A User Guide to the Canadian System of National Accounts

Note to readers

This document is a guide to the various components of the Canadian System of National Economic Accounts, describing frameworks, major concepts, definitions and the purpose of each component. It was published in 1989. Most of the information does not change. However, the Canadian System of National Economic Accounts is constantly making important improvements. For more information see Latest developments in the Canadian economic accounts.

Chapter 6

Balance of Payments and International Investment

I - Balance of payments

General

a) Availability

The official annual Canadian balance of payments estimates begin with the year 1926. The framework and statistical series evolved as economic, social and institutional changes occurred, causing discontinuities between the series as published in the earlier and later time periods. However, in recent annual reports, an attempt has been made to provide official series from 1926 on a consistent basis and in the current format. Quarterly estimates have been available since 1953.

The most recent detailed description of the development of the balance of payments and international investment position statistics appears in 'Canadian Balance of International Payments and International Investment Position - A Description of Sources and Methods', Statistics Canada, Catalogue 67-506.

b) As part of the Canadian System of National Accounts

The balance of payments accounts predate all other components of the System of National Accounts and, as such, stood alone as an analytical tool for many years. Although an integral part of the overall system, it is to many ways quite different from the other components. Unlike the input-output, income and expenditure and financial flow accounts which lead into each other, with the final stage of one set of accounts providing the opening stage of the next, the balance of payments runs parallel to all three systems, feeding information about international transactions into all parts. The schematic diagram illustrates the relationship of the balance of payments to other parts of the system.

International transactions are grouped in the balance of payments into two basic accounts, current and capital. The current account distinguishes transactions in goods, services, investment income and transfers (no distinction is made between capital and current transfers); the capital account covers investment and other transactions in financial claims, including transactions in official international reserves.

The balances registered in the two accounts should in principle be of equal size and opposite sign. If the current account records exports in excess of imports (receipts greater than payments), the capital account should show an equivalent amount of net foreign investment through the acquisition of foreign financial assets, including Canada's international reserve holdings, and/or reduction of liabilities.

c) Principles and concepts

The accounts record transactions between residents and non-residents of Canada. The primary criterion for deciding whether a transaction belongs in the balance of payments is the residency of the two transactors. It is important not to confuse residency with citizenship. For example, transactions between two Canadian citizens, one living in Canada and one abroad, constitute relevant entries for the balance of payments, whereas transactions between a Canadian and a U.S. citizen both residing in Canada are not relevant. The question of what determines resident status will be discussed later.

The current account, which records transactions in goods and services, factor income flows and transfers, is in principle compiled when ownership change takes place or service is rendered. This payable/receivable guideline is in conformity with the other components of the national accounts which are, in general, on an accrual rather than a cash payment basis.

The Canadian accounts attempt to reflect the value of a transaction at the price at which settlement occurs. This may differ from what is normally thought of as being the equivalent of a market price in the national accounting sense, that is, the amount of money that a willing purchaser pays to a willing seller at arm's length. Any general attempt to apply a notional market price would give rise to major practical difficulties. There are many transactions for which no market prices exist, such as those between affiliated companies in an enterprise, gifts and other unrequited transfers. There are also a multiplicity of times and values used in the business world to record a transaction so that reported data may refer to a contract date, shipment date, delivery date or customs clearance date, and valuations range from producer cost, purchaser price, transfer price between affiliates, or valuation for custom duties.

Attempts to apply a uniform valuation are not feasible and with few exceptions the Canadian accounts accept reported valuations. The unit generally used both for reporting basic data other than merchandise and for compiling balance of payments tables is the enterprise. The scope of the enterprise is restricted to its consolidated Canadian operations so that all transactions with non-residents, both related and unrelated are reported. Because of the focus of the accounts and the lack of industrial detail in the balance of payments, the enterprise is the logical choice as the unit best equipped to provide required data.

The fact that Canadian dollars are the unit of account in the balance of payments presents some conversion problems when transactions are denominated in foreign currencies. The difficulties relate to the choice of an exchange rate that corresponds with the timing of the transaction and to the application of the same exchange rate to both sides of a transaction.

Conversions are carried out on the basis of daily exchange rates in the case of such series as merchandise imports, monthly averages where the data are reported only on a monthly basis and quarterly averages when knowledge of the date of the transactions is imprecise. For those transactions derived from opening and closing stock figures, particularly short-term capital and official reserves, attempts are made to calculate transactions from balances in original currencies so as to eliminate valuation changes due to exchange rate movements.

The capital account is used to record transactions in financial claims on and liabilities to non-residents, as well as investment in tangible assets. Conventionally, in the balance of payments and the non-resident sector in other components of the national accounts, investment in physical assets is recorded as a financial transaction and included in the category 'other claims'. It is treated as if the trans-border transaction was a loan and a notional unit in the receiving country undertook the investment in tangible assets on behalf of the foreign investor.

The accounts are constructed on the principle of double-entry book-keeping. Every transaction involves a credit and debit entry. Credit entries carry a positive sign and cover the export of real resources such as goods and services, investment income receipts, and transfers received. In the capital account credit entries include the sale of assets to non-residents and borrowings from non-residents. All credit entries represent inflows of funds. Debit entries, which carry a negative sign, include imports of goods and services, investment income payments and transfer payments; acquisitions of foreign assets and payments of liabilities are debit entries and represent outflows of funds.

The fact that each transaction requires offsetting credit and debit entries ensures a theoretically balanced system, but because the two entries are normally derived independently, timing, coverage or valuation differences inevitably create some imbalance in the system. When this occurs, the accounts are balanced artificially with a statistical discrepancy item. In a perfect system, for example, exports of a shipload of grain would result in a positive entry under merchandise exports and an exactly balancing negative entry, normally in the capital account, showing the payment received either in the form of an acquisition of a foreign asset or a payment of a liability. The specific entry might be an increase in a foreign bank deposit account, or alternatively, the payment might be applied to reducing a loan from a foreign bank.

