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Submitted To : Mr. Puneet Mittal
Submitted By: P.ThaneeshKumar Roll no : 10231
Table Of Contents
1 2 3 4 5 6 7 8 9
Introduction Balance of payments deficit Composition of the balance of payments sheet Imbalances Balance of payments crisis Balancing Mechanisms The balance of payments divided Balance of payments deficit and surplus Structure and characteristics of the current account
3 4 5 6 7 8 11 15 17 21 27
10 Structure and characteristics of the capital and financial account 11 References
services. as well as financial transfers. plans to address global imbalances have been high on the agenda of policy makers since 2009. which. its trade balance will be in deficit. but the shortfall will have to be counter balanced in other ways – such as by funds earned from its foreign investments. while deficit nations become increasingly indebted. there will be an offsetting entry in 3 . The BOP summarizes international transactions for a specific period. usually a year.A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world. such as the current account. For example. Every transaction that is made between a country and one of its trading partners is recorded in the balance of payments. This can result in surplus countries accumulating hoards of wealth. if a country is importing more than it exports. Sources of funds for a nation. These transactions include payments for the country's exports and imports of goods. imbalances are possible on individual elements of the BOP. the capital and current account. is zero. it must sum to zero – there can be no overall surplus or deficit. such as for imports or to invest in foreign countries. When all components of the BOP sheet are included it must balance – that is. by running down reserves or by receiving loans from other countries. and is prepared in a single currency. such as exports or the receipts of loans and investments. The capital account records transactions involving the inflow and outflow of assets to and from a country. are recorded as positive or surplus items. by definition. While the overall BOP sheet will always balance when all types of payments are included. Uses of funds. are recorded as a negative or deficit item. A country’s balance of payments is composed of two separate accounts. With record imbalances held up as one of the contributing factors to the financial crisis of 2007–2010. and financial capital. The current account records transactions involving the import and export of goods and services in to and out of a country. typically the domestic currency for the country concerned. Historically there have been different approaches to the question of how to correct imbalances and debate on whether they are something governments should be concerned about. The balance of payments is the sum of these two accounts. What this means is that for every entry (credit (+) or debit (-)) on a country’s balance of payments sheet.
a country’s central bank must use its international reserves. The latter of the two types of balance of payments deficits is more common. which consists of trade in intangible commodities between countries. The first and most significant component is the balance of merchandise trade. The second entry on the current account balance is net trade in services. services. Service trade includes tourist expenditures abroad. the transaction is recorded as a capital inflow. dividends and interest payments. this includes payments to foreign investors and receipts from overseas investments in the form of profits. The current account is made up of several components. Such payments are known as official 4 . Balance Of Payments Deficit A country is said to be running a balance of payments deficit when the nonreserve portion of the capital account and the current account are not in balance. The last item recorded on the current account balance is net unilateral transfers. when a country sells a domestic asset to a foreign country. stock in a company. This payments gap can be the result of excessive overseas investment. or lends overseas. or the import and export “visible” goods. or a current account deficit that is not financed entirely by non-reserve capital inflows. The third type of transaction recorded on the current account balance is net investment income. Similarly. or finances from one country to another with no expectations of repayment to the donating country from the beneficiary. or borrows abroad. or a government bond).one of the two accounts. This method of recording transactions is known as “doubleentry bookkeeping”. A unilateral transfer includes the transfer of goods. The capital account records transactions involving the purchase or sale of assets and liabilities. When a country purchases a foreign asset (such as a private bank deposit. and a variety of other internationally tradable services. shipping and receiving expenses. In order to finance a balance of payments deficit. particularly in the case of developing countries. Provision of foreign aid is the most easily recognized type of unilateral transfer. the transaction is recorded as a capital outflow on the capital account.
or spending if it is in deficit. exchange rates. the supply of international reserves can be depleted in its financing. thus effecting interest rates. which might. The current account shows the net amount a country is earning if it is in surplus. by the principles of double entry accounting. the two principal divisions on the BOP have been the current account and the capital account. and a host of other economic factors. Its called the current account as it covers transactions in the "here and now" . and 2.reserve transactions.) They change a country’s money supply. Both of these factors can be particularly significant in the case of developing countries. whose reserve positions tend to be smaller and more vulnerable to short term economic shocks.) in the case that a country is running a chronic balance of payments deficit. for example. At high level. A balance isn't always reflected in reported figures. thus reducing the country’s capacity to fund imports and obtain credit. It includes the reserve account (the international operations of a nation's central bank). It is the sum of the balance of trade (net earnings on exports – payments for imports). an entry in the current account gives rise to an entry in the capital account. Expressed with the standard meaning for the capital account. and in aggregate the two accounts should balance. report a surplus for both accounts.International reserve transfers are particularly important for two reasons: 1. factor income (earnings on foreign investments – payments made to foreign investors) and cash transfers. and involve the transfer of international reserves between central banks. Composition of the balance of payments sheet Since 1974.those that don't give rise to future claims. those are earnings and will be recorded in the current account). but when this happens it always means something has been missed—most 5 . The capital account records the net change in ownership of foreign assets. the BOP identity is: The balancing item is simply an amount that accounts for any statistical errors and assures that the current and capital accounts sum to zero. along with loans and investments between the country and the rest of world (but not the future regular repayments / dividends that the loans and investments yield.
