises. If SNA 1990 wishes to emphasize feasibility, a first-stage version of it might contain (1) a monetary and banking system capital finance account and (2) a catch-all other domestic sector capital finance account.

Let us consider the types of financial transaction to be used. We have suggested that much of the difficulty in producing sector capital finance accounts may stem from the complexity of the classification scheme for financial claims. For SNA 1990 we suggest first a greatly condensed scheme consisting of four broad financial categories:

A. Foreign assets

B. Currency and deposits

C. Bills, bonds, and loans

D. Other claims.

The existing thirteen-claim categories can, of course, be allocated to these headings. ^9/ Our purpose here is only in part simplification. In many applications foreign assets (category A), properly defined, will consist largely of net foreign exchange. And currency and deposits (category B) is closely related to money, broadly defined. So these categories are likely to be of analytical use.

To understand why category C as a whole might not be very useful, let us consider such an item on the various SNA 1968 capital finance accounts. Each of the sectors might accumulate and each of them might issue these instruments. In these circumstances it would generally not be possible to identify who is acquiring from whom (that is, who is financing whom). And we are probably no better off if we narrow the category to bonds, long-term. On the other hand let us consider the category of central government bond issues. Here we have only one sector issuing the instrument. In the absence of secondary market transactions, we know the acquiring sector is financing the government. Even with secondary market transactions, there is a much better chance with government bond issues of being able to identify who is financing whom. And that is the central objective in financial flow tracing. To generalize, the most useful financial transaction types will be those designed so as to have only one or two sectors issuing or only one or two sectors acquiring the instrument. Category C needs to be broken down.

This discussion of the most useful categories of financial transaction types for a flow-of-funds matrix is related to Table 24 in SNA 1968 (see Appendix III). There we find the same 13 types of claim that appear in the sector capital finance accounts, but within each of the 13 types we also find institutional sector detail to indicate sectors bearing the liabilities for that particular claim. ^11/ The line for a subcategory such as 5iii (bonds, long-term, liability of the central government) would have a single issue figure under central government off to the right and figures for the various sector acquisitions off to the left. Given such detail, it is clear that the category central government debt could be assembled as the sum of 4iii, 5iii, 7iv, and 8iii—that is, the sum of all the central government liability components we wish to define into central government debt. Alternatively, if we wished to build up data for the 13 basic claim types we would have to reverse this process, allocating central government debt to the Table 24 subcategories. The Table 24 analysis thus shows us how we can conceptually relate the 13 basic claim types both to basic data sources and to analytically significant categories.

Perhaps the simplest effective breakdown for the bills, bonds, and loans that comprise Category C would be into central government debt, bank loans, and other, but most countries should consider at least the following:

C. Bills, bonds, and loans

1. Central government debt

2. Central government loans

3. Central bank advances

4. Financial institution loans and advances

5. Other debt.

This or a similar list should be adopted for the SNA 1990 standard accounts to suggest the type of detail that countries would find analytically useful. It will be remembered that these are the types of claims in Tables 1 and 2, above, that we used to indicate inter-sectoral tracing of financial flows.

Let us summarize our position in regard to the financial transaction types presented in the SNA 1968 sector capital finance accounts. To produce these accounts as presented requires a high level of financial detail—detail at the level of the subcategories of Table 24, which is generally available only in the most statistically advanced countries. Further, the transaction types in these accounts are not very effective in financial flow analysis: they provide little sector-to-sector identification of flows. The alternative classification that we have presented is simpler and, as we shall show in Section IV, below, can be derived directly from data available in almost all countries. And it is a scheme that is demonstrably useful in financial flow analysis.

In conclusion, we feel that the flow-of-funds accounts should be represented in SNA 1990 by a closed set of condensed capital finance accounts. We have suggested such accounts for the rest-of-world, general government, the monetary and banking sector, and the other domestic sector. To form a standard system we could add to these four capital finance accounts a gross product and income account and three income/outlay accounts (rest-of-world, general government, and households, etc., including nonprofit institutions). ^11/ These eight accounts could form a closed, interlocking system—a system that in its condensed form is achievable for most countries in the next decade or so. This system could be a standard first stage leading to a later more detailed standard system.

If financial analysis is to have an improved social accounting data base, increased statistical effort must focus on the sector capital finance accounts. To help in this effort these accounts must have a prominent place in the simplest, most central, UN standard accounts formulation.