The offsetting entries are not necessarily split between the current and capital accounts. Many transactions result in entries which both appear either in the current or the capital account. In the case of foreign purchases of Canadian government bonds, where the resulting inflow of funds is used to build up international reserves, both entries are of a capital nature.

A distinction should be made between transactions as measured in the balance of payments and a record of foreign payments. The two are sometimes confused.Some entries conventionally recorded in balance of payments statements call for no payments in the traditionally accepted sense of the term. These include such transactions as the monetization of gold produced domestically which when held by the central authorities is considered the equivalent of a foreign financial asset; transfers in kind for which there is no quid pro quo; and the shipment of goods or services between affiliates in which the settlement is effected by contra book entries.

The Canadian balance of payments does not include retained earnings of Canadian direct investment abroad, nor that of foreign direct investment in Canada as receipts and payments in the current account. In some countries they are recorded as if they were actually paid or received and then reinvested in the affiliate; despite the fact that no funds cross the border, notional transactions are recorded in investment income in the current account and in direct investment in the capital account.

Apart from classification differences, the balance of payments capital account reveals the same underlying characteristics as the financial flow accounts. Transactions in financial assets and liabilities reflect the flow of funds during an accounting period and not changes between opening and closing statements of the level of holdings. The net capital flows represent the saving or dissaving on account of current transactions translated into lending or borrowing in financial instruments.

The capital account net balance is in principle equal but opposite in sign to the surplus or deficit on current account and in the minds of many users is associated with the financing of the exchange of goods and services. However, the account also reflects financial activity only remotely connected with production and the current account. There may be considerable capital movement for investment and speculative purposes. These may show up as offsetting flows including foreign exchange reserve movements.

A number of factors which change the net indebtedness of a country are not recorded in the balance of payments accounts. Canada's external assets and liabilities may change due to reclassification of assets and liabilities, valuation adjustments, the effects of exchange rate variations, the impact of retained earnings and territorial changes. The items are similar in nature to those recorded in the reconciliation of financial flow and balance sheet accounts.

The schematic presentation of the Canadian System of National Accounts illustrates the interrelationship of the balance of payments with the other components, while the format of the summary table of the Canadian balance of payments with figures for the year 1981 is shown in Table 5A. The table consists of standard components that have been agreed to internationally. The current account includes merchandise, travel services, freight and shipping services, business services, government transactions, investment income and transfers. The capital account distinguishes direct investment, portfolio investment, Government of Canada claims including official international reserves, other investments abroad, liabilities in the form of money market instruments, Canadian banks' net foreign currency borrowing or lending abroad, and the allocation of Special Drawing Rights.

d) Balances in the accounts

The striking of analytical balances in the accounts has been the subject of much discussion. The number and the choice of balances a country may wish to focus upon is a matter of what are considered relevant for interpreting, monitoring and developing policy in the field of international economic relations.

There are a number of balances commonly calculated by most countries. The balance on goods, services, investment income and transfers, known as the current account balance, is in fairly general use and represents transactions that increase or decrease a country's wealth vis-a-vis non-residents (apart from valuation changes, etc.). A surplus or deficit on current account does not in itself indicate a desirable or undesirable situation for any country at a particular point in time; the balance has to be seen in the light of other factors before an assessment can be made.

The current account balance is frequently augmented by what is commonly referred to as the 'basic' balance. The intention is to look at the balance emanating from transactions that are unlikely to be reversed in the near future. In striking the basic balance, long-term capital inflows and outflows are combined with the current account balance to provide a better indication of underlying trends in the economy's international transactions. The difficulty with such a balance is that it ascribes a motivation to capital flows which cannot be known from the statistics alone.

Balances for individual items are of analytical interest and often form part of the standard balance of payments presentation. The most important of these is probably that relating to merchandise transactions, although for countries heavily dependent on tourism the balance on travel account may be of greater interest.

Extending the statistical analysis of the economy

The balance of payments statement is essentially a one sector account in the sense that it is entirely focussed on Canada's relations with the rest of the world. To this extent one might ask what it adds to the non-resident sector accounts embodied in the income and expenditure and financial flow accounts. The answer is a comprehensive presentation, greater detail and a different perspective. The balance of payments brings together all transactions with non-residents in one package and does not sub-divide them into those associated with current production, income flows and financial assets and liabilities. In addition it provides an enormous range of data on international transactions not available elsewhere.

Although summary statements appear in other branches of the System of National Accounts, the balance of payments is a primary source for many statistics of international transactions (an important exception being merchandise trade). The accounts provide the only comprehensive picture of the importance of international transactions to the compiling country, not only revealing the structure and relative strength and weakness of the goods and service components, but suggesting the degree of sophistication of the economy in its financial transactions with the rest of the world.

The remainder of this section describes in some detail the transactions recorded in the current and capital accounts. Because of the importance of the resident/non-resident distinction to the entire balance of payments concept the section also contains the Canadian working definition.

a) Transactions recorded in the current account

The classification system used in the balance of payments stems largely from a traditional or conventional, rather than theoretical, base. The categories usually shown relate to groupings of similar transactions, important in the context of international trade and analytically useful. The categories follow a traditional split common in other systems of the accounts of goods, services and income.

The internationally recommended sub-division of services is unique to the extent that it is a classification of groupings which are of general importance in external transactions. For example, the travel service account is more in the nature of an economic or analytical classification, combining the outputs of several industries and commodities.