Invisible trade would record international buying and selling of services. • Factor income – repayments and dividends from loans and investments • • • Especially in older balance sheets. surpluses or deficits on its individual elements can lead to imbalances between countries. the operations of the country's central bank.commonly.) 6 • • . and sometimes would be grouped with transfer and factor income as invisible earnings. entries under Current account might include: • Trade – buying and selling of goods and services • • • Exports – a credit entry Imports – a debit entry Trade balance – the sum of Exports and Imports Factor earnings – a credit entry Factor payments – a debit entry Factor income balance – the sum of earnings and payments. Imbalances The BOP has to balance overall. Visible trade recorded imports and exports of physical goods (entries for trade in physical goods excluding services is now often called the merchandise balance). Countries with deficits in their current accounts will build up increasing debt and/or see increased foreign ownership of their assets. a common division was between visible and invisible entries.) An overall current account deficit. A basic deficit which is the current account plus foreign direct investment (but excluding other elements of the capital account like short terms loans and the reserve account. The types of deficits that typically raise concern are • A visible trade deficit where a nation is importing more physical goods than it exports (even if this is balanced by the other components of the current account. For example. An actual balance sheet will typically have numerous sub headings under the principal divisions. In general there is concern over deficits in the current account.
and is pushed into the US resulting in excess consumption and asset price inflation. This causes issues for firms of the affected nation who have received the inbound investments and loans.Causes of BOP imbalances There are conflicting views as to the primary cause of BOP imbalances. occurs when a nation is unable to pay for essential imports and/or service its debt repayments. where a global savings glut caused by savers in surplus countries. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency. and decide to pull out their funds. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. An alternative view. its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency. is that the primary driver is the capital account. also called a currency crisis. runs ahead of the available investment opportunities. However a point is reached where overseas investors become concerned about the level of debt their inbound capital is generating. which are associated at first with rapid economic growth. Crises are generally preceded by large capital inflows. this is accompanied by a rapid decline in the value of the affected nation's currency. with much attention on the US which currently has by far the biggest deficit. argued at length in a 2005 paper by Ben Bernanke . as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Balance of payments crisis A BOP crisis. business competitiveness . Balancing mechanisms 7 . and private behaviour such as the willingness of consumers to go into debt to finance extra consumption. it generally further depresses the local economy. the government's fiscal deficit. but while this can help those with debts in denominated in foreign currencies. Typically. The conventional view is that current account factors are the primary cause these include the exchange rate.
It also tends to make investment flows into the capital account less attractive so will help with a surplus there too. the supply of its own currency on the international market tends to increase as it tries to exchange it for foreign currency to pay for its imports.One of the three fundamental functions of an international monetary system is to provide mechanisms to correct imbalances. and this extra supply tends to cause the price to fall. BOP effects are not the only market influence on exchange rates however. there are three possible methods to correct BOP imbalances. as can increasing the desirability of exports through other means. though it is generally assumed a nation is always trying to develop and sell its products to the best of its abilities. Conversely a downward shift in the value of a nation's currency makes it more expensive for its citizens to buy imports and increases the competitiveness of their exports. These methods are adjustments of exchange rates. adjustment of a nations internal prices along with its levels of demand. Rebalancing by adjusting internal prices and demand 8 . When a country is selling more than it imports. The extra demand tends to cause a rise of the currency's price relative to others. they are also influenced by differences in national interest rates and by speculation. though in practice a mixture including some degree of at least the first two methods tends to be used. and rules based adjustment. Exchange rates can be adjusted by government in a rules based or managed currency regime. Improving productivity and hence competitiveness can also help. Rebalancing by changing the exchange rate An upwards shift in the value of a nation's currency relative to others will make a nation's exports less competitive and make imports cheaper and so will tend to correct a current account surplus. thus helping to correct a deficit (though the solution often doesn't have a positive impact immediately due to the Marshall–Lerner condition. When a country is importing more than it exports. Broadly speaking. the demand for its currency will tend to increase as other countries ultimately need the selling country's currency to make payments for the exports. and when left to float freely in the market they also tend to change in the direction that will restore balance.
