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

II - International investment position

General

A relatively complete set of official estimates of the Canadian international investment position goes back to the year 1926, and was first published as a whole in 1950.

Initially the reports consisted of highly summarised statements, but over the years the framework was extended so that finally by 1967 a fairly detailed and complete statement of Canada's balance of international indebtedness existed. Estimates are now prepared and published annually. The classifications used have remained largely unchanged through the history of the series so that there is a high degree of continuity in the statistics.

This last piece in the statistical mosaic of the Canadian economy, is probably the least well known, certainly in the context of its relationship to other parts of the System of National Accounts. The measurement of outstanding international investment has also been relatively neglected in the statistical manuals of the international agencies until more recent years, when international indebtedness began to pose serious economic problems.

Detailed definitions and links that have been forged between other parts of the system are less clearly evident in the case of international investment.

The international investment position statement is a record of Canadian residents' investment abroad and nonresidents' investment in Canada. Essentially it is a balance sheet that records financial claims on non-residents as assets and non-residents' claims on Canada as liabilities. The balance represents the net international investment position; an excess of assets over liabilities indicating a positive contribution to net national wealth and the reverse signifying a negative contribution. Table 5A and Table 5B include a condensed version of the Canadian international investment position as at the end of 1981. It is included in the table with the balance of payments to demonstrate its close links with the format of the capital account.

The structure of the normal balance sheet is modified in the international investment position presentation to the extent that the asset side shows no investment category 'non-financial assets'. Following national accounting convention, all investments abroad in tangible goods are treated as if they were financial assets; for example, ownership of plant and equipment is included in the category 'direct investment' and ownership of real estate and goods abroad is covered under 'miscellaneous investment'.

The system has two distinct links with other branches of the Canadian System of National Accounts. Changes in international investment outstanding are largely the result of inter-country flows of capital recorded in the balance of payments capital account. Secondly, the international balance sheet transforms into the rest of the world sector in the national balance sheet accounts. In the latter context international investment can be seen in terms relative to accumulated domestic investment.

The broad concepts, classifications and definitions governing the international investment position statements are those that apply to the balance of payments capital account, particularly in the case of principal items such as direct and portfolio investment. For most series it is possible to track the flows directly between the two systems because the transactors are usually identical, the classification system and definitions are similar, and the valuation of assets and liabilities is normally the book value found in the accounts of the surveyed corporations. Apart from the overall statement which provides summary measures of assets and liabilities, the Canadian international investment statistics focus on a detailed decomposition of direct investment abroad and foreign direct investment in Canada. Investment is classified as 'direct' when it is associated with some form of ownership influence over the receiving enterprise, normally accomplished by equity ownership. The level of direct investment is examined by country of destination in the case of Canadian investment abroad, or country of origin for inward flowing investment, the industry in which it is taking place, the size of investment and the number of enterprises involved. Supplementary data also put the amount of foreign investment in Canada in perspective by expressing it as a proportion of overall investment in the industry.

Extending the statistical analysis of the economy

The international investment position statement runs parallel to the rest of the world sector in the national balance sheet accounts and uses identical figures but it adds considerably to the stock of economic statistics. It presents a quite different perspective on international investment by focussing on the purpose of investment rather than the instrument; it provides a greater historical perspective; and it explores certain categories of investment in much greater depth.

a) Classifications

The summary framework is simple - a balance sheet with eight categories of assets and a like number of liabilities. These items are only briefly described below as they tend to match the previously defined classes used in the balance of payments capital account.

The character of the classification in the international investment position differs from that used in the national balance sheet accounts. In the investment position it is designed to allocate claims according to the underlying purpose of the investment, whereas in the balance sheet the design is structured around the type of instrument and sectoral relationships. To a large extent the classifications in the investment position have been shaped by the analytical use made of the data and by the source material available.

