Balance of Payment (Part 2)

IV. Methodology

The BOP Methodology Uses a double-entry accounting system. This means that every recorded item should have a debit and a credit, and there should be a net balance of zero.

Balance of Payments credits (act of making an entry) denote increases in liabilities, owners’ equity, revenue and gains; and decreases assets and expenses; debits denote decreases in liabilities, owners’ equity, revenue and gains; and increases in assets and expenses.


The ideal balance of payment should be:

Current Account = Capital Account+ Financial Account

In practice, however, the accounts frequently do not balance. Data for balance of payments estimates often are derived independently from different sources. As a result, there may be a summary net credit or net debit (i.e., net errors and omissions in the accounts). A separate balancing item is used to offset the credit or debit. In our country we call it NET UNCLASSIFIED ITEMS.

Hence:

Current Account= Capital Account+Financial Account (+ - Net Unclassified Items or Balancing Items)


NET UNCLASSIFIED ITEMS (or errors and ommissions) is an offsetting account to bring above-the-line and below-the-line into balance. A positive discrepancy denotes an understatement of receipts and/or overstatement of payments. Conversely, a negative entry denotes an overstatement of receipts and/or understatement of payment.

This separate entry, equal to that amount with the sign reversed, is then made to balance the accounts. Because inaccurate or missing estimates may be offsetting, the size of the net residual cannot be taken as an indicator of the relative accuracy of the balance of payments statement. Nonetheless, a large, persistent residual that is not reversed should cause concern. Such a residual impedes analysis or interpretation of estimates and diminishes the credibility of both. A large net residual may also have implications for interpretation of the investment position statement.


V. Standard Components of the Balance of Payment (BOP)

The following are the Standard components of the BOP:

 Current Account which includes goods and services; income; and current transfer
 Capital Account and Financial Account (Capital transfer is included in this component which includes debt forgiveness of nonresidents and donations of fixed assets by one econony to another economy. This also includes taxes on capital transfers like gift tax, estate tax)


Current Account

It covers import and export of goods and services. Goods which involves:
 General merchandise
 Goods for processing
 Goods procured in ports by carriers
 Non monetary gold

Services involves:
 Transportation
 Travel
 Communication services
 Construction services
 Insurance services
 Financial services
 Computer and information Services
 Royalties and license fees
 Other business services
 Personal, cultural and recreational services
 Government services

Another classification under Current Account is Income which includes compensation for employees and investment income. Investment income consists of direct investment income, portfolio investment income and other investment income.

Another classification under Current Account is Current Transfer – transfers where no quid pro quo (economic value) is placed. It is classified as a current transfer when it directly affect the level of disposable income and should influence the consumption of goods or services. That is, current transfers reduce the income and consumption possibilities of the donor and increase the income and consumption possibilities of the recipient.

Included in the Current Transfer are:
 cash transfers effected between governments for the purpose of financing current expenditures by the recipient government
 gifts of food, clothing, other consumer goods associated with relief efforts
 Gifts of certain military equipment
 Annual contributions made by member governments to international organizations
 Payments made by government or international organizations to governments for salaries for technical assistance.
 Workers’ remittances (migrants who stay in an economy for a year or more)


Capital Account and Financial Account


Capital account covers all transactions that involve the receipt or payment of capital transfers and acquisition or disposal of nonproduced, nonfinancial assets.

The financial account covers all transactions associated with changes of ownership in the foreign financial assets and liabilities of an economy. Such changes include the creation and liquidation of claims on, or by, the rest of the world.

The foreign financial assets of an economy consist of holdings of monetary gold, SDRs (Special Drawing Rights), and claims on nonresidents. The foreign liabilities of an economy consist of indebtedness to nonresidents.


Components of the Financial Account as a Functional Type


The following are the components of the Financial Account as a Functional Type:

 Direct Investment
 Portfolio Investment
 Reserve Assets
 Other Investment

Direct Investment means a significant voice in the management of an enterprise operating outside his or her resident economy, often having substantial equity capital in the enterprise. Combined ownership of 10% or more. Ownership of less than 10% of total equity in an enterprise is already classified as Portfolio Investment.

Portfolio Investment – includes equity securities and debt securities which are traded and tradable in organized and other financial markets. Debt securities include bonds and notes, money market instruments, and financial derivatives that include a variety of new financial instruments. Equity securities covers all instruments and records acknowledging, after the claims of all creditors have been met, claims to the residual values of incorporated enterprises; holders of preferred shares are also included.

Reserve Assets - consist of those external assets that are readily available to and controlled by monetary authorities for direct financing of payments imbalances, for indirectly regulating the magnitude of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes.

The category of reserve assets, comprises monetary gold, SDRs, reserve position in the Fund, foreign exchange assets (consisting of currency and deposits and securities), and other claims.

Other Investment – these are neither classified as direct investment, portfolio investment and reserve assets. This includes short-term (contractual maturity of one year or less) and long-term investments (contractual maturity of more than one year or with no stated contractual maturity)


VI. Functions of the BOP Data

The following are the functions of the BOP data:

• Important for national and international policy formulation (i.e. for external aspects which are necessary for an interdependent world economy);
• Used for analytical studies (causes of payment imbalances and necessity of implementing adjustment measures)
• Indispensable link in the compilation of data for various components of national accounts (those related to the measurement of national wealth)
• The need to account for flows of foreign currency across national boundaries.
• Helps a country evaluate its competitive strengths and weaknesses, and forecast the strength of its currency.


REFERENCES:


John Downes and Jordan Elliot Goodman, Barrons Financial Guides: Dictionary of Finance and Investment Terms, Seventh Edition, 2006.

Bangko Sentral ng Pilipinas, Selected Philippine Economic Indicators, August 2009.

www.bsp.gov.ph

International Monetary Fund, Balance of Payments Manual 5th Edition.