Introduction to the Conceptual Framework

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1 Introduction to the Conceptual Framework Workshop on the new Balance of Payments and International Investment Position Statistics Manual BPM6 Beirut February 14-16, 2012

2 Scope of International Accounts The International accounts for an economy summarize the economic relationships between residents of that economy and the rest of the world. They comprise: The international investment position (IIP), the stock of financial assets and liabilities compiled on a specific date; The balance of payments, a statement that systematically summarizes economic transactions for a specific time period; and The other changes in financial assets and liabilities account covering other flows, such as valuation changes that reconcile the balance of payments and the IIP for a specific period.

3 Scope of an Economy International accounts are generally compiled for individual countries but could be constructed in respect of a group of economies, e.g., Euro Area, BCEAO, BEAC, and the ECCB as well as regions within a country.

4 Definition of the International Investment Position The international investment position (IIP) is a statistical statement that shows at a point in time the value of financial assets of residents of an economy comprised of claims on nonresidents and gold bullion held as reserve assets; and the liabilities of an economy to nonresidents. The difference between the assets and liabilities is the net position and represents either net claims on or net liabilities to the rest of the world. The consolidated balance sheet for the nation includes the stock of nonfinancial assets in addition to the IIP.

5 Definition of the International Investment Position The IIP relates to different points in time, and has an opening value (beginning of the period) and a closing value (or end of the period). The integrated IIP statement reconciles the opening and closing value of the IIP through transactions in financial items and other changes (other volume changes and revaluations).

6 Illustrative Example of the IIP Suppose an investor purchases 10 units of foreign bonds at a unit price of US$5 million. Suppose at the time of the transaction, the exchange rate between the U.S. dollar and the domestic currency was US$1=1.2 domestic currency units. Let us also assume that at the beginning of the period the exchange rate was US$1 = 1 domestic currency units. At the end of the period, the price of the foreign bonds increases to 7 million dollars per unit and the exchange rate moves to US$ = 1.5 domestic currency units. The IIP expressed in domestic currency units would appear as follows:

7 Illustrative Example of the IIP Foreign Assets 1. Currency and Deposits Opening Balance Transactions Price Revaluations Exchange Rate Closing Balance Foreign Bonds

8 Definition of the Balance of Payments The balance of payments is a statistical statement in double entry format that summarizes transactions in goods, services, primary and secondary income, and financial items between residents and nonresidents. Since each transaction in the balance of payments is recorded as consisting of two entries of equal and opposite sign, the sum of the entries is conceptually zero, that is the accounts as a whole are in balance.

9 Accounting Convention for International Accounts The accounting convention underlying the international accounts derives from broad bookkeeping principles. To understand the accounting system for international accounts, three bookkeeping principles can be distinguished: Vertical double-entry bookkeeping also known simply as double-entry bookkeeping used in business accounting. Horizontal double-entry bookkeeping; Quadruple-entry bookkeeping.

10 Accounting Convention for International Accounts Vertical double entry Under a vertical double-entry bookkeeping, each transaction leads to at least two entries, traditionally referred to as a credit entry and a debit entry, in the books of the transactor. This principle ensures that the total of all credit entries and that of all debit entries for all transactions are equal, thus permitting a check on the consistency of accounts for a single unit. Vertical double-entry bookkeeping also ensures the fundamental identity of a unit s balance sheet, i.e., the total value of assets equals the total value of liabilities plus net worth.

11 Accounting Convention for International Accounts Horizontal double-entry This concept is useful for compiling accounts that reflect the mutual economic relationships between different institutional units in a consistent way. If a unit A provides something to unit B, the accounts of both A and B show the transaction for the same amount: as a payment in A s account and as a receipt in B s account. Horizontal double-entry bookkeeping ensures consistency of recording for each transaction category by counterparties. For example, at the worldwide level interest receivable is equal to interest payable.

12 Accounting Convention for International Accounts Quadruple double-entry The simultaneous application of both the vertical and horizontal double-entry bookkeeping results in a quadruple bookkeeping system underlying the recording in the national accounts and the international accounts. It deals in a coherent way with multiple transactors or groups of transactors each of which practices vertical double-entry bookkeeping. A single transaction between two counterparties gives rise to four entries.

13 Accounting Convention for International Accounts International accounts deal with interactions among a multitude of units in parallel and thus require special care from a consistency point of view. E.g. a liability of one unit is mirrored in a financial asset of another unit. Consequently, they should be identically valued, allocated in time, and classified, to avoid inconsistencies in aggregating data into regional or global totals. Even though international accounts, show data for one economy s flows and positions with nonresidents, the underlying accounting system is based on the quadruple accounting system.