The emphasis placed on the international investment position as a vehicle for analysing the extent to which the Canadian economy is owned and controlled abroad and assessing the potential for short-run flights of capital has had an important bearing on the classification structure. In addition, techniques adopted for the collection of information on international investment transactions that affect only a relatively small universe are quite different from those used to capture balance sheet data for entire domestic sectors, and to some extent this has dictated the outline of the classification system.

i) Direct investment

Direct investment represents the book value of long-term capital owned in subsidiaries, affiliates and branches by investors in a position to exercise influence over the management of the enterprise. It is normally identified by related investors holding a sufficiently large block of voting shares, at least 10 percent of the voting equity. The book value includes not only the owner's equity holdings, which is the main factor determining whether investment should be classified to direct investment, but all other forms of long-term debt, such as bonds, debentures, loans and advances. The series are important inasmuch as they provide a valuation of real and financial assets owned in Canada by nonresidents, or owned abroad by Canadians, in enterprises over which they exercise some measure of influence.

Additional series measure the long-term capital employed in firms in Canada that are controlled from abroad, as well as those that are controlled by Canadian residents. These are known as the 'control' series. The series provide an important dimension of international investment. Capital controlled by non-residents in particular industries may differ from the capital 'owned' series and vice versa. Control over large amounts of capital employed can be exercised with a fairly limited ownership of voting stock.

However, the total amount of capital owned (by residents and non-residents) will always be identical to the total capital. For the ownership series, the concept is the same as the balance of payments and includes all long-term investment employed in Canada by direct investors. The control series does not have a counterpart in the balance of payments.

In the case of Canadian direct investment abroad, there is an element of non-resident participation to the extent that Canadian enterprises undertaking such investment are themselves foreign owned. Although the figure of Canadian investment abroad is not reduced to eliminate this, a special entry recognizing the fact is recorded as a liability in the balance sheet. That part of foreign investment that has flowed through Canada to other countries is excluded from foreign investment in Canada since the latter is compiled on the basis of long-term capital employed in Canada. To arrive at total foreign long-term capital employed in Canadian enterprises, non-resident equity in Canadian investments abroad must be added to foreign investment in Canada.

ii) Portfolio investment

Portfolio investment abroad by Canadian residents and in Canada by non-residents encompasses the holding of securities in which the holder is not in a position to exercise a voice in the management of the company. The intention is generally to hold the security as an investment instrument rather than as a means of exercising influence or control. Securities are valued at the book value reflected in the accounts of the issuer. Portfolio investment in Canada, the single largest liability item, contains large foreign holdings of government and public utility debt. Estimates for some investments having similar characteristics to portfolio investment are found in the miscellaneous category; in instances where the estimate is more judgmental the classification boundaries have been less strictly applied.

iii) Miscellaneous investment

Miscellaneous investment abroad by Canadian residents includes holdings of non-corporate real estate, bank and other long-term loans, claims on foreign estates and trusts, the estimated equity of Canadian members in international trade unions and of policy holders in insurance abroad. The item is essentially a residual category of longerterm type investment and has in the past been used as repository for difficult to classify onetime transactions.

Miscellaneous long-term investment in Canada includes foreign holdings of Canadian securities not included in portfolio investment, mortgages on Canadian real estate, non-corporate real estate holdings in Canada, and other uniquely identifiable long-term investment such as allowances for non-resident equity in Canadian owned international bridges and cable facilities.

Again this category reflects a rather heterogeneous collection of items and is in the nature of a residual classification in which the measurement of Canada's liabilities to foreigners is less detailed than in other categories.

iv) Government of Canada long-term investment abroad

An important Canadian asset with no matching liability is Government of Canada long-term investment abroad, including loans to foreign governments. Also included in this category are capital subscriptions and advances to international financial agencies, excluding the provision of funds to the International Monetary Fund, which is classified to Canada's official monetary assets. A significant element of Government of Canada assets abroad consists of medium and long-term export credits.

v) Other Canadian investments

Other Canadian investments abroad fall into four categories: non-bank holdings of deposits abroad, the chartered banks' net foreign currency asset position, a miscellaneous short-term category, and Canada's official monetary assets.

In more recent years the chartered banks category has remained unused as chartered banks have consistently recorded net foreign currency liabilities.