If a nation is earning more than it spends the net effect will be to build up savings. NI = national investment. which will automatically have a deflationary effect. On the other hand. making its exports more competitive. To a large degree. the change is optional for the surplus country. correction by deflation to the degree required by the large imbalances that arose after WWI proved painful. The natural effect of this will be to increase the money supply. NS = national savings (private plus government sector). as a consequence of selling more than it buys it will experience a net inflow of gold. While the gold standard is generally considered to have been successful up until 1914. is to increase its level of internal demand (i. or when imbalances exist between members of a currency union such as the Euro zone. Prices will be reduced. and thus correcting the imbalance. When a country has a favourable trade balance.When exchange rates are fixed by a rigid gold standard. if a country has an adverse BOP its will experience a net loss of gold. However the nation has the option of taking the gold out of economy (sterilizing the inflationary effect) thus building up a hoard of gold and retaining its favourable balance of payments. which leads to inflation and an increase in prices.e. unless it chooses to leave the gold standard. the standard approach to correct imbalances is by making changes to the domestic economy. with deflationary policies contributing to prolonged unemployment but not re-establishing balance. That is: where CA = current account. which then tends to make its goods less competitive and so will decrease its trade surplus. the mechanism is largely automatic. In the case of a gold standard. an alternative expression is that it is the excess of savings over investment. except to the extent that those savings are being used for investment. A possible method for surplus countries such as Germany to contribute to re-balancing efforts when exchange rate adjustment is not suitable. Apart from the US most former members had left the gold standard by the mid 1930s. its spending on goods). If consumers can be 9 . While a current account surplus is commonly understood as the excess of earnings over spending. but compulsory for the deficit country.
Keynes suggested that traditional balancing mechanisms should be supplemented by the threat of confiscation of a portion of excess revenue if the surplus country did not choose to spend it on additional imports. though it still relied primarily on the two traditional mechanisms. or if the corporate sector divert more of their profits to investment. or if the government runs a fiscal deficit to offset private savings. Keynes. 10 . and then correct any imbalances that arise by rules based and negotiated exchange rate changes and other methods. However his ideas were not accepted by the Americans at the time. However. accurate balance of payments figures were not generally available. one of the architects of the Bretton Woods system had wanted additional rules to encourage surplus countries to share the burden of rebalancing. Rules based rebalancing mechanisms Nations can agree to fix their exchange rates against each other. In their April 2010 world economic outlook report. this did not prevent a number of switches in opinion on questions relating to whether or not a nations government should use policy to encourage a favourable balance.35% of its GDP and calls to reduce its surplus by increasing demand have not been welcome by officials. then any current account surplus will tend to be reduced. American economist Paul Davidson had been promoting his revamped form of Keynes's plan as a possible solution to global imbalances which in his opinion would expand growth all round with out the downside risk of other rebalancing methods. The Bretton Woods system of fixed but adjustable exchange rates was an example of a rules based system. History of balance of payments issues historically. In 2008 and 2009.encouraged to spend more instead of saving. However in 2009 Germany amended its constitution to prohibit running a deficit greater than 0. as he argued that they were in a stronger position to do so and as he regarded their surpluses as negative externalities imposed on the global economy. the IMF presented a study showing how with the right choice of policy options governments can transition out of a sustained current account surplus with no negative effect on growth and with a positive impact on unemployment. adding to fears that the 2010s will not be an easy decade for the euro zone.
The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports. each of which accounts for a different type of international monetary transaction. Within the current account are credits and debits on the trade of merchandise. and royalties from patents and copyrights. Within these three categories are sub-divisions. for example). business service fees (from lawyers or management consulting. This refers to the acquisition or disposal of non-financial assets (for example. it imports more than it exports. which are salaries sent back into the home country of a national working abroad. the capital account and the financial account. The last component of the current account is unilateral transfers. The Current Account The current account is used to mark the inflow and outflow of goods and services into a country. Services refer to receipts from tourism. and if it has a balance of trade surplus. The capital account is broken 11 . engineering. as well as foreign aid that is directly received. These are credits that are mostly worker's remittances. like a mine used for the extraction of diamonds.The Balance of Payments Divided The BOP is divided into three main categories: the current account. a physical asset such as land) and non-produced assets. sold or given away (possibly in the form of aid). goods and services together make up a country's balance of trade (BOT). Receipts from incomegenerating assets such as stocks (in the form of dividends) are also recorded in the current account. If a country has a balance of trade deficit. are also put into the current account. The Capital Account The capital account is where all international capital transfers are recorded. When combined. Earnings on investments. which includes goods such as raw materials and manufactured goods that are bought. both public and private. which are needed for production but have not been produced. transportation (like the levy that must be paid in Egypt when a ship passes through the Suez Canal). it exports more than it imports.