The data are normally presented on a gross basis. Both exports and imports are shown rather than only the net flow, on the principle that to a large extent the credit and debit entries are unrelated and net figures mask the importance of international trade in the compiling country's economy.

The separate identification of income flows, sometimes referred to as factor services to indicate that they relate to flows associated with factors of production, is essential in providing a bridge between the balance of payments and the national and domestic concepts employed in the other accounting systems. As already noted, national product includes the output of residents produced both in the domestic economy and abroad less the output of non-residents produced in the domestic economy. Factor income receipts recorded in the balance of payments measure the value of production abroad of residents while payments measure the output produced in the domestic economy by non-residents; their separate identification is critical to the overall System of National Accounts. The Canadian accounts at present only include investment income in this category; other small amounts of factor service payments and receipts are not identified.

i) Merchandise trade

The merchandise account covers transactions in moveable goods in which ownership changes between residents and non-residents. The account presents only summary figures adjusted to fit balance of payments concepts and geographical areas; detailed commodity and geographic distributions of external trade figures are not included as these are available from other sources. In the case of merchandise trade figures the balance of payments is a user of existing series rather than a prime source, its more usual role.

The primary source for data are customs documents processed when goods cross the national frontier. In principle, exports are valued at the point of shipment and before the addition of inland freight, insurance and handling charges, while imports are valued at fair market value in the last country of shipment (normally the wholesale level). As with exports, the customs valuation excludes inland freight from the point of consignment to the foreign port of exit, insurance and handling charges. In practice it has been determined that some export values are reported inclusive of freight and insurance costs and these are adjusted out of the totals for balance of payments purposes; they more correctly are classified as services.

Certain exceptions are made in applying the general definitions covering merchandise trade. Some apply to the change of ownership rule; for example, transactions between related units where no legal change in ownership occurs are nevertheless included in trade, as are goods leased on a financial type lease. There are also examples of goods not crossing international boundaries that are included and by contrast, goods crossing boundaries that are excluded. For example, ships, aircraft and drilling rigs may not cross frontiers but ownership changes occur and they are included in the figures, whereas such items as goods crossing frontiers temporarily for art exhibitions, trade shows, repair and processing or construction projects are excluded.

A number of adjustments are made to the merchandise figures compiled from customs documents to adapt them to balance of payments concepts. The adjustments are made with the objective of placing trade figures on a consistent and compatible footing with other balance of payments measures and to avoid duplication or omission of items. The adjustments are classifiable into three types - coverage, valuation and timing.

Examples of the adjustments are: a deduction from exports of foreign tourists' Canadian purchases which are classified to the travel account; the addition of imports and exports of ships which may not be documented by customs normal methods; the removal of automotive special tooling and other charges included in trade figures which are more appropriately classified to business services; the substitution of progress payments on the construction of ships, civil aircraft and some military equipment for actual deliveries; and the raising of export values to allow for reporting undercoverage and adjustment for differences between the U.S. import customs values and Canada's export customs values as revealed by reconciliation studies with United States trade data. The above represent illustrative examples only; for a full account see, 'The Canadian Balance of Payments and International Investment Position - A Description of Sources and Methods', Statistics Canada Catalogue 67-506.

ii) Travel

Receipts and payments on travel account comprise the sale of goods and services to foreign visitors to Canada and the purchase of goods and services by Canadian visitors abroad. The account includes fares received by Canadian carriers for the transportation of non-resident visitors to Canada and payments by residents for international travel on foreign carriers. The treatment in the Canadian accounts differs from some countries to the extent that transportation costs associated with passenger travel are not assigned to a separate transportation account.

The coverage extends beyond the normal definition of visitor and includes not only traditional excursionists and vacationers and business visitors, but students visiting for less than a year, seasonal workers and residents, crews, persons visiting for medical care, transit passengers who clear customs, diplomats and military personnel and their dependents travelling to a posting for less than a year.

iii) Freight and shipping

This account covers receipts of Canadian-operated carriers from transporting Canadian exports, or carrying foreign owned goods in transit through Canada or between foreign ports, plus receipts for chartering vessels to nonresidents, plus the spending of foreign carriers in Canada, other than airline expenditures which are included in the business receipts account.

Payments include the costs of transporting imports to Canada by foreign carriers, the cost of transporting Canadian goods (in particular oil and natural gas) in transit through the United States or in Canada by foreign carrier, the costs of chartering non-resident carriers, plus the purchases made abroad by Canadian resident carriers, other than airlines whose expenditure is included in the business account. Freight costs on imports carried by Canadian carriers and on exports carried by foreign carriers are not relevant entries for balance of payments as they normally constitute a resident/resident or a non-resident/non-resident transaction.

The account covers carriage by ocean going and inland water vessels, aircraft, trains, trucks and pipelines. Bunker supplies and stores are included in this account, although they might equally well be classified as trade in goods. In most cases handling and loading charges are also included in the account.

iv) Business services

The service account provides a wealth of original data on transborder purchase and sale of business services, with data being published for sixteen separately identified categories. The services cover those associated with particular types of industry such as the transportation or computer industries; services provided by an individual or corporation and based on specific skills such as legal, accounting, engineering etc; a generic type of service like research and development that may relate to any industry or skill; payments or receipts for some rights or privileges such as royalties, patents, trademarks, franchises, etc. The classifications used are pragmatic rather than fitting an overall theoretical frame. The detailed services appear regularly in the balance of payments publication and in "Canada's International Trade in Services", Statistics Canada, Catalogue 67-203:

v) Government transactions

Transactions include expenditures of the Canadian governments abroad and the receipts from expenditure of foreign governments in Canada. The type of expenditures included are those related to the maintenance of diplomatic, military and commercial representation abroad, and payments to international organizations.