3. Flow-of-funds accounts, the Fund’s GFS, BOP, and MBS, and the harmonization issue

We have taken the view that the hope for an early statistical realization of sector capital finance accounts rests importantly on early development of such accounts for the government, the rest-of-world, and the monetary and banking sectors. In order to serve the social accounting purpose, they must, of course, fit into a matrix. This means that at the technical level there must be consistent sector coverage and consistent accounting treatment of transactions within and (especially) across sectors. This is our understanding of what harmonization means. Harmonization among the three Fund systems: government finance statistics (GFS), balance of payments statistics (BOP), and money and banking statistics (MBS), and between each of these and SNA 1990, becomes an issue because GFS, BOP, and MBS (or closely related country data) are likely to be basic source material for the new flow-of- funds accounts.

Each of the three Fund systems has had international comparability as a goal. Each has provided useful compilations of data. In this process some member countries have altered their accounts in the direction of the respective Fund conventions. To the extent that the Fund’s standard systems are not harmonized, such alterations may make the local articulation of these accounts more difficult. There is to some extent an inherent conflict between international comparability and local articulation of sector accounts, but this is especially so if the international standards are not harmonious.

If GFS, BOP, and MBS had been developed for systematic social accounting purposes, their instruction manuals might well now provide uniform and consistent measurement conventions. However, these systems did not come about in this way. They were created within the Fund over a. considerable period, each guided by the analytical needs of a particular group of specialists. It is true that steps toward harmonization were taken as the later systems were developed and the earlier ones revised. But differences remain, and now that the differing measurement conventions have taken hold among analysts both within and outside the Fund, changing them will be difficult. Perhaps over time the analytical advantages of a social accounting approach may be persuasive in moving toward harmonization: after all, the problems dealt with by the Fund usually deal with the interrelationships among these three sectors. But at present the differing needs of each system’s primary users may continue to impede a true harmonization.

SNA 1990, on the other hand, is constrained to build full consistency into its system. In this situation, what is to be done? Of course we should harmonize to the extent possible. But wisdom may suggest stressing the construction of standard reconciliation or bridge tables linking the key time series in the four systems to permit analysts to move from one system to another in both estimation and analysis. We understand such an effort to be under way. It should be given urgent priority because such tables could greatly facilitate the construction of SNA by individual countries.

Curiously, the single most important harmonization issue for the SNA seems likely to be overlooked entirely. In order to comprise a closed system, all the sector accounts of that system must be in the same unit of account, the same currency. Thus, it is essential to SNA that the rest-of-world account be expressed in the local currency. But this in turn means that there must be a balance of payments account in the local currency as a data source. The increasing trend throughout the world is to do balance of payments analysis in some international currency such as U.S. dollars. The loss of any analytical connection with domestic sector data is apparently less important than the fact that payments to abroad must be made in an international currency. In countries without local currency balance of payments data, or where such data are of low quality, the Fund could aid the development of the SNA accounts by assuring the early compilation or improvement of these data. ^12/

We shall not here deal with the many technical aspects of the harmonization issue, but we shall try to offer an approach to these problems, one that suggests a rough ordering of priorities. We suggest that attention first be focused on the definitions of sector coverage for the major domestic sectors and the rest-of-world. The remaining issues here are relatively minor and, with compromise, true consistency should be achievable. And complete harmony on major sector definitions would greatly simplify the conversion of BOP, GFS, or MBS data into the corresponding SNA capital finance accounts.

Our second priority for harmonization would be toward standardization of the financial/nonfinancial line in each sector account for the four systems. Conceptually, entries indicating the exchange of goods, services, and transfers lie above this line in each sector account, and entries recording the exchange of claims (including cash balances) lie below this line. In SNA 1968 the line is marked by the net lending item in each capital finance account, which, broadly, equals the difference between gross saving and gross capital formation for each sector. ^13/ In this harmonization we would be trying to standardize the definition of the deficit/surplus of each sector; conceptually, the algebraic sum of these items across all sectors (including the rest-of-world) should be zero. Drawing this line is an essential feature of flow-of-funds accounts.

For example, in GFS, although lending minus repayments is separated out from other government expenditure and revenue, it is for analytical purposes located above the overall deficit/surplus line (that is, as part of the net aggregate that is to be financed by government debt issue). Although this practice cannot be accepted by SNA, the separate identification of the item makes the shift of these financial transactions to below the deficit line simple. This applies, of course, providing the technical specifications for the lending minus repayments total are in harmony with those for the other sectors. This harmonization is an example of our second priority focus.

