Balance of Payments Manual

Chapter

II. Conceptual Framework of the Balance of Payments and International Investment Position

Author(s):
International Monetary Fund
Published Date:
November 2005
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Definitions

12. Part one of this Manual deals with the conceptual framework of balance of payments accounts and the international investment position. Part one covers the framework’s relationship to national accounts; to concepts of residence, valuation, and time of recording; and to the unit of account and conversion.

13. The balance of payments is a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. Transactions, for the most part between residents and nonresidents,1 consist of those involving goods, services, and income; those involving financial claims on, and liabilities to, the rest of the world; and those (such as gifts) classified as transfers, which involve offsetting entries to balance—in an accounting sense—one-sided transactions. (See paragraph 28.)2 A transaction itself is defined as an economic flow that reflects the creation, transformation, exchange, transfer, or extinction of economic value and involves changes in ownership of goods and/or financial assets, the provision of services, or the provision of labor and capital.

14. Closely related to the flow-oriented balance of payments framework is the stock-oriented international investment position. Compiled at a specified date such as year end, this investment position is a statistical statement of (i) the value and composition of the stock of an economy’s financial assets, or the economy’s claims on the rest of the world, and (ii) the value and composition of the stock of an economy’s liabilities to the rest of the world. In some instances, it may be of analytic interest to compute the difference between the two sides of the balance sheet. The calculation would provide a measure of the net position, and the measure would be equivalent to that portion of an economy’s net worth attributable to, or derived from, its relationship with the rest of the world. A change in stocks during any defined period can be attributable to transactions (flows); to valuation changes reflecting changes in exchange rates, prices, etc.; or to other adjustments (e.g., uncompensated seizures). By contrast, balance of payments accounts reflect only transactions.

Principles and Concepts

15. The remainder of this chapter deals with the conceptual framework of international accounts; that is, the set of underlying principles and conventions that ensure the systematized and coherent recording of international transactions and stocks of foreign assets and liabilities. Relevant aspects of these principles, together with practical considerations and limitations, are thoroughly discussed in subsequent chapters.

Double-entry System

16. The basic convention applied in constructing a balance of payments statement is that every recorded transaction is represented by two entries with equal values. One of these entries is designated a credit with a positive arithmetic sign; the other is designated a debit with a negative sign. In principle, the sum of all credit entries is identical to the sum of all debit entries, and the net balance of all entries in the statement is zero.

17. In practice, however, the accounts frequently do not balance. Data for balance of payments estimates often are derived independently from different sources; as a result, there may be a summary net credit or net debit (i.e., net errors and omissions in the accounts). A separate entry, equal to that amount with the sign reversed, is then made to balance the accounts. Because inaccurate or missing estimates may be offsetting, the size of the net residual cannot be taken as an indicator of the relative accuracy of the balance of payments statement. Nonetheless, a large, persistent residual that is not reversed should cause concern. Such a residual impedes analysis or interpretation of estimates and diminishes the credibility of both. A large net residual may also have implications for interpretation of the investment position statement (See the discussion in Chapter 23.)

18. Most entries in the balance of payments refer to transactions in which economic values are provided or received in exchange for other economic values. These values consist of real resources (goods, services, and income) and financial items. Therefore, the offsetting credit and debit entries called for by the recording system are often the result of equal amounts having been entered for the two items exchanged. When items are given away rather than exchanged, or when a recording is one-sided for other reasons, special types of entries—referred to as transfers—are made as the required offsets. (The various kinds of entries that may be made in the balance of payments are discussed in paragraphs 26 through 31.)

19. Under the conventions of the system, a compiling economy records credit entries (i) for real resources denoting exports and (ii) for financial items reflecting reductions in an economy’s foreign assets or increases in an economy’s foreign liabilities. Conversely, a compiling economy records debit entries (i) for real resources denoting imports and (ii) for financial items reflecting increases in assets or decreases in liabilities. In other words, for assets—real or financial—a positive figure (credit) represents a decrease in holdings, and a negative figure (debit) represents an increase. In contrast, for liabilities, a positive figure shows an increase, and a negative figure shows a decrease. Transfers are shown as credits when the entries to which the transfers provide the offsets are debits and as debits when those entries are credits.

20. The content or coverage of a balance of payments statement depends somewhat on whether transactions are treated on a gross or on a net basis. The Manual contains recommendations on which transactions should be recorded gross or net. The recommendations are appropriately reflected in the list of standard components and in suggested supplementary presentations.

Concepts of Economic Territory, Residence, and Center of Economic Interest

21. Identical concepts of economic territory, residence, and center of economic interest are used in this Manual and in the SNA. Economic territory may not be identical with boundaries recognized for political purposes. A country’s economic territory consists of a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely. For maritime countries, geographic territory includes any islands subject to the same fiscal and monetary authorities as the mainland.

22. An institutional unit has a center of economic interest and is a resident unit of a country when, from some location (dwelling, place of production, or other premises) within the economic territory of the country, the unit engages and intends to continue engaging (indefinitely or for a finite period) in economic activities and transactions on a significant scale. (One year or more may be used as a guideline but not as an inflexible rule.)

