In a CDS transaction, the borrower seeks to obtain a loan from the protection buyer in a CDS. For protection, the protection buyer avails of the CDS by paying a default protection fee from a protection seller based on tradable CDS Index. The borrower can be a private entity or a government (for sovereign debts). The borrower pays interest to the protection buyer for his loan using the LIBOR (London Interbank Offered Rate). The borrower should repay the loan to the protection buyer upon maturity date. In case of default of the borrower, the protection buyer will seek recovery from the protection seller. There are two kinds of settlement to be done by the protection seller depending on the agreement: Physical settlement and Cash Settlement. If a physically-settled CDS is triggered, the protection seller pays the face value of the debt (or another pre-specified amount) to the protection buyer in exchange for the debt itself, which would be worth less than face value given the recent credit event. Triggering a cash-settled CDS would require the protection seller to make a payment to the protection buyer of the difference between the original value of the debt (typically the face value) and the current value of the debt based on a specified valuation method.
Innovation and Current Trends of the CDS
There is a need to place clear and unambiguous terms of “credit event” and “reference entity” in the contract. The ISDA, International Swaps and Derivatives Association, sets standards for all derivative contracts.
In the case of in Ursa Minor Ltd. v. Aon Fin. Prods., Inc., 2000 WL 1010278 (S.D.N.Y. 2000) , Escobel Land Inc. (a company in the Philippines), obtained a $10M loan from Bear Stearns for the construction of condominiums in the Philippines. Escobel also secured a surety bond from Government Service Insurance System ("GSIS"), a Philippines government entity, which guaranteed Escobel's payment to Bear Stearns (BS). BS in turn obtained 1) a CDS from Aon Financial Products Limited ("Aon") as well as 2) an unconditional guarantee ("Guarantee") from Aon Corporation ("Aon") “for whatever reason or cause,” together promising to pay BSIL $10 million plus expenses if GSIS failed to satisfy its obligations under the surety bond. To reduce its own exposure, Aon entered into its own CDS agreement with Société Générale ("SG"), wherein SG agreed to pay Aon upon the occurrence of a defined "credit event," which is default of the Republic of the Philippines or any of its successors.” When Escobel's payment under its BS loan came due, Escobel failed to pay, triggering a demand on GSIS. GSIS refused, arguing that the surety bond might not be enforceable against GSIS because the GSIS representative who supposedly assigned the bond to BS did not have the authority, and because GSIS already had canceled the bond after discovering the collateral that Escobel had offered to secure the bond was not genuine. Due to GSIS' refusal to pay, BS was able to recover from its CDS with Aon agreeing to cover GSIS' default "'for whatever reason or cause," even if the underlying obligation was illegal or invalid.
By this reason, Aon sought to recover from SG based on the same credit event and by its reference entity, which is default of GSIS which is a successor or agency of the Republic of the Philippines. Unfortunately, Aon was not able to recover from SG because the basis or reference entity, the default of GSIS was held not to be a default of the Republic of the Philippines. The GSIS was held not to be a government of the Republic of the Philippines, being a separate entity altogether.
In the case of Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co., 2003 WL 21305355 (S.D.N.Y.), Argentina obtained a loan from Eternity Global in turn obtained a CDS from JP Morgan for a guarantee and promise to pay Eternity Global in case of Argentina’s bankruptcy or default in payment. Subsequently, Argentina sought a “voluntary debt exchange” by exchanging its debts to other foreign bonds in order to minimize payment of interests. By this reason, Eternity Global sought to recover from JP Morgan by reason of such “voluntary debt exchange”. It was held that Eternity Global cannot recover from the CDS because a “voluntary debt exchange program” does not constitute a term for bankruptcy or default in payment.
Another innovation in the over the counter CDS market is the reduction of the notional amount of CDS through a series a portfolio compression cycles, also known as tear-ups (according to ISDA) and has reduced operational, legal and capital costs and improved efficiency of the CDS market. Portfolio compression reduces the number of line items in CDS portfolios without changing the risk parameters of the portfolio. It is done by terminating existing trades and replacing them with smaller number of trades with the same risk profile and cash flows as initial portfolio.