which is a balance of trade deficit. The Balancing Act The current account should be balanced against the combined-capital and financial accounts. real estate. uninsured damage to fixed assets. If a country has a fixed asset abroad. finally. We should also note that. and. and financial assets by migrants leaving or entering a country. death levies. the transfer of ownership on fixed assets (assets such as equipment used in the production process to generate income). international monetary flows related to investment in business. the transfer of goods. the sale of that fixed asset would be considered a current account inflow (earnings from investments). The current account deficit would thus be funded. When a country has a current account deficit that is financed by the capital account. private assets held abroad. this borrowed amount is marked as a capital account outflow. Liberalizing the Accounts The rise of global financial transactions and trade in the late-20th century spurred BOP 12 . special drawing rights (SDRs) held with the International Monetary Fund. private and official. this would appear as an inflow of foreign capital in the BOP. gift and inheritance taxes. the transfer of funds received to the sale or acquisition of fixed assets. with fluctuating exchange rates. this rarely happens. gold. When there is a deficit in the current account. If a country is borrowing money to fund its current account deficit. However. as mentioned above. Assets owned by foreigners. the change in the value of money can add to BOP discrepancies. bonds and stocks are documented.down into the monetary flows branching from debt forgiveness. However. Also included are government-owned assets such as foreign reserves. the country is actually foregoing capital assets for more goods and services. the difference can be borrowed or funded by the capital account. The Financial Account In the financial account. are also recorded in the financial account. and direct foreign investment.
this is usually the account that is being referred to. Until mid-1993. management consulting. the merchandise trade account has been combined with a second sub-account. 13 . Many of these countries had restrictive macroeconomic policies. engineering. its competitiveness in the world marketplace. Since then. not only allowing a more transparent and sophisticated market for investors. Fees from patents and copyrights on new technology.in which capital flows into these markets tripled from USD 50 million to USD 150 million from the late 1980s until the Asian crisis developing countries were urged to lift restrictions on capital and financial-account transactions in order to take advantage of these capital inflows. transportation. With the advent of the emerging market economic boom . capital markets began to grow. or given away. and business services. such as law. software. It is an indication of the desirability of a country's products and services by the rest of the world. Merchandise trade consists of all raw materials and manufactured goods bought. but also giving rise to foreign direct investment. Most outsourcing of labor is a debit to the services account. to determine the total for the balance of trade. services. The current account is composed of 4 sub-accounts: 1. But with capital and financial account liberalization. and therefore. and accounting. sold. Liberalization can also facilitate less risk by allowing greater diversification in various markets The Current Account When a trade deficit or surplus is reported. books. The regulations also limited the transfer of funds abroad. eventually increasing the nation's overall gross domestic product by allowing for greater volumes of production. by which regulations prevented foreign ownership of financial and non-financial assets. 2. For example. this was the figure that was used when the balance of trade was reported in the media. investments in the form of a new power station would bring a country greater exposure to new technologies and efficiency. Services include tourism.and macroeconomic liberalization in many developing nations. and movies also are recorded in the service category.
In addition. The Financial Account The financial account. and the sale of natural and intangible assets to foreigners minus the capital transfers. 1. bonds. 2. consists of 2 categories. Income receipts include income derived from ownership of assets. gift and inheritance taxes. such as the rights to natural resources. residents. such as dividends on holdings of stock and interest on securities. Acquisition and disposal of non-produced. a debit is assigned to the capital account of the donor nation. and legacies. such as worker remittances from abroad and direct foreign aid. 4. franchises. Unilateral transfers represent one-way transfers of assets. non-financial assets represent the sales and purchases of non-produced assets.3. and the purchase of foreign natural and intangible assets by U. and leases. The amount of goods and services imported compared to the amount exported is known as the balance of trade. and the sales and purchases of intangible assets.S. trademarks. such as patents. In the case of aid or gifts. a subdivision of the capital account. copyrights. death duties. and real estate: 14 . Capital transfers include debt forgiveness and migrants’ transfers (goods and financial assets accompanying migrants as they leave or enter the country). The Capital Account The capital account is equal to capital transfers. A trade surplus exists when exports exceeds imports over a measured period and a trade deficit exists when imports exceeds exports. which lists trade in assets such as business firms. stocks. uninsured damage to fixed assets. capital transfers include the transfer of title to fixed assets and the transfer of funds linked to the sale or acquisition of fixed assets.