Principles for Valuation and Time of Recording

23. A uniform basis of valuation for the international accounts (both real resources and financial claims and liabilities) is necessary for compiling, on a consistent basis, any aggregate of individual transactions and an asset/liability position consistent with such transactions. In this Manual, the basis of transaction valuations is generally actual market prices agreed upon by transactors. (This practice is consistent with that of the SNA.) Conceptually, all stocks of assets and liabilities are valued at market prices prevailing at the time to which the international investment position relates. A full exposition of valuation principles; recommended practices; limitations; and the valuation of transfers, financial items, and stocks of assets and liabilities appears in Chapter 5. (The exposition includes cases in which conditions may not allow for the existence or assumption of market prices.)

24. In the Manual and the SNA, the principle of accrual accounting governs the time of recording for transactions. Therefore, transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is a change in ownership. The change may be legal or physical (economic). In practice, when a change in ownership is not obvious, the change may be proxied by the time that parties to a transaction record it in their books or accounts. (The recommended timing and conventions for various balance of payments entries, together with exceptions to and departures from the change of ownership principle, are covered in Chapter 6.)

Concept and Types of Transactions

25. Broadly speaking, changes in economic relationships registered by the balance of payments stem primarily from dealings between two parties. These parties are, with one exception (see footnote 1), a resident and a nonresident, and all dealings of this kind are covered in the balance of payments. Recommendations for specific entries are embodied in the list of standard components (see Chapter 8) and are spelled out in detail from Chapter 9 onward.

26. Despite the connotation, the balance of payments is not concerned with payments, as that term is generally understood, but with transactions. A number of international transactions that are of interest in a balance of payments context may not involve the payment of money, and some are not paid for in any sense. The inclusion of these transactions, in addition to those matched by actual payments, constitutes a principal difference between a balance of payments statement and a record of foreign payments.

Exchanges

27. The most numerous and important transactions found in the balance of payments may be characterized as exchanges. A transactor (economic entity) provides an economic value to another transactor and receives in return an equal value. The economic values provided by one economy to another may be categorized broadly as real resources (goods, services, income) and financial items. The parties that engage in the exchange are residents of different economies, except in the case of an exchange of foreign financial items between resident sectors. The provision of a financial item may involve not only a change in the ownership of an existing claim or liability but also the creation of a new claim or liability or the cancellation of existing ones. Moreover, the terms of a contract pertaining to a financial item (e.g., contractual maturity) may be altered by agreement between the parties. Such a case is equivalent to fulfillment of the original contract and replacement by a contract with different terms. All exchanges of these kinds are covered in the balance of payments.

Transfers

28. Transactions involving transfers differ from exchanges in that one transactor provides an economic value to another transactor but does not receive a quid pro quo on which, according to the conventions and rules adopted for the system, economic value is placed. This absence of value on one side is represented by an entry referred to as a transfer. Such transfers (economic value provided and received without a quid pro quo) are shown in the balance of payments. Current transfers are included in the current account (see Chapter 15) and capital transfers appear in the capital account. (See Chapter 17.)

Migration

29. Because an economy is defined in terms of the economic entities associated with its territory, the scope of an economy is likely to be affected by changes in entities associated with the economy.

30. Migration occurs when the residence of an individual changes from one economy to another because the person moves his or her abode. Certain movable, tangible assets owned by the migrant are, in effect, imported into the new economy. The migrant’s immovable assets and certain movable, tangible assets located in the old economy become claims of the new-economy on the old economy. The migrant’s claims on, or liabilities to, residents of an economy other than the new economy become foreign claims or liabilities of the new economy. The migrant’s claims on, or liabilities to, residents of the new economy cease to be claims on, or liabilities to, the rest of the world for any economy. The net sum of all these shifts is equal to the net worth of the migrant, and his or her net worth must also be recorded as an offset if the other shifts are recorded. These entries are made in the balance of payments where the offset is conventionally included with transfers.

Other imputed transactions

31. In some instances, transactions may be imputed and entries may be made in balance of payments accounts when no actual flows occur. Attribution of reinvested earnings to foreign direct investors is an example. The earnings of a foreign subsidiary or branch include earnings attributable to a direct investor. The earnings, whether distributed or reinvested in the enterprise, are proportionate to the direct investor’s equity share in the enterprise. Reinvested earnings are recorded as part of direct investment income. An offsetting entry with opposite sign is made in the financial account under direct investment-reinvested earnings to reflect the direct investor’s increased investment in the foreign subsidiary or branch. (Reinvested earnings are discussed in chapters 14 and 18.)

Changes Other Than Transactions

Reclassification of claims and liabilities

32. The classification of financial items presented in this Manual is designed to reveal the motivation of creditor or debtor. Financial items are subject to reclassification in accordance with changes in motivation. A case in point is the distinction between direct investment and other types of investment. For example, several independent holders of portfolio investment (in the form of corporate equities issued by a single enterprise located abroad) may form an associated group to have a lasting, effective voice in the management of the enterprise. Their holdings will then meet the criteria for direct investment, and the change in the status of the investment could be recorded as a reclassification. Such a reclassification would be reflected, at the end of the period during which it occurred, in the international investment position but not in the balance of payments. Similarly, claims on nonresidents can come under, or be released from, the control of resident monetary authorities. In such cases, there are reclassifications between reserve assets and assets other than reserves.

Valuation changes

33. The values of real resources and financial items are constantly subject to changes stemming from either or both of two causes. (i) The price at which transactions in a certain type of item customarily take place may undergo alteration in terms of the currency in which that price is quoted. (ii) The exchange rate for the currency in which the price is quoted may change in relation to the unit of account that is being used. Valuation changes are not included in the balance of payments but are included in the international investment position.

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