Finally, we approach the complexities of the harmonization of the various types of financial transactions. Here, too, we suggest a “closing in on the area” strategy. We urge first the standardization across sectors of broad groups of claims such as the four groups we suggested by way of simplifying the capital finance account (see Section III.2). In this way there are far fewer borderlines to define. Beyond this we can only urge the wisdom of the view that in these matters it is necessary to have some agreed upon convention; which particular convention is less important. And where agreement is not possible, we should take on the obligation of providing reconciliations.

Let us consider just one key example in this category. It is our hope that harmonization can be effected in the area of foreign exchange, and, in particular, the area of international reserves. The flow in these net foreign assets appears only in the monetary sector and the rest-of-world sector accounts. The analytical purpose of the identification of these reserves—a key part of the means of payment for international transactions—is broadly the same for users of both BOP and MBS. Furthermore, both estimates generally rely on the same (monetary sector) sources for data. To a practitioner there would seem to be no reason for differences in these flows where they are expressed in the local currency unit. At minimum, we should have a clear reconciliation.

4. Balances, flows, and valuation changes

About a decade ago the standard accounts of SNA 1968 were extended in the Guidelines ^14/ to add a system of balance sheet and reconciliation accounts to the capital finance accounts. The construction of national and sectoral balance sheets and reconciliation accounts is in general envisioned as a stage beyond the construction of sectoral capital finance accounts (that is, flow-of-funds accounts). Nevertheless, because flow estimates are often derived from balance sheet increments, the two areas appear to have a substantial overlap and it is this overlap that we here wish to explore.

From an accounting viewpoint, asset and liability balances change either as a result of transactions, which are encompassed in the flow measure, or as a result of revaluations—that is, write-ups or write-downs of the asset or liability valuations. This principle is embodied in the definition of the reconciliation accounts which include all the differences between opening and closing balance sheet accounts that are not covered by the flows in the capital finance accounts. That is, the reconciliation accounts will consist largely of revaluations of balance sheet items. ^15/

In general, the Guidelines call for nonfinancial assets on the balance sheets to be valued at current market values. This rule makes large annual revaluations of tangible assets highly likely; and since the companion entry to every revaluation is a corresponding change in the transactor’s net worth, we are assured of large and frequent revaluations in sector equities. The situation differs dramatically, however, when we consider financial assets. With only three exceptions, the Guidelines call for these assets to be valued at nominal or face values. And these financial assets—so-called fixed-claim assets—are similarly valued as liabilities. The upshot of these rules is that much of the array of claims on the flow-of-funds matrix is not subject to regular revaluations owing to asset price changes.

The exceptions to the use of nominal values for financial assets are made in the cases of: (1) gold, (2) long-term bonds, and (3) corporate equity securities. Current market valuations are proposed for all three of the above. Market valuations are also proposed for long-term bonds and corporate equity securities on the liability side of the balance sheet. Thus, revaluations are to be expected in these three items. The Guidelines also allow for another important type of revaluation. The foreign assets category will be subject to revaluation if the local balance sheet convention is to show the local currency equivalent of the foreign exchange that is receivable or payable on the claim. In all, we are alerted to three types of flow-of-funds claims in which revaluations are likely to play a role in the balance sheet/reconciliation account scheme: (1) corporate equity securities, (2) long term bonds, and (3) foreign assets (including gold). ^16/

Let us now return to the situation of the implementation not of balance sheets and reconciliation accounts but merely of the capital finance accounts themselves. Our problem will be reduced to removing revaluations that we pick up when we estimate flows from balance sheet increments. To consider it we must anticipate some of the results of our discussion below of estimating procedures. Of the main sectors we will estimate first only the accounts for the financial sectors will be estimated from balance sheets. And the valuation conventions on these balance sheets will be near enough to face values so that the increments will be good approximations of the actual flows for most items. However, if long-term bonds are a substantial portfolio item, and the balance sheets value them at market values, removal of the revaluations will be in order. Finally, we may have difficulty reconciling the flow in net foreign exchange, to the corresponding flow as shown in the balance of payments. And valuation changes may be at the heart of this matter. This last is the harmonization issue that we referred to above.

At a later stage in the implementation, balance sheets of enterprises—both government and private—will be used as sources. Revaluations of fixed assets as well as other items on the balance sheet are to be found here and can probably be avoided in flow estimates only by a case-by-case scrutiny of the accounts. In addition, large revaluations in the corporate stock account are so likely that this item should not be used to estimate the cash inflow derived from net cash stock issues if at all possible. In most cases, this flow is small and, luckily, plays a minor role in the flow-of-funds matrix.