however. foreign currencies. this appears as an inflow of foreign capital. In the balance of payments. credits and other long-term assets. banks. A country with a persistent current account deficit is. Structure and Classification 15 . Surpluses in 1 account are counterbalanced by deficits in the other. However. U. agency.S. These assets include U. U. the sum of the balance of payments statements should be zero.S. Foreign-owned assets in the United States are divided into foreign official assets and other foreign assets in the United States. the specific accounts can. government assets. and since credits must equal debits and the balance of payments is equal to credits minus debits.1. These assets include gold. when the United States buys more goods and services than it sells—a current account deficit—it must finance the difference by borrowing. the accounts do not exactly offset each other. and exchange rate movements that change the recorded value of transactions. it deviates slightly from zero. reserve position in the International Monetary Fund. effectively exchanging capital assets for goods and services. BOP = Current Account + Capital Account = Credits . Balance of Payments Deficit and Surplus The current account should balance with the capital account. currency.S. foreign securities. and corporate securities. because of statistical discrepancies.S. or by selling more capital assets than it buys—a capital account surplus. U. In reality. and private assets.S. direct foreign investment. banks.S. because every transaction is recorded as both a credit and a debit (double-entry accounting).-owned assets abroad are divided into official reserve assets. liabilities reported by U. therefore.S. claims reported by U. accounting conventions. For practical reasons. government. direct investment. and almost always do. and U.Debits ≈ 0 For example. Large trade deficits mean that the country is borrowing from abroad or selling assets to foreigners. 2. have surpluses and deficits. and U.S.
That balance is the result of errors and omissions in the compilation 16 . National compilers are in better positions than IMF staff to make estimates and adjustments for components that do not exactly correspond to the basic series of the compiling economy. the capital and financial account. other countries may be able to provide additional data. etc. The classification system also reflects efforts to link the structure of the financial account to that of the income accounts and that of the international investment position. bilateral comparisons of particular components or total transactions. The scheme is designed as a flexible framework to be used by many countries in the long-term development of external statistics. Balance of payments statistics must be arranged within a coherent structure to facilitate their utilization and adaptation for multiple purposes—policy formulation. Some countries may not be able to provide data for many items. projections. Furthermore. several components may be available only in combination. and the international investment position . selected supplementary information. regional and global aggregations.The standard components of both sets of accounts and contains discussions and elaboration of the current account. however. the resulting balance will almost inevitably show a net credit or a net debit. In practice. when all actual entries are totaled. Net Errors and Omissions Application of the principles presented in this Manual should result in a consistent body of positive and negative entries with a net (conceptual) total of zero. The standard components should nevertheless be reported to the IMF as completely and accurately as possible. analytical studies. The structure and classification of balance of payments standard components reflect conceptual and practical considerations. and are in general concordance with the SNA and with harmonization of the expanded classification of international transactions in services with the Central Product Classification (CPC). take into account views expressed by national balance of payments experts. or a minor component may be grouped with one that is more significant.
In balance of payments statements. Freight insurance is now included with insurance services. if the balance of those components is a credit. other services are accorded increased prominence in the fifth edition. with the exception of freight insurance. the standard practice is to show a separate item for net errors and omissions. There may be analytical interest in both separate and inclusive treatment of the two for purposes of various domestic and international comparisons. Passenger transportation is closely linked with travel. Therefore. Structure and Characteristics of the Current Account It does not cover the carriage. the item for net errors and omissions will be shown as a debit of equal value. Both the structure and classification of the specific other services are related to the importance attached to these items by international bodies [e. in the General Agreement on Tariffs and Trade (GATT) ] as a basis for negotiations and by analysts 17 . that item is intended as an offset to the overstatement or understatement of their corded components.of statements. in which some related services are included. Some errors and omissions may be related to recommendations for practical applications approximating principles.g. The new grouping should facilitate international comparisons and is in accord with other statistical systems. The traveler (consumer) moves to the location of the economy that provides the goods and services desired. in some instances. Labeled by some compilers as a balancing item or statistical discrepancy. Travel is subdivided into two major components: business and personal. Transportation subsumes. Treated as part of a residual item in the fourth edition of the Manual. the size of the residual item does not necessarily provide any indication of the overall accuracy of the statement. such services may not be subject to clear distinctions from goods. Travel differs from other components of services in that it is a demand-oriented activity. Thus. of nonresident passengers by resident carriers. Sometimes the errors and omissions that occur in the course of compilation offset one another. Nonetheless. the shipment and other transportation items as presented in the fourth edition of the Manual.) There is a close interrelationship between freight services and goods and. interpretation of the statement is hampered by a large net residual. and vice versa. within an economy.