14 BOP of an Individual Economy Uses Double Entry Accounting System The basic accounting convention for an economy s BOP statement is that every recorded transaction is represented by two entries with exactly equal values. Each transaction is reflected as a credit and a debit entry. In conformity with business and national accounting, in the balance of payments, the term: Credit is used to denote a reduction in assets or an increase in liabilities, and Debit is used to denote a reduction in liabilities or an increase in assets. Sum of all transactions = 0

15 The Compiling Economy Records Credit (CR) entries for: exports of goods provision of services provision of factors of production to another economy financial items reflecting a reduction in the economy s external assets, or an increase in external liabilities

16 The Compiling Economy Records Debit entries (DR) for: imports of goods, acquisition of services, use of production factors provided by another economy, financial items reflecting an increase in assets or a decrease in liabilities. N.B. The financial account records net acquisitions of assets and net incurrence of liabilities but their interpretation in relation to the rest of the BOP follows the accounting convention.

17 Elaboration of the Definition of the Balance of Payments The balance of payments registers transactions between an economy s residents and residents of the rest of the world. A transaction is an interaction between two institutional units that occur by mutual agreement or through the operation of the law and involves an exchange of value. Mutual agreement means that there is prior knowledge and consent by the institutional units. Transactions imposed by force of law are applicable mainly to certain distributive transactions such as the payment of taxes, fines, and penalties.

18 Elaboration of the Definition of the Balance of Payments Although taxes or penalties are imposed on individual units by administrative or judicial decisions, there is collective recognition and acceptance by the community to pay taxes and penalties. Transactions reflect the creation, transformation, exchange, transfer, or extinction of economic value. By the nature of international accounts, internal (i.e., intra-unit) transactions are not recorded. However, following the residency criteria, transactions between a branch and its parent enterprise are shown as interactions between institutional units, with a branch recognized as a separate institutional unit (i.e. a quasi corporation).

19 Elaboration of the Definition of the Balance of Payments When a notional enterprise is created for holding land and associated buildings by nonresident owners, transactions between the nonresident owners and the notional enterprise are considered interactions between institutional units. Transactions between two resident institutional units in a transferable external asset are domestic transactions and therefore excluded from the coverage of the BOP. The sectoral change in the holdings of external assets resulting from domestic transactions are nonetheless shown in the IIP. The changes in positions are attributable to other changes in volume of assets (OCVA).

20 Elaboration of the Definition of the Balance of Payments Most transaction can be clearly observed as the way they take place also reflects the underlying economic relationship. However, some transactions (as they appear to the institutional units) do not reflect the underlying economic relationships, hence need to be rearranged so that the accounts portray economic reality. Rerouting (e.g. social security contributions paid by employers directly to a retirement scheme) and partioning (e.g. interest received from or paid to financial intermediaries) are the two types of rearrangements employed in the international accounts. Transactions of agents transactions in the underlying items are attributed to the principals concerned.

21 Coverage of the Balance of Payments Many international transactions recorded in the BOP do not involve payments of money. The inclusion of transactions other than those involving money payments constitute the principal difference between a BOP statement and an exchange record.

22 Categories of Transactions Exchanges: provision and acquisition of economic values is two-sided. Exchanges of goods and services for financial items. Payments for, or receipt of primary income on, the factors of production. Barter (exchange of goods and services for other goods and services). Exchanges of financial items for other financial items.

23 Categories of Transactions Secondary income and capital transfers: Transactions involving secondary income and capital transfers differ from exchanges in that one transactor provides an economic value to another transactor but does not receive an equivalent value in return. The lack of economic value on the one side must be balanced by an entry referred to in BOP and national accounts as secondary income or capital transfers.

24 Imputation of Transactions Imputation of transactions refers to constructing entries in the accounts when no separate transactions are identified by the parties involved. As a general rule transactions are to be imputed only in specific cases: Retained earnings of direct investment enterprises are attributed to direct investors as if the retained earnings had been distributed in proportion to direct investors ownership of the equity and then reinvested by them in the direct investment enterprise.

25 Imputation of Transactions Investment income earned on technical reserves held by insurance corporations is deemed to be payable to policyholders who are then deemed to pay this income back to insurance corporations as premium supplements even though in terms of actual cash flows the property income is retained by the insurance corporations. Retained earnings of investment funds are treated as if they were distributed to shareholders who are then deemed to reinvest in the investment fund.

26 Imputation of Transactions When a government has a nonresident entity to undertake fiscal functions related to government borrowing and/or incurring government outlays abroad with no or incomplete economic flows between the government and the nonresident entity related to these fiscal activities, transactions are imputed in the accounts of both the government and the nonresident entity to reflect the fiscal activities of the government.

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