Overall, our review of the problems involved in the overlap of flow-of -funds estimation and the revaluation of balance sheet items has indicated that the overlap is not large. Experience indicates that at present most of the errors that are due to unidentified revaluations being mixed into the flows are small errors in relation to classification problems and other data shortcomings.

1. Getting the initial estimates

Our method of presentation will be to describe the statistical implementation of a simplified flow-of-funds matrix using the sort of statistical base found in the least developed countries in, let us say, the 1970s. This will enable us to enumerate the bare statistical necessities for such an undertaking. We shall then move on to describe the successive stages of statistical elaboration of the matrix in the movement toward a full system. For this exercise we shall assume that BOP, GFS, and MBS are not available to use as data sources.

Table 1 (see p. 4) presents an illustration of the format we use for the earliest stage flow-of-funds matrix. ^18/ It contains a very simple sectoring scheme of 5 sectors: the central government, the central bank, the commercial banks, the rest-of-world, and a catch-all other domestic sector which includes enterprises, households, and a variety of smaller sectors including provincial and local government and other financial institutions. And the classification for types of financial claims follows closely the scheme we advocated above. In Table 1, financial institution loans and advances is divided between central bank advances and other loans and advances which in our simple sectoring becomes entirely commercial bank loans and advances. It is to be noted that several of the key claims we have selected for enumeration are claims attributable to the sectors we have selected, so that if data are available for these sectors they will in general be available for these claims. We note also that in laying out sector accounts we do not suggest government as a whole or financial institutions as whole. Each of these more aggregative sectors contains subsectors whose data are not likely to be available at the earliest stage.

2. Tightening the system

One of the great advantages of the above initial flow-of-funds implementation is its launching of a very creative stage for the statistical system of a developing country. Broadly, the condensed flow-of-funds matrix provides the incentive and points out the direction for a number of substantial improvements in financial statistics. We shall now try to indicate the nature of these developments.

Table 1 might have very few entries in the discrepancy columns. If this is the case, we would understand this to be not because of the high quality of our estimates, but rather because of the necessity for residual estimates for the other domestic sector. In effect, many of our discrepancies will be transferred to and incorporated in the estimates for this sector. Now, we can conceive of these discrepancies as arising from the existence of two differing estimates for one flow-of-funds matrix cell—estimates from two differing statistical sources. For example, figures for bank reserve deposits usually appear in the balance sheets of both the central bank and the commercial banks. If the figures differ, and if, rather than selecting one as the basis for both bank reserves flow estimates, we retain both flow estimates—each in its respective sector—then we have identified a discrepancy which will appear in the discrepancy column. It is very important in flow-of-funds work to make such identifications wherever possible and to have them appear in the discrepancy columns, for if the discrepancies are large and involve key policy variables, we want them out in the open so that they can be dealt with.

The estimates we have so far assembled have involved three (largely) separate data sources. Thus it is likely that this sort of discrepancy will already have been encountered and that the differences will turn out to be recalcitrant (that is, the estimates cannot be reconciled by modest efforts). We suggest five possibilities for such discrepancies which might well be significant: (1) central government borrowing from abroad (central government versus balance of payments data), (2) central government cash balance (central government versus banking data), (3) change in foreign exchange reserves (balance of payments versus banking data), (4) central government gross saving (central government versus national, income and product data), and (5) government debt issue (central government data versus data compiled in the central bank).

In order to gain a sense of why the exploration of these discrepancies has creative possibilities, we must visualize the typical statistical “system” of many developing countries. The data sources we have been considering will to some extent correspond to different data producing organizations. Perhaps there will be a bureau of statistics producing the national income and product data. Probably the central bank will supervise banking data and the assembly of the balance of payments data, and the treasury (or auditor general) will generate the central government data. In the developing country situation these organizations may well generate their respective data with a minimum of technical communication with respect to statistical methods and/or detailed breakdowns. Coordination and cooperation among governmental agencies may not yet have developed. The point is that a detailed reconciliation effort of the sort required to reduce the flow-of-funds discrepancies requires the kind of technical consultation that can become an important force for coordination.

Organizationally, flow-of-funds also needs a home. Some single organization needs to be responsible for its generation: an interagency committee will not have sufficient authority to be successful. Probably the central bank will have closest access to the major necessary data sources and eventually to analytical users. The latter is desirable because users will press for continuous, current generation of the data and for needed types of further detail.