receipts by an economy from certain individuals working abroad are classified either as current transfers or as compensation of employees. Although the significance of these services varies widely in the international accounts of countries. This treatment of income as a separate component of the current account accords with that in the SNA. be recorded as credits and debits. production. Valuation. For example. The Manual and the SNA define a current transfer in the same way. the structure provides a ready reference for items likely to assume increasing importance in international transactions. services. and Time of Recording In the current account. Current transfers are grouped separately from goods. and the disaggregation of transfers into current transfers and capital transfers—a departure from previous editions —aligns with SNA treatment and with various analytical presentations. respectively. This emphasis on gross recording in the current account stems from the fact that credit and debit entries for many specific types of current transactions are seldom related in a causal way. and related issues. For example. and increases the analytical usefulness of the international accounts. The distinction between real resources and transfers. Income comprises compensation of employees and investment income (covering direct investment income and other dividends and interest). Gross Recording. however. Individual components are defined in such a way that entries would be made on a gross basis. gross outflows from and gross inflows to the economy should. provision of travel services has. in principle. and income because the former are generally conceived as showing distinctive characteristics. tightens the links between income and financial account flows and between the balance of payments and the international investment position. may sometimes be rather arbitrary. even though provision and acquisition of travel services are included in the single component for travel. from an economic 18 . This change removes inconsistencies in the use and meaning of the term current as it concerns transactions and balancing items in the Manual and the SNA.involved with domestic and international aspects of trade. the classification depends on how long the individuals have stayed in the countries where they are working.
Nonetheless. little connection with the acquisition by the same economy of such services. In general. gross figures provide a better basis for analysis of changes in net balances.g.. The structure of the capital and financial account also is generally compatible with other statistical systems of the IMF and is consistent with the classification of related income components of the current account and with the international investment position. portfolio investment. The capital and financial account of the balance of payments is divided into two main categories: the capital account and the financial account. gross recording remains the principle for recording transactions in the current account and. and reserve assets) while the SNA classification is primarily by type of instrument: monetary gold. The capital account covers all transactions that involve the receipt or payment of 19 . Two specific applications important for the IMF represent the use of gross figures: (i) Valuation of the SDR is based on a basket of currencies selected in consideration of the issuing countries’ shares in world exports of goods and services and weighted in broad proportion to those shares. the primary basis for classification of the financial account is functional category (i. some transportation services) or because of netting procedures used to derive certain estimates. etc. in general. Moreover. loans. However. (ii) The relative size of an IMF member’s gross transactions in the current account is one factor used to determine the relative quota of a Fund member.e. is more useful than net recording for balance of payments accounts of the SNA external accumulation accounts. direct investment.. STRUCTURE AND CLASSIFICATION Exceptions to the general rule of gross recording are sometimes made because of the practical difficulty of collecting certain information on a gross basis (e. gross transactions recorded in the current account are often indicators of the relative importance of particular items within an economy and of the relative importance of various economies in international transactions. Also. currency and deposits. Gross transactions recorded in the current account are therefore used to compare economies and to provide weights for aggregation. other investment.standpoint. in the balance of payments. gross figures are utilized in contexts other than the analysis of balance of payments developments.
land and subsoil assets) and transactions associated with non produced.e. The following changes are among those specifically excluded: valuation changes in. or by. In previous editions of the Manual.. The financial account covers all transactions associated with changes of ownership in the foreign financial assets and liabilities of an economy. patents. in assets for which there are no changes in ownership. changes resulting from territorial or other changes in classification of existing assets (for example. Capital Account The capital account consists of two categories: (i) capital transfers and (ii) acquisition or disposal of non produced. monetization or demonetization of gold. acquisition or disposal of non produced. When there is a change in ownership and an asset acquired at one price is disposed of at a different price. or reclassifications of. However. both assets are recorded at respective market values and the difference in value—holding (capital) gain or loss—is included in the balance of payments. franchises. nonfinancial assets. portfolio investment to direct investment). in the case of resident-nonresident transactions in land 20 . general government and other sectors). copyrights. nonfinancial assets comprises transactions associated with tangible assets that may be used or necessary for production of goods and services but are not actually produced (e. the rest of the world. which reflect exchange rate or price changes. and valuation changes. trademarks. reserves.g. allocation or cancellation of SDRs. etc.g. Within each.. debt forgiveness is specified as category while migrants’ transfers comprise a category under other sectors. nonfinancial assets. capital transfers were included indistinguishably with current transfers in the current account. intangible assets (e. Such changes include the creation and liquidation of claims on.capital transfers and acquisition or disposal of non produced. changes resulting from the unwillingness or inability of a debtor who resides in one economy to make full or partial repayment including expropriation without compensation—in settlement of a claim to a creditor who resides in another economy and regards part or all of the claim as unrecoverable). All changes that do not reflect transactions are excluded from the capital and financial account.. write-offs (that is. In concept. and leases or other transferable contracts). Capital transfers are classified primarily by sector (i.