Costs of maintaining representation abroad include the wages and salaries of locally employed staff but not those of staff posted from the home country. The series by no means cover the entire range of government transborder transactions. For example, interest flows, trade in defence equipment and materials, government official travel and government pension payments all appear in different accounts.

vi) Other services

This account is a catch-all for services that do not fit the more specifically defined accounts. Resident/non-resident transactions included relate to educational, cultural and entertainment services, gross earnings of short-term migrant labour and current transborder flows associated with trade union operations.

vii) Investment income

This section elaborates on the introductory comments to the current account on the importance of investment income estimates for determining national and domestic aggregates throughout the System of National Accounts.

The account covering interest, dividend and miscellaneous investment income flows between Canada and the rest of the world includes the earnings of branches of Canadian companies located abroad and foreign owned branches operating in Canada. Also included are net revenues and expenditures of Canadian banks with non-residents, including the profits of their foreign affiliates; net revenues from abroad of Canadian insurance companies, including profits of foreign branches, and net payments to foreign insurance companies, including profit of their Canadian branches. Much of miscellaneous investment income is made up of interest and dividend flows; the separate classification of this item is largely one of historical accident.

The investment income account does not measure factor payments and receipts as defined precisely in the System of National Accounts and as required for the purpose of moving between domestic and national concepts. It includes some service payments built into the banking and insurance investment income estimate through the estimating technique and excludes some factor income flows. Such flows include short-term migrant workers' earnings, daily commuter workers' earnings and income accruing to the owners of patents, copyrights and other intellectual property. The factor income series is not one normally associated directly with the balance of payments account but is derived from it and is highly important in the overall framework of the national accounts.

The account is symmetrical insofar as the treatment of withholding taxes is concerned. Investment income payments are recorded gross of withholding taxes and such taxes are recorded as transfer receipts on the opposite side of the accounts. In the case of receipts, attempts are also made to record the figures on a gross basis but the exercise is more difficult because of data sources and availability. The account therefore, attempts to adhere to the principle of recording gross rather than net figures and to make explicit the appropriate entries for the sector accounts of the income and outlay accounts.

The Canadian accounts depart from recommended international practice with regard to the investment income estimates. At present only dividends actually remitted are entered in the account. The recommended practice, and that followed by some countries, is that retained or undistributed earnings of foreign direct investors should be shown as outflows in proportion to their equity participation and unremitted earnings of direct investors abroad of the compiling country should be included as inflows. The Canadian accounts do however show stock dividends paid out of retained earnings as part of the investment income account, even though this transaction may only involve a book transaction.

Including unremitted earnings as a flow in the current account would require an offset in the direct investment category of the capital account to maintain the balance. The treatment requires a fictional outflow of earnings and an instant reinvestment by the direct investor. The recommended treatment would result in the reallocation of retained earnings of foreign direct investors to the non-resident sector from the domestic corporate sector and a counterpart entry for Canadian direct investors.

The exclusion of retained earnings from the accounts tends to mask the true extent of direct investment and necessitates an additional reconciliation item to explain the difference between the capital account flows and the change in the international investment position.

The Canadian decision to exclude the item hinged in part on the availability of data, and in part on reservations regarding the recommended international practice.

viii) Transfers

This account represents the final major category in the current account and groups together transactions in which there is no exchange of values but simply a one way transaction with no 'quid pro quo'. The account which identifies different types of transfers is necessary as a balancing device to offset the recorded inflow or outflow of real or financial resources which occur and for which there is no exchange transaction.

The Canadian account includes such items as taxes, inheritances and migrants' funds, personal and institutional gifts and remittances and official technical and economic assistance other than in the form of loans. The balance of payments account makes no distinction between current and capital transfers, but items are identified in sufficient detail to permit the distinction to be made in other components of the national accounting system in arriving at sector gross saving estimates.

ix) Current account balance

The difference between receipts and payments on the combined merchandise, services, investment income and transfer accounts described above represents net investment abroad. An excess of exports over imports results in lending abroad, while a negative figure, or an excess of payments, indicates borrowing from abroad. The non-resident sector capital finance account in the income and expenditure accounts records the same balance but with change of sign - Canadian lending equals rest of the world borrowing.

As previously noted the current account surplus or deficit is theoretically equal but with opposite sign to the net transactions in financial claims (including official reserve assets) recorded in the capital account. For example, inflows of funds generated by net export earnings become outflows as they are lent to non-residents through the acquisition of foreign financial claims. In practice a statistical discrepancy exists between the two accounts.

The causal factors underlying surpluses and deficits are not revealed by balance of payments statistics. The figures, at best, are symptoms of conditions and point the analysis in the right direction. Frequently it is unclear whether net flows of capital are the result of current transactions or whether capital flows themselves have been responsible for generating current account flows. Only close analysis of economic events in the compiling country and in its major trading partners can shed light on this question.

b) Transactions in the capital account

The capital account is the vehicle for recording transactions between residents and non-residents in financial assets and liabilities. The categories employed in Canada are those traditionally used in balance of payments statements.

As with the current account, only capital transactions affecting residents' and non-residents' claims are recorded. In addition, in order to be considered relevant for the accounts, claims must legally exist; therefore authorization of lines of credit and contingencies are not included. National accounting conventions also require that some entries of a nonfinancial nature be included in the capital account.

For example, in the case of the acquisition by a nonresident of tangible fixed capital, the property is always deemed to belong to a resident and the nonresident's ownership is always deemed to be a financial interest and appropriately entered in the capital account.