3. Expanding the system

The strategy for expanding our condensed matrix, either toward the SNA 1968 sector capital finance accounts scheme or toward a still fuller flow-of-funds system, is the same simple one: to break down the other domestic sector—that is, to proceed to make direct estimates for subsector accounts and in turn break each subsector account out of the other domestic sector, leaving, each time, a smaller and more homogeneous residually estimated other domestic sector. This procedure implies that added sector detail is more useful analytically than transaction detail at this point. And this will continue to be true until the main parts of the enterprise sector can be separately shown.

If a country has a substantial system of economic planning, an appropriate statistical direction would be toward a public sector account (that is, to estimate accounts for provincial and local government and for government enterprises). Provincial and local governments themselves (or at least the large ones) should be able to provide income, outlay, and financing data in budget documents. If necessary, earlier actuals can be carried forward on the basis of budget figures. Or it may be possible to assemble a synthetic account from planning ministry data if the plan covers provincial and local government capital formation and financing. And perhaps the banking data can provide figures for bank loans to this sector. As we enter this sector into the matrix, we will be defining and allocating the components of provincial and local government debt issues. There may be security issues (perhaps assigned into other domestic debt), borrowing from the central government (into central government loans), bank loan borrowing (into other loans and advances), and, perhaps, borrowing from abroad (into other domestic debt).

Next we consider nonfinancial government enterprises. Let us suppose that the central government or planning data do not provide the detail we need in order to assemble a capital finance account, and so a new compilation must be made. The initial task will be to transcribe the balance sheet and the appropriate income statement items ^25/ for each enterprise from published annual reports or reports filed with regulatory agencies or with the registrar of companies. If there are many such enterprises, a sample of the largest may be advisable; often, a surprisingly small number of government enterprises can comprise 80 percent or more of the sector. Given the transcriptions, a standard balance sheet format must be designed—one as close as possible to the flow-of-funds classification but still one into which all the enterprise statements can be transformed in order to permit compilation. If the accounts have been audited by auditing companies, the balance sheet formats will be surprisingly similar. At this point in the derivation of the flow-of-funds account from these data, rough estimates of some items will no doubt be necessary. Finally, either the sample or blown up estimates for the universe may be used for the flow-of-funds sector.

Another subsector that will be quite easy for most developing countries to assemble is that of the nonbank financial institutions. In the early development of a financial system, there are generally few such institutions. The procedure is as outlined above for government enterprises.

The expansions of the condensed matrix that we have considered so far are illustrated by Table 2 (see p. 3). The sectors in the matrix at this stage are similar to the full flow-of-funds scheme, except that private corporate enterprises are not yet separated out of the other domestic sector. ^26/ For many developing countries, this will be as far as the flow-of-funds implementation can be taken, assuming only a modest commitment of resources. An assembly of basic financial data for private corporations is not likely to already exist, and such a compilation may be beyond the capability of a small statistical shop. Thus, the final stage in this case will await the compilation from tax files, official financial reports, or company reports of aggregate balance sheets and income statements for a significant sample of private companies. Still, these data are important for many uses and the compilation task will not be an enormous one. ^27/

Throughout our description of the breaking down of the other domestic sector, we have paid little attention to the expansion of transaction type detail. But the financial transaction coverage has been slowly expanding. Each new directly estimated subsector picks up new claims in its liabilities or its portfolio that were not previously in the matrix because, in effect, they were washed out when the subsector was a consolidated part of the other domestic sector. That sector is de facto a consolidated one because of its residual derivation. Thus, perhaps the greatest increase in the system’s coverage of private claims will occur when private corporations can be finally separated from households.

A final commentary relating SNA 1990 to the implementation process as we have described it should be made. As the developing countries set out to disaggregate the national capital finance account into sector capital finance accounts, their data sources do not permit them first to estimate such an account for general government as a whole and then break it down further into central, provincial, and local government, or to estimate such an account for all financial institutions and then break this down for the central bank, commercial banks, and other financial institutions. As we have seen, the process is rather the reverse. Accounts are first estimated for the key subsectors—those in fact of policy importance—and these are later added to in order to assemble government or financial institutions or nonfinancial enterprises as a whole. This suggests that perhaps SNA 1990 should present a sequence of standard systems, a developmental sequence that would guide countries toward the implementation of a full SNA system.