Financial Account The foreign financial assets of an economy consist of holdings of monetary gold. nonfinancial assets. and the pledging or setting aside of an asset (as in a sinking fund) does not settle a claim or alter the ownership of the asset. However. a foreign currency. assets must represent actual claims that are legally in existence. The authorization. These instruments can be valued by reference to the market prices of the derivatives or to the market prices of the 21 . in accordance with the treatment of these items in the SNA. or a unit such as the SDR—is not relevant.(including subsoil assets). The only exception concerns land purchased or sold by a foreign embassy when the purchase or sale involves a shift of the land Structure and Characteristics of the Capital and Financial Account From one economic territory to another. the creditor and debtor must be identified as residents of different economies. commitment. In such instances. a transaction in land between residents and nonresidents is recorded under acquisition or disposal of non produced. The changes recorded for all of the assets described in this paragraph consist of the total values of assets acquired during the accounting period by residents of the reporting economy less the total values of the assets disposed of by residents to nonresidents. Furthermore. all acquisition or disposal is deemed to occur between resident units. or extension of an unutilized line of credit or the incurrence of a contingent obligation does not establish such a claim. nonresidents. options and other financial derivatives are included among financial items. and claims on nonresidents. The foreign liabilities of an economy consist of indebtedness to nonresidents. The unit in which the claim or liability is denominated—whether the national currency. and the nonresident acquires a financial claim on a notional resident unit. SDRs. To determine whether financial items constitute claims on. or liabilities to.
The offset to this latter type of provision of an asset is a transfer. The following specific cases are examples. one party to a transaction may provide a financial item and not receive any economic value in exchange.. Financial items may be exchanged for other financial items or for real resources. a financial claim on a resident entity that is considered the owner. derivatives satisfy the definition of foreign financial assets and liabilities. The conventions stated in this Manual result in ownership of some nonfinancial assets being construed as ownership of financial assets (claims). This change in ownership is financed by a financial claim (i. is always attributed to residents of the economies in which the assets are located. in effect. However. In subsequent periods. To establish whether a transaction involving a foreign asset is a transaction between a resident and a nonresident. Alternatively. the market value of the good is recorded under goods in the current account. and debt repayment. All nonfinancial as well as financial assets attributed to such an enterprise are regarded as foreign financial assets for the owner of the enterprise. that entity is a resident of the economy in which it operates rather than a resident of the economy of the owner. the compiler must know the identities 22 . At the time the imputed change in ownership occurs. and an offsetting entry is made in the financial account. Thus. such as land and structures. when the owner of such assets is a nonresident.commitments underlying the derivatives. which is recorded in the current account as investment income payable or receivable. an asset of the lessor and a liability of the lessee). Therefore. The financial asset should be classified as a loan. An unincorporated enterprise operating in a different economy from the one in which the owner of the enterprise resides is considered a separate entity. Transactions in assets Transactions in assets (specifically. The ownership of immovable assets. this value could be viewed as the amount that one party must pay to the other party in order to extinguish the contract. he has. the actual leasing payment must be divided into interest. Any goods transferred under a financial leasing arrangement are presumed to have changed ownership. including the creation and liquidation of claims) most often reflect exchanges of economic values. one party recognizes a liability and the other recognizes a claim. changes of ownership. As a result. which is recorded in the financial account and reduces the value of the lessor‘s asset and the lessee’s liability. both parties to a derivative contract recognize a financial instrument.e.
for assets.of both parties. The first resident’s transaction with a nonresident is canceled by the same resident’s subsequent transaction with another resident (if the value of the claim does not change). recorded transactions may include not only those that involve assets and liabilities and take place between residents and nonresidents but also those that involve transferable assets of economies and take place between two residents and. the identity of the nonresident creditor is a factor only in a few instances (for example. Thus. conducted the transaction with another resident or with a nonresident. So. in this Manual. transactions that take place between non residents. the introduction. during the same recording period. however. or whether a nonresident dealt with another nonresident or with a resident. permit identification of the two parties to the transaction. The most prevalent types of transactions that do not cancel each other are. For instance. transfer the claim to another resident classified in a different sector. For liabilities. many transactions between residents and between nonresidents will offset each other and thus will not actually appear as entries in the balance of payments statement. a resident may acquire a claim against a nonresident and. those transactions between resident creditors classified in different functional categories or domestic sectors. who acquired or relinquished a transferable claim on a nonresident. in the balance of payments. The information available on transferable claims constituting foreign assets may not. of a domestic sect oral breakdown for the portfolio investment and other investment components of the financial account makes it necessary to record certain transactions between resident sectors within the economy—although such transactions cancel each other for the total economy. Because the credit and debit entries for most components of the financial account are according to the rules of this Manual generally net. in differentiating between direct investment and other types of capital and in determining regional allocation). As a result. Net recording can also result in a transaction between a resident and a nonresident being offset by a transaction between residents or by a transaction between nonresidents. to a lesser extent. only 23 . a recommendation that the balance of payments be confined solely to asset transactions between residents and nonresidents would be difficult or impossible to implement. Also. STRUCTURE AND CLASSIFICATION Ascertain whether a resident.