In addition to clearcut transactions, a number of borderline cases, decided more on pragmatism than on principle, affect the capital account. Namely, refinancing of debt instruments are included as new flows, allocations of Special Drawing Rights are included as capital flows, and as previously noted, unremitted earnings are not included in direct investment.

Unlike the current account, most capital flows are recorded on a net rather than a gross basis. The increases and decreases occurring during the reference period for any particular asset are consolidated into a single net figure. In the case, say, of deposits abroad, a single figure records the value of the change in the balance between the opening and closing period, rather than recording total deposits and total withdrawals during the period.

Recording net flows is in part attributable to the availability of data but it is also based on the fact that gross changes may be of limited analytical interest. The classification system distinguishes a limited number of analytically valuable items in the context of international capital transactions. Each category tends to exhibit different characteristics and behaviour patterns. The basic distinction is the general separation of net claims on non-residents (assets) and net liabilities to non-residents. Within these two main sub-divisions there are basically five key sub-groupings: direct investment, portfolio investment, Government of Canada investments including official reserves, banking data and miscellaneous capital. Although the principal balance of payments statement presents only summarised data with a limited breakdown, supplementary information expands the classification system in a great many directions.

As noted earlier, the balance of payments and financial flows have different systems of classification for financial assets and liabilities. Although the aggregate net position recorded in the two systems coincide and the underlying data are the same, users cannot easily move between the two systems. The justification for the dichotomy is the type of analysis for which the two systems were designed.

The broad question of classification systems and their harmonisation is currently being discussed in the international agencies. A more closely related classification for use in the financial flows and balance of payments capital account may eventually emerge serving both international and domestic financial analysis.

The following briefly describe the characteristics of the main categories of transactions.

i) Direct investment

Direct investment capital is that which is directed into entities which allow the investor to influence or have a voice in the management of the enterprise. Control of an entity through direct investment is normally assumed when ownership is at least 50% of voting stock, but for operational purposes of measuring 'influence or a voice in management', direct investment is assumed to occur with ownership of at least 10% of the equity of an enterprise and includes the value of all claims intended to remain outstanding for more than one year. Direct investment applies not only to incorporated enterprises but branch operations and other unincorporated businesses.

Those enterprises owned by residents that are controlled by non-residents through such mechanisms as franchises, licensing, etc., are without foreign capital, and as such, are not included in the direct investment category.

The mix of transactions grouped under direct investment varies from funds transferred to finance fixed capital formation, to funds used to acquire existing tangible assets or voting stock and to those providing working capital to finance inventory investment and receivables. In general the capital is intended to remain with the enterprise for more than one year.

The pulling together of such diverse types of transactions under one heading is justified by the objectives of direct investment which distinguish it from other forms of investment. The direct investor is usually motivated by long term objectives and is less likely than portfolio investors to be substantially affected by short-run changes in interest rates and exchange rate variations. Fluctuations in the series are more likely to be the result of distribution of profits, take-overs and divestitures. Direct investment may also have a significant impact on trade flows of the involved countries.

ii) Portfolio investment

This series covers transactions in bonds and corporate equities, excluding those held by direct investors, official monetary authorities and Canadian banks. Other than these exceptions, in principle all transactions in outstanding issues, new issues and retirements of both Canadian and foreign securities are covered. The series attempts to capture transactions between residents of one country and another no matter what the currency of transaction, the currency of denomination of the instrument, or the physical location of the securities. The value of the securities traded excludes payments of taxes, commissions and issue expenses; estimated fees and commissions on new securities are classified as services in the current account.

Although the series refers to equities and bonds which represent capital in long-term forms, namely, with an original date to maturity longer than one year, there are frequently short-term capital movements in instruments of this sort.

The short and long-term designation of flows has become more and more difficult to justify as new financial instruments and new financing practices have developed, and the terms are no longer used to any great extent in the Canadian balance of payments classifications.

Although the summary balance of payments statement distinguishes only bonds and stocks under the general portfolio heading, supplementary tables provide detail by type of issuer; for example, in the case of Canadian securities, issues by the three levels of government in Canada can be identified, while foreign issues are identified with some geographic detail and type of issue.

iii) Government of Canada investments and official international reserves

Government of Canada loans and subscriptions to international aid organizations and export loans are classified to this group. Canada's official reserves are also included, having been integrated into the main body of the capital account rather than segregated as a separate financing item; in many respects they are now treated as one type of capital flow among many.

This treatment has been adopted on the grounds that the reserves are but one of a number of means by which any imbalance in the accounts is offset. The balance is now maintained by a variety of means in addition to reserve changes; adjustment of interest rate differentials, exchange rate changes and government borrowing, all represent means by which imbalances are dealt with.

The definition of reserves is not unambiguous, particularly with respect to the range of existing claims on non-residents that are available to central authorities to finance payments imbalances, either directly or indirectly. Opinions may differ over what assets can reasonably be considered to be available to central authorities.

In general however, and under normal conditions in Canada, only those foreign claims actually owned by the central authorities are included as part of international reserves.

Canadian reserves are defined to include convertible foreign currency holdings of the Exchange Fund Account, the Receiver General of Canada and the Bank of Canada; monetary gold in the hands of the central authorities; Special Drawing Rights; and Canada's reserve position in the International Monetary Fund. Changes in value that occur in these holdings depend on both actual flows and exchange rate fluctuations, but only those changes due to actual flows are included.

iv) Canadian banks' net foreign currencytransactions with non-residents

Foreign currency transactions of Canadian chartered banks booked in Canada with nonresidents are provided on a net basis in this category. Unlike the treatment of other institutions, the foreign currency claims of banks are netted because of their intermediation role in international finance. The net position of the banks in recent years has been that of a borrower and the item has appeared as a liability but this could swing to an asset position if foreign currency lending booked in Canada should exceed deposits accepted in foreign currencies in Canada.

v) Other capital movements

A number of categories of transactions comprise this broad grouping: on the asset side, non-bank deposits and other investments and claims abroad, and on the liability side, net issues of Treasury Bills and other money market instruments, allocation of Special Drawing Rights and other liabilities.