The official monetary asset series includes convertible foreign currency holdings of the Exchange Fund, the Receiver General for Canada and the Bank of Canada, official holdings of monetary gold, Special Drawing Rights and Canada's reserve position in the International Monetary Fund. The other short-term categories include such items as Canadian residents' bank balances held abroad, investments in foreign treasury bills and trade and other receivables due from abroad.

The remaining foreign investment in Canada is sub-divided into five broad liability categories:

• allocation of Special Drawing Rights,
• non-resident holdings of Canadian dollars,
• the chartered banks' net foreign currency liability position,
• other short-term liabilities, and
• non-resident equity in Canadian assets abroad.

(The equity position of non-residents in Canadian investment abroad through their ownership of Canadian enterprises has already been noted).

Special Drawing Rights are a form of official reserves issued by the International Monetary Fund and used in the settlement of balance of payments imbalances. The inclusion of amounts identical to the initial allocations of Special Drawing Rights to Canada are recognized as a liability to the International Monetary Fund in the Canadian international investment statement.

The treatment is in accord with the Government of Canada's recognition of a liability in its published public accounts. This treatment is to a large extent conventional as no apparent liability exists because of the creation and allocation of SDRs. The allocations also appear as an asset in the international investment figures as a component of Canada's official reserves.

The other short-term liability categories noted above cover Canadian dollar deposits of nonresidents with financial institutions in Canada, holdings by non-residents of Government of Canada treasury bills, Government of Canada demand liabilities mainly payable to international investment agencies, holdings by non-residents of short-term paper issued by Canadian corporations, bank borrowing abroad, short-term advances to sales finance and consumer loan companies from their foreign parents and shortterm trade and other payables.

The summary balance sheet shows the net balancing item, equivalent to net worth (assets less liabilities) but labelled net international investment. Unlike the net worth of a corporation, which under normal conditions is positive, it is quite usual for countries to record negative net international investment. It means that the level of foreign investment is greater than that country's investment abroad.

A cumulative figure of the statistical discrepancies between the current and capital account of the balance of payments is given as a footnote item in the summary measures to indicate the possible over- or understatement of the net international investment position. The cumulative statistical discrepancy is suggestive of an overstatement of the country's net international indebtedness. Some part of the unmeasured outflow of funds recorded in the balance of payments in recent years is likely to have been associated with the net acquisition of assets.

b) Valuations

No single valuation method is used in constructing the international investment position figures. Brief reference was made to valuation methods in describing the classification categories but they have neither been specifically identified nor discussed.

The three basic valuations are book values, face values and market values. The process of valuing international investment is more difficult and lacks the symmetry and checks available in valuing domestic sectors' balance sheets. Domestically the universe can more easily be identified and in some cases financial assets and liabilities can fairly readily be balanced.

The most widespread valuation used is book value in Canadian funds which is defined as the value of claims as they appear in the books of the issuer.

Although constrained at times by the practical problems of assembling data, an attempt is made in preparing the estimates of direct investment to use values recorded in the books of the unit in which investment is being measured. The book value of direct investment in, say, a wholly owned subsidiary, is its net worth or equivalent, the value of the company assets less depreciation, deferred taxes and any other liabilities which the company may have.

The book value is, of course, determined by the way in which the company values its own assets and the method used to depreciate its assets. In general, straight-line depreciation will be based on historical rather than replacement cost of assets. It has been argued that a valuation based on replacement rather than historical cost is a more appropriate valuation for balance sheet data but in the international investment position such figures are not generally available.

In principle, the book value method is also applied in arriving at that part of the estimate of portfolio investment consisting of investment in shares. In addition to value changes due to resident/nonresident transactions in new and outstanding shares, estimates of the book value of untraded share holdings change significantly on a year-to-year basis, due to the growth in internal earnings of companies.

The book value method yields a different estimate from that which would result from using the value of shares carried on the books of the investors.

Those parts of direct investment, portfolio investment and other long-term investment representing bonds and other forms of debt securities are valued at the nominal or face value at which they are carried in the books of the debtor. Foreign currency denominated bonds are an exception and are valued at the yearend exchange rates vis-a-vis the Canadian dollar; the valuation method employed may result in estimates considerably different from either carrying or market valuations.