the distribution to direct investors of earnings (in the form of stock dividends) included in investment incomeincome on equity results in an increase. any profit or loss could be regarded as the realization of a holding (capital) gain or loss and could be entered. for example—when the maturity of a debt instrument is extended (and thereby changed from a nominally short-term claim to a nominally long-term claim) or when a government takes over an obligation for liabilities incurred by the private sector and the sector of the domestic debtor is altered. a pair of transactions between a resident and a nonresident has occurred. in the appropriate component of the financial account.) The issue may be viewed two ways. In a similar way. shown in the financial account. (i) If two changes of asset ownership have occurred. Another borderline case arises when a transactor intends to dispose of a certain asset at virtually the same moment that ownership of the asset is acquired. the profit or loss 24 . (Examples are arbitrage and certain other dealings in financial assets.) Changes in contractual terms for existing assets are thus construed as constituting transactions to be included in the balance of payments statement. (ii) If no change of ownership has effectively taken place. are recorded. Reinvested earnings The reinvested earnings of a direct investment enterprise (which accrue to a direct investor in proportion to participation in the equity of the enterprise) are recorded in the current account of the balance of payments as being paid to the direct investor as investment income-income on equity and in the financial account as being reinvested in the enterprise. in the investors’ equity. these reinvested earnings increase the value of the stock of foreign assets of the direct investor’s economy. questions may arise as to whether transactions have taken place. As a change in the original terms of a contract requires the assent of both parties. (That is. the existing claim is considered to be satisfied by the creation of a new one. like any other realization of a holding gain or loss. Borderline cases In some cases. Thus.the increase in the second resident’s holdings. The effect is the same as if the second resident dealt directly with the nonresident. which are actually acquired through a transaction with the first resident.
Net decreases in claims or other assets and net increases in liabilities are recorded as credits.. the net for each should be totaled not net credits and debits separately. are consolidated in a single entry. Net recording Two or more changes in a specific asset. net recording generally is of more interest than gross recording.. For example. net increases in assets and net decreases in liabilities are recorded as debits. For direct investment. direct investors on the part of affiliated enterprises (and vice versa) be recorded for the appropriate components of direct investment (i. always represent net changes. and such data can be utilized in supplementary presentations when appropriate. This entry reflects the net effect of all the increases and decreases that occur during the recording period in holdings of that type of asset. the holding gain or loss realized on the purchase and sale of financial items at different market prices. Net recording for standard components distinguished in the capital and financial account is specified partly because gross data for transactions often are not available. 25 . the net approach is always favored. gross entries may be a relevant factor in analyzing aspects of the payments positions or financial markets (e. for example. Nonetheless.g.could be seen as a fee for a service. without regard to the fact that some items may have been owned only briefly. In addition. particularly for reasons of analytic usefulness. It is recommended that the treatment described in (i) be used because entries in the financial account may reflect. Changes derived from records showing amounts outstanding at the beginnings and ends of reporting periods. it is suggested in this Manual that separate totals for liabilities to.e. if equity securities and debt securities are combined to show a net figure for these two components. and the net change is recorded for that item. In the totaling of net credits and debits for two or more separate components. which would give added prominence to the transactions— between residents and between nonresidents—that are covered in the statement. or changes in two or more different assets classified in the same standard component. equity capital and other capital) in addition to the net figures for each. and claims on. purchases (by nonresidents) of securities issued by resident enterprises of an economy are consolidated with sales (by nonresidents) of such securities. For instance. securities transactions) of economies.
to obtain or provide additional real resources in connection with commercial and financial activities. In the collection of data. Further classification levels in these categories are based upon factors relating to general analytical usefulness and compatibility with other statistical systems. domestic sector. of course. and. Such changes may occur to settle actual imbalances or to deal with prospective imbalances. inward or outward). including those resulting from exchange rate changes. Changes in financial items recorded in the balance of payments occur for a wide variety of reasons. type of instrument. acquire. original contractual maturity. to take advantage of interest rate differentials. In this Manual. However. subordinate and supplementary classification. The primary basis for the classification of components of the financial account is functional type.e. to make holding (capital) gains (or avoid losses) on past or future valuation changes. or expand enterprises.. McGraw-Hill 26 . direction of investment (i. it is usually not feasible to inquire into the underlying causes and motivations for changes in holdings. and to diversify investments. to influence or react to exchange rate movements. The components can. in the case of direct investment. Characteristics of this kind are readily observable and can thus be used as a basis for developing a classification scheme. when appropriate. several bases are utilized for classifying financial items: functional type. assets and liabilities. behavior is also associated to a considerable degree with such attributes as type of asset and sector of holder. to establish.Classification The primary purpose of the classification of items in the financial account is to facilitate analysis by distinguishing categories that exhibit different patterns of behavior. References • Economics 8th Edition by David Begg. Stanley Fischer and Rudiger Dornbusch. be rearranged to meet specific analytic requirements and to include.
Shaikh Saleem o 27 . Causeway Press Business Environment .• • Economics Third Edition by Alain Anderton.
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