The 'other' capital flow categories are residual groups made up of such diverse items as real estate transactions, mortgage financing, transfers of capital for administration by trust companies, migrants' funds not transferred at the time of migration, and changes in accounts receivable and payable.

No clearly defined groupings are recommended internationally outside direct investment, portfolio investment and official reserves so that the 'other' capital designation tends to be a heterogeneous collection of capital flows defined in a way that best fits the institutional background and importance of international transactions of the compiling country.

Allocations of Special Drawing Rights (SDRs) form a separate entry in the liability category, and constitute a counterpart entry to the SDR allocation appearing as part of the change in Canada's official international reserves. The SDR is an international currency created by the International Monetary Fund and allocated to Fund members who are participants in the Special Drawing Account. This was a step taken by the Fund to increase the supply of world reserves and alleviate shortages of reserve currencies and gold which beset countries with balance of payments problems.

c) Residents of Canada

Because the concept of residency is crucial in the balance of payments system, some further discussion of the factors determining whether a person or entity is a resident of a country is warranted. Generally the determination of residency is clearcut but it should not be confused with nationality or citizenship.

Persons are considered residents when their stay in Canada is for a period of one year or more. This definition excludes visitors, seasonal workers, commuter workers, crew members of ships, aircraft, etc., who do not live in Canada and are here for less than a year. Canadian citizens residing abroad for a period longer than a year are regarded as nonresidents. Special status is accorded to government personnel and staff members of international organizations - Canadian government employees stationed abroad are considered residents of Canada no matter how long their overseas posting, while employees of foreign governments posted to Canada are not regarded as residents.

The status of governments is straightforward, with agencies, departments and establishments of all levels of Canadian government being residents, including embassies, consulates, military bases, etc., located outside the country. Embassies and other representative bodies of foreign governments located in Canada are not considered residents. The rationale for the special treatment of governments and their employees operating outside their home country is that they remain subject to the laws and regulations of their own country and not those of the country in which they are located.

The greatest difficulties arise in connection with enterprises. In most cases they are classified as residents of the country in which they engage in production and/or conduct transactions in land and other non-financial intangible assets such as leases, patents, copyrights, etc. Ownership of the enterprise is not relevant in deciding residency and many Canadian resident enterprises are foreign owned.

Practical problems encountered in applying the general definition include breaking up single legal entities operating in two countries into two distinct operations, allocating transactions of operators of mobile equipment, namely aircraft, ships, and oil drilling rigs spanning more than one country, and the geographic attribution of agents' transactions. In principle, if equipment is used exclusively between two countries the operation should be split between them, but if mobile equipment moves between many countries and is only in a country for a relatively short time it should be attributed to the one country in which the owner resides and the operating company is incorporated. Transactions undertaken by agents on behalf of a principal should always be considered a transaction of the country in which the principal resides.

In practice the application of principles is constrained by available data. Fortunately, in most cases the definition of Canadian resident accords with the data collecting boundaries. It might be noted out of interest that there are a limited number of companies incorporated in Canada that are treated as nonresidents - they have neither activities nor investment in Canada.

Other features of the balance of payments accounts Supplementing the annual accounts described above, quarterly estimates and statements of the detail underlying aggregate series extend the scope of potential analysis; the current, but not the capital, account is seasonally adjusted. Bilateral balance of payments statements are available for transactions between Canadian residents and residents of the United States, Japan, United Kingdom, other European Economic Community countries, other countries in the Organization for Economic Co-operation and Development and all other countries. Although no constant price estimates appear in balance of payments publications, the current account main aggregates are deflated and appear in the input-output and income and expenditure systems of accounts.

To facilitate the analysis of merchandise transactions the reports provide trade balances for selected commodity groups, a reconciliation between trade estimates on a customs basis and a balance of payments basis, and a terms of trade index. Investment income and transfer payments are also itemized in greater detail in supplementary tables.

A series of regularly published supporting tables assist in the analysis of capital flows. Direct and portfolio investment gross inflows and outflows are given along with their geographic distribution, the type of securities according to principal borrowers, and for new issues of Canadian bonds the currency in which they are denominated. Gross purchases and sales of money market instruments are available by principal class of borrower, for example, Government of Canada, other levels of government, financial corporations and other commercial enterprises.

Because of the increasing importance of international capital flows the foreign currency transactions of Canadian chartered banks with non-residents are depicted in more detail than is available in the main table; statements provide the banks' foreign currency asset and liability changes by country of residency of clients.

Supplementary statements also spell out the mix of transactions involved in changes in Canada's holdings of international reserves and the extent of the Government of Canada's foreign currency financing.

Finally, a table is included listing selected claims on, and liabilities to, non-residents that are included in the 'other' claims category. The principal entries cover trade payables and receivables and borrowings between related enterprises which, because of their short-term nature, do not fit into the direct investment concept and selected Canadian dollar transactions of chartered banks, namely Canadian dollar loans to non-residents and deposits made abroad. Borrowing from foreign banks, including Government borrowing under standby credit facility arrangements, accrued interest on Canadian bonds held by non-residents and Canadian dollar deposits from abroad are important components of the 'other' liability category.

The theoretical framework of the balance of payments and the concepts employed in measuring the transactions are designed to provide a system in which the current and capital accounts are always in balance. This does not happen in practice. Because of the diversity of transactions and the problems of data collection a discrepancy inevitably exists between the current and capital account; a separate entry is built into the system to allow for such a balancing item.