CDS contracts are subject to clearing house rules and regulations. In the US, the Depository Trust and Clearing Corporation (DTCC), considering one of the world’s largest clearing houses.
REFERENCES:
Mike Jakola, Kellog School of Management, Northwestern University, Credit Default Swaps Index Options, June 2, 2006.
“Central Clearinghouse Planned to reduce Counterparty Risk in Credit Default Swaps Market,” Global Finance, July-August 2008.
“Credit Default Swaps Market Outstandings Shrinks as Dealers Tear-up Offsetting Agreements,” Global Finance, December 2008.
“Credit Default Swaps 101: A Primer on Legal Remedies,” Robins, Kaplan, Miller & Ciresi, February 16, 2009 (i.e. visit www.google.com)
“Credit Default Swaps: The Next Crisis?” by Janet Morrissey, March 17, 2008, (i.e. Search time.com)
Showing posts with label International Economics. Show all posts
Showing posts with label International Economics. Show all posts
Sunday, October 10, 2010
Credit Default Swaps (Part 1)
Credit default swaps are a financial instrument used to transfer and mitigate the risk of credit exposure. They are a bilateral contract between the buyer, who purchases protection of the credit risk, and the seller, who provides protection.
A credit default swap (CDS) is a contract between two parties where a protection buyer pays a premium to the protection seller in exchange for a payment if a credit event occurs to a reference entity. CDS are customizable, over-the-counter products and can be written to trigger in the event of bankruptcy, default, failure to pay, restructuring, or any other credit event of the reference entity. "Credit event" will usually determine whether the protection buyer has reason to demand payment from the protection seller. "Reference entity," which is the entity whose obligation is the subject of the swap.
Credit default swaps are a type of credit derivative that can be used to function as a sort of insurance or hedge against an existing investment. Credit default swaps are the largest type of credit derivative in terms of trading volume.
The CDS market has grown $180 billion in 1997; By 2004 it has grown to $5 trillion; In the 2006, $17 trillion; In 2010, it has an annual business of $70 trillion (notional amount).
As the CDS market increased in importance, tradable CDS indexes arose to allow players to trade a broader spectrum of credits at a lower cost and in a more liquid market (i.e. Dow Jones CDX and International Index Company Itraxx). The composition of each index is determined by member banks and a particular name remains in the index until the CDS is triggered due to a credit event. A new index is formed periodically but each incarnation of the index shares the majority of its names with the previous index. The member banks that help compose and price the index include sixteen major international banks. Each of the member banks makes a market in the CDS index and it is freely tradable with low bid-ask spreads of ½ to ¼ of a basis point. It pays the seller a premium relative to the amount of the debt obligation being covered—typically calculated by multiplying the principal amount by a number of basis points—called the spread—whose value is determined by the credit-worthiness of the third party.
Unlike hedging with less risky bonds which requires a cash outlay upfront, CDS do not subject the buyer to interest rate risk or funding risk. CDS allow hedgers or speculators to take an unfunded position solely on credit risk. The market originally started as an inter-bank market to exchange credit risk without selling the underlying loans but now involves financial institutions from insurance companies to hedge funds.
The ISDA, International Swaps and Derivatives Association, sets standards for all derivative contracts.
A credit default swap (CDS) is a contract between two parties where a protection buyer pays a premium to the protection seller in exchange for a payment if a credit event occurs to a reference entity. CDS are customizable, over-the-counter products and can be written to trigger in the event of bankruptcy, default, failure to pay, restructuring, or any other credit event of the reference entity. "Credit event" will usually determine whether the protection buyer has reason to demand payment from the protection seller. "Reference entity," which is the entity whose obligation is the subject of the swap.
Credit default swaps are a type of credit derivative that can be used to function as a sort of insurance or hedge against an existing investment. Credit default swaps are the largest type of credit derivative in terms of trading volume.
The CDS market has grown $180 billion in 1997; By 2004 it has grown to $5 trillion; In the 2006, $17 trillion; In 2010, it has an annual business of $70 trillion (notional amount).