Short-term claims are normally valued at nominal or face value when they can be transferred on demand at full value. In this case the difference between market value, carrying value and face value is unlikely to be significant.

Investment abroad by Canadian residents and outstanding obligations to non-residents may require further valuation adjustments to convert claims denominated in foreign currencies into Canadian funds. Canadian direct and portfolio investments abroad are converted into Canadian dollars at the exchange rate prevailing at the date for which the estimate is being prepared. All debt securities are now converted into Canadian dollars at the year-end closing exchange rate of the year of estimate.

Other features

The main emphasis of the international investment position statement, outside its balance sheet function, has been to illuminate the extent of direct investment in Canada and direct investment abroad, particularly from a geographical and industrial perspective. It also exposes in some detail the structure of outstanding Canadian debt held by non-residents.

Direct investment in Canada is analysed by geographic distribution of ownership and the industries in which ownership is held. Data on Canadian direct investment abroad are analysed by number of concerns holding investments, the size of investment and the size of those making the investment; the number of concerns in which investments are held and the form of organization of those involved are also published. Separate series for gross inflows and outflows of funds by industry, which together comprise the published net direct investment estimate, are available for all countries combined and for the United States alone. These series are valuable in assessing the extent to which direct investment funds may be being withdrawn from or invested in Canada, a fact sometimes masked by net figures.

In order to provide perspective, a number of series have been constructed to illuminate the extent of direct investment in both the Canadian and foreign economies.

A measure of total investment controlled in Canada by foreign direct investors, or abroad by Canadian direct investors, indicates the leverage type impact of ownership. For foreign direct investment in Canada, capital owned and controlled by non-residents are both calculated as proportions of total capital employed in Canadian industries, providing some perception of the degree of foreign penetration in major segments of the economy. The statistical difficulties in compiling the series are formidable and involve, amongst other things, meshing foreign investment estimates based on consolidated balance sheets with total Canadian investment aggregates based on unconsolidated balance sheets, and in compiling both series within comparable industry classifications. The results, nevertheless, are regarded a valuable contribution in understanding the role of direct investment in Canada.

The industrial classification used in the international investment series is one that grew up with the series and one that is out of step with the industrial classifications employed in other parts of the System of National Accounts. Based on the classification of the consolidated enterprise to its principal activity, it is likely to be less pure than the industrial classification of establishment or company data and should be used cautiously with statistical series classified by other levels of organization.

Subsequent to the development of the direct investment series which focus on ownership and control, much supporting and supplementary information has become available through other surveys, such as those associated with the Corporations and Labour Union Returns Act (CALURA) and the former Foreign Investment Review Act.

The international investment position supporting tables also include portfolio investment in Canada according to the principal area of residence of the holder, the type of investment and the industry in which the investment is held. Detail is published which throws light on the debt structure of different levels of government, the total value of net long-term funded debt outstanding and the amount held by non-residents. Estimates also provide the currency of payment, date of maturity and estimated debt service payments in future years.

Although the formal structure of the Canadian international investment statistical system has tended to be fixed over many years, the system itself tends to be more flexible than other branches of the System of National Accounts.

With no international guidelines to follow, it has reacted more promptly to emerging situations in terms of preparing special purpose tables and analysis.

Uses of the international investment position

Uses are mainly found in government and academic circles where international investment position estimates serve to support research studies on the impact of international capital flows and the development of position papers and policies relating to external relations. The estimates are also frequently used by financial analysts to support projections of balance of payments developments.

The international investment position estimates provide a valuable set of statistics that offer an insight into one aspect of Canadian relationships with the rest of the world. The system is capable of 'standing alone' and the series themselves analysed independently and within the framework of the system, or 'interconnected' in which case the system is used in conjunction with other branches of the System of National Accounts, particularly the balance of payments. From previous comments it should be clear that the estimates are the only source of information on the geographic disposition or origin of international investment.