Because balance of payments statements tend to be associated with foreign exchange transactions, it is easy to overlook the fact that only a small proportion of the gross transactions recorded in the balance of payments pass directly through the interbank foreign exchange market. Many transactions are netted out in private foreign currency bank accounts or in inter-company accounts, and in the netting of foreign exchange transactions of bank customers undertaken within the network of branches of individual banks. Many transactions recorded in the balance of payments do not pass through the market at all, such as the payment of taxes withheld at source which are recorded as both outflows and inflows, official contributions made in kind, or direct investment which takes the form of export of goods by the parent offset by the issuance of capital stock or debt by the subsidiary. It is really only at the margin that settlements require currency transactions.

Uses of the balance of payments accounts

It might be argued that the balance of payments accounts are not as widely used as the income and expenditure accounts even though they are equally well known and have certainly been in existence for many more years. If, in fact, such a contention were true it would be because they cover a more restricted field and tend to be used by a more specialised group of analysts. The important role played by international transactions in the Canadian economy ensures the balance of payments a leading position among the indicators of the state of the economy.

The external transactions that form the core of the balance of payments system also feed into the other components of the System of National Accounts and are therefore frequently used within the framework of these other components. What is happening in the balance of payments is reflected in the expansion or contraction of the domestic economy, in employment and income changes and levels, and in the condition of financial markets.

Balance of payments figures are most frequently found in descriptive analysis; external transactions are described, in a systematic way and their relationships one to another and with domestic transactions are examined. Such analysis helps in understanding the factors underlying shifts in economic activity and focuses on the important changes taking place. Such descriptive analysis appears regularly, not only in the reports that accompany the release of the statistics but in a broader perspective in the annual reports of the Bank of Canada, the Economic Council of Canada and in the White Paper normally released by the Minister of Finance coincident with the budget.

On a day-to-day basis, selected economic activities which form part of the balance of payments framework are monitored by the central bank. As a result of this surveillance, adjustments may be made to maintain exchange rates within desirable ranges, either through direct intervention in the foreign exchange markets, or the adjustment of domestic interest rates and the consequential change in international interest rate differentials. The monitoring includes international reserve movements and government debt transactions, both important component parts of the balance of payments.

More importantly perhaps, balance of payments statistics provide the support material for the analysis accompanying new policy development in such fields as tariffs, non-tariff factors affecting trade, free trade, exchange rates, direct investment, codes of behaviour for multinational enterprises, and impact of interest rate changes on international capital flows. Examples of this type of use can be found in Royal Commission studies, the most recent being on the economic union and development prospects for Canada. Balance of payments data also supported analysis in previous Royal Commissions on taxation, money and banking and Canada's economic prospects.

Economic Council of Canada reports on special aspects of the Canadian economy such as foreign aid, external trade and tariffs have prominently featured the balance of payments. Both the data and the framework have been used to provide perspective on the effect of existing policies and to measure the impact of alternative policy changes. An excellent example of the use of balance of payments and international investment data occurred in the studies leading up to the implementation of the Foreign Investment Review Act. The background study, 'Foreign Direct Investment in Canada' known as the 'Gray' report, made extensive use of capital and current transactions with non-residents in developing its recommendations.

In more recent bilateral negotiations with the United States over freer trade in both merchandise and services, balance of payments data have been under close scrutiny. The need for more detail underlying the rapidly expanding trade in services has resulted in a new annual publication, "Canada's International Trade in Services", Statistics Canada, Catalogue 67-203.

External transactions have provided a rich area for theoretical exploration. The balance of payments framework has long been prominent in the development of theories attempting to explain the adjustment process of international trade. Two such examples are the classical theory which describes the automatic adjustment process under the gold standard and the elasticity approach which deals with the balance of payments adjustment process under flexible exchange rates.

Other theories view the balance of payments as the outcome of national income and expenditure policies, in which improvements in balance of payments hinge on raising income relative to the absorption of goods and services. A more recent theory, labelled the monetary approach to the balance of payments, argues that balance of payments imbalances arise because of disequilibrium in the domestic supply and demand for money, an excess demand leading to a balance of payments surplus and an excess supply resulting in a deficit.

The above examples demonstrate the importance of balance of payments estimates in assessing the impact of changes in trade policy, exchange rates, domestic interest rates, changes in tariffs and even broad domestic economic policy.

Links and reconciliations with other branches of the accounts

The balance of payments linkage to other systems is different in nature and more complex than that which exists between other components of the national accounts. First, the balance of payments does not fit sequentially into the system in the same way that capital finance accounts in the income and expenditure system lead into financial accounts, which in turn connect with balance sheet statements. Secondly, the balance of payments international definitions, classifications and concepts are rooted in different soil. The internationally recommended framework developed under the auspices of the International Monetary Fund, while the other systems owe their international framework to the United Nations.

The balance of payments, in some ways, replicates other components of the system of accounts but only for the international segment of the economy. The current account, for example, records transactions in goods, services, investment income and transfers, and parallels the income and expenditure non-resident sector account, while the capital account is a replication of the financial flows for the rest of the world.

In the Canadian system, the balance of payments current account is integrated into and forms part of both the input-output and the income and expenditure systems. The capital account is reformatted and integrated into the financial flow system, at the same time providing the changes in assets and liabilities that feed into the international investment position and national balance sheet systems.

a) Links with input-output

In the case of the input-output tables, because they are structured to examine fine level industry and commodity flows, merchandise imports and exports are taken from the detailed figures of the International Trade Division's reports. The data are however adjusted to reflect the balance of payments concepts.