As the CDS market increased in importance, tradable CDS indexes arose to allow players to trade a broader spectrum of credits at a lower cost and in a more liquid market (i.e. Dow Jones CDX and International Index Company Itraxx). The composition of each index is determined by member banks and a particular name remains in the index until the CDS is triggered due to a credit event. A new index is formed periodically but each incarnation of the index shares the majority of its names with the previous index. The member banks that help compose and price the index include sixteen major international banks. Each of the member banks makes a market in the CDS index and it is freely tradable with low bid-ask spreads of ½ to ¼ of a basis point. It pays the seller a premium relative to the amount of the debt obligation being covered—typically calculated by multiplying the principal amount by a number of basis points—called the spread—whose value is determined by the credit-worthiness of the third party.
Unlike hedging with less risky bonds which requires a cash outlay upfront, CDS do not subject the buyer to interest rate risk or funding risk. CDS allow hedgers or speculators to take an unfunded position solely on credit risk. The market originally started as an inter-bank market to exchange credit risk without selling the underlying loans but now involves financial institutions from insurance companies to hedge funds.
The ISDA, International Swaps and Derivatives Association, sets standards for all derivative contracts.
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.
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.
Balance of Payment (Part 1)
I. Introduction
This introduces the concept of the balance of payment (BOP). The format of the balance of payment shall be presented as provided in the BOP Manual, 5th edition as approved by the International Monetary Fund.
Measurement of the external positions of member countries has been a central feature of International Monetary Fund operations since inception. Such measurement is conducted in the dual context of Fund responsibility for surveillance of countries’ economic policies and provision of financial assistance in support of adjustment measures to correct balance of payments disequilibria. Consequently, the Fund has a compelling interest in developing and promulgating appropriate international guidelines for the compilation of sound and timely balance of payments statistics. Such guidelines, which have evolved to meet changing circumstances, have been embodied in successive editions of the Balance of Payments Manual (the Manual) since the first edition was published in 1948. Because of the important relationship between external and domestic economic developments, timely, reliable, and comprehensive balance of payments statistics based on an appropriate and analytically oriented methodology are an indispensable tool for economic analysis and policy making. Indeed, with the growing interdependence of the world’s economies, the need for such statistics—which reflects in part the underlying movement towards greater liberalization and integration of markets—has increased over time.
The revised Manual has been prepared by the Fund’s Statistics Department in close consultation with balance of payments experts in member countries and international and regional organizations (including the Statistical Office of the European Communities, the Organisation for Economic Cooperation and Development, the United Nations, and the World Bank).
II. Concept
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.
It is a systematic record of a nation's total payments to foreign countries, including the price of imports and the outflow of capital and gold, along with the total receipts from abroad, including the price of exports and the inflow of capital and gold.
It also draws a series of balances between inward and outward transactions, provides a net flow of transactions between residents of one country and the rest of the world; and reports how that flow is funded. Economic transactions include:
• Exports and imports of goods, such as oil, agricultural products, other raw materials, machinery and transport equipment, computers, white goods and clothing
• Exports and imports of services such as international transport, travel, financial and business services
• Income flows, such as dividends and interest earned by foreigners on investments in a country and by such country investing abroad.
• Financial flows, such as direct investment, investment in shares, debt securities, loans and deposits
• Transfers, which are offsetting entries to any one-sided transactions listed above such as foreign aid and funds brought by migrants to the country.
As defined by the Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas, balance of payment systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world.
As one of the primary functions of the IMF is to prevent financial crises and assist countries in balance of payment difficulties, the collection of standardized, comparable balance of payment data is seen as a core task.
III. Conceptual Framework of the Balance of Payment (BOP)
Most entries in the balance of payments refer to transactions in which economic values are provided or received in exchange for other economic values. These economic values consist of real resources (goods, services and income) and financial items (recorded in the balance of payments at the prices at which the items are acquired or disposed of).
Economic Territory consists of a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely.
An institutional unit has a center of economic interest and is a resident unit of a country when, from some location (dwelling, place of production, or other premises) within the economic territory of the country, the unit engages and intends to continue engaging (indefinitely or for a finite period) in economic activities and transactions on a significant scale. (One year or more may