The data are used primarily to provide a measure of the magnitude of the country's aggregate claims on, and liabilities to non-residents, the distribution of assets and liabilities, the liquidity of the country, and whether on balance the country is a net debtor or creditor. In analysing Canada's current position, projecting future trends, and formulating policy, it has been useful to distinguish the types of investments, examine the composition of assets and the structure of debt, isolate the amount of debt carrying contractual obligations and identify claims carrying service obligations in foreign currencies. These examples have all been of interest at one time or another in Canada for the study of specific problems involving large scale capital movements, direct investment levels, sharp losses in holdings of international reserves, exchange rate fluctuations and interest rate movements.

Policies relating to the encouragement or discouragement of foreign investment in Canada have leaned heavily on international investment position measures of direct investment and the extent of foreign control over parts of the Canadian economy. The established levels of direct investment have also served as the base from which to project future growth patterns, sub-divided between growth attributable to new flows of capital and that due to the reinvestment of current earnings by existing direct investment enterprises.

The data are frequently used in conjunction with balance of payments estimates because of the interrelated nature of the transactions; in some cases the relationships are direct as with the capital account, and in others indirect as in the case of current account entries. Projections of debt service payments and receipts and of dividend flows depend to a large extent on estimates of the levels of direct and portfolio investment; the relationships in this situation are fairly clear and straightforward.

There are however, important relationships involving international investment and balance of payments that defy easy analysis. For example, the pattern of trade is partially dependent on the amount and direction of direct investment, but it is difficult to know whether foreign trade may be stimulated because of the links between related companies, or dampened because the foreign controlled firm supplies the domestic market formerly served by imports. Unravelling the full impact of these relationships is vital to any bilateral trade negotiations and commercial policy. This type of analysis requires the joint use of international investment and balance of payments data.

Rapid growth in international financial markets and massive and instantaneous transfers of funds across international borders have made it more necessary than ever to keep track of international movements of funds, at the same time making it more difficult. As a major player on the international debt scene, it is important for Canada to monitor the overall size and growth in Canadian loans to high risk debtors; repercussions from potential or actual defaults reverberate throughout domestic financial institutions. On the other side of the coin, with the growing dependence of Canada on foreign financing of government deficits, the maintenance of accurate estimates of foreign held debt is essential because of its close relationship to domestic interest rate policy and the rate of economic activity in the country.

Links and reconciliations with other branches of the accounts

One of the principal links is with the national balance sheet system in which the international investment position forms the rest of the world sector account. The chapter covering balance sheet accounts specifically describes this link and will not be repeated here. The net balances derived from the two systems of accounts are identical and the underlying data are derived from the same source. As noted earlier, superficially the two sets of data appear quite different because they use disparate classification categories. The only occasion when a reconciliation item may be required is when the phasing in of new data gets temporarily out of step.

The other direct link is with the balance of payments, where flows in the capital account represent the major elements in changes in the level of assets and liabilities in the international investment position. This link and the reconciliation items required to tie the two series together were described in the chapter on balance of payments; readers are referred to the relevant section in that chapter for further details.

Technically the international investment position numbers are derived independently from the balance of payments data, and year-to-year changes are not built up from the capital account flows plus reconciliation items such as exchange rate and valuation changes. The estimates rely mainly on surveys of assets and liabilities outstanding as opposed to the flow data used extensively in the balance of payments. Because of the different source data, the reconciliation, although theoretically straightforward, is at best an imprecise statistical exercise; by the same token, it plays a role in validating some of the component series.

Reconciliation is further complicated by the statistical discrepancy recorded in the balance of payments. If the cumulative discrepancy were entirely attributable to errors and omissions in the current account of the balance of payments it could be ignored in the reconciliation. If, however, it was all due to capital items it would be required as a reconciliation entry. The size of the cumulated statistical discrepancy indicates a consistent understatement of payments/outflows or overstatement of receipts/inflows in the balance of payments accounts, which when carried into the international investment estimates represents an overstatement of indebtedness.

At present no official reconciliation of the international investment position and the rest of the world sector balance sheet account is published regularly, although the concordance of different classifications used in the two systems is contained in the balance of payments and international investment sources and methods publication (Statistics Canada, Catalogue 67-506). Partial reconciliation statements between the flows of the capital account of the balance of payments and the level changes in the international investment position appear in reports on the latter series.