Sales and purchases of services are taken directly from the balance of payments. In aggregate terms the balance of payments and the input-output system are fully integrated in the sense that the statistics used are identical.

In the case of both the balance of payments and input-output systems, the customs valuation of merchandise exports reflected in external trade statistics needs adjusting to remove elements of service values, such as freight and insurance. In principle this adjustment should be unnecessary as such costs should be excluded from the customs trade valuations; in practice, however, these costs are sometimes included. The adjustments are made at the commodity level in both the balance of payments and the input-output system. Freight and insurance constitute service charges in the balance of payments and a margin and not part of the producer's value in the input-output system. The producer value is taken to be at the point of shipment for export.

In the input-output system, imports of goods at producers' prices are valued at the Canadian border and include import duties, plus shipping and insurance charges up to the border when provided by a non-resident. This valuation of imports creates a conceptual difference between the balance of payments and the input-output systems. To reconcile the two systems the freight and insurance payments recorded as services in the balance of payments must be transferred to the value of imports of.goods in the input-output tables. The overall level of payments to non-residents remains the same in both systems.

To the extent that imported commodities constitute part of the range of commodities used by Canadian industries in their productive activity, they appear implicitly in the 'use' matrix. However, it is only in the final demand matrix that the obvious link with the balance of payments is apparent.

Investment income flows which form part of the current account in the balance of payments are not incorporated in the import and export figures employed in the input-output structure; they are factor payments and as such do not need to be distinguished in the domestic production measure.

Receipts by residents of investment income from abroad is not relevant while investment income of non-residents arising in Canada is implicitly embodied in the domestic measure. Investment income flowing between residents and non-residents is required only in order to convert from a domestic to a national concept.

Transfer payments and receipts are excluded from the input-output tables. These transactions which are important within the balance of payments framework have no relevance within the production accounts; they are redistributional transactions which occur after the production process.

b) Links with income and expenditure

Canadian balance of payments statistics are incorporated into the income and expenditure accounts, both as a component in deriving gross domestic product from the demand side and in compiling the non-resident sector account. The classifications and concepts employed in both systems coincide. The main expenditure table includes exports and imports of goods and services incorporated directly from the balance of payments.

Investment income flows and current transfer payments between residents and non-residents are not required as inputs into the measure of expenditure on domestic production but are incorporated along with goods and services in the non-resident sector account which covers all current transactions of the sector.

The income and outlay account for non-residents is derived from and agrees with the current account of the balance of payments, except for transfers relating to inheritances and migrants' funds which are classified in the current accounts in the balance of payments but as capital in the income and expenditure accounts. After allowing for this difference the current account surplus or deficit is identical, with sign reversed, to the gross saving recorded in the non-resident sector income and outlay account.

c) Links with financial flows

The integration of the balance of payments capital account into the financial flow accounts is complete and fully consistent at the aggregate level - the capital account forms the rest of the world sector. The integration is not transparent because of the differing classification of financial instruments adopted in the two systems. The net lending/ borrowing in the rest of the world account is conceptually identical with the net capital flows in the balance of payments. To preserve this identity and due to the different treatment of inheritances and migrants' funds within the system, the financial flows records them in 'net purchases of existing assets'.

The net capital flows recorded in both systems reflect either foreign saving made available to Canada, or Canadian saving lent abroad. As with the current account, the signs in the two systems are reversed, Canadian lending abroad is seen as an outflow of capital from Canada and appears as a negative entry in the balance of payments, but viewed from the rest of the world perspective the entry is a positive inflow of capital.

At the published level of detail the reconciliation requires a reformatting of the balance of payments capital account to fit the financial flows, in some cases sub-dividing and reallocating items and in other cases combining published items. A detailed reconciliation is not regularly published but illustrative examples have appeared, the most detailed being that included in 'The Canadian Balance of Payments and International Investment Position - A Description of Sources and Methods' Statistics Canada, Catalogue 67-506.

An interesting example of the different approaches to recording transactions occurs in the case of Canadian bond issues. The balance of payments summary statement uses the instrument as the basis of reporting and records a single net flow under liabilities to non-residents comprising new issues, retirements and trade in outstandings. The financial flow accounts categorize bond transactions by issuer.

There seems to be little substantive reason for the different classifications which are probably attributable to the historical sequence of development. Attempts are now being made to bring greater consistency to the classifications for balance of payments and the rest of the System of National Accounts, particularly in the area of financial transactions.

d) Links with the international investment position

The capital account of the balance of payments bears the same relationship to the international investment position as the financial flows bear to the national balance sheets. The international investment position is, in fact, a balance sheet of Canada's position with non-residents in which are recorded claims on and liabilities to non-residents. As noted in an earlier section the international investment position statistics are the basis for the rest of the world sector in the national balance sheet accounts.

The change between opening and closing balance sheets is principally the result of transactions in assets and liabilities during the period. Thus transactions recorded in the balance of payments capital account constitute a large part of the changes in the Canadian international investment position.

Other events unconnected to transactions also affect changes in the stock of assets and liabilities and must be explained in order to reconcile the Canadian balance of payments capital account and the international investment position. Such a reconciliation is prepared periodically and includes such items as reclassification of assets or liabilities, exchange rate fluctuations, and the reinvestment of undistributed earnings.

One reason why the link between the balance of payments capital account and the international investment position is not always widely appreciated is that there has been a paucity of information in international statistical manuals concerning guidelines and classifications relating to international investment balance sheets. This presumably reflects a rather late recognition of the value of balance sheet data, a fact borne out by the historical lag in the development of estimates of international indebtedness estimates by many countries. Such data have assumed a much higher profile in recent years as international capital movements have become the centre of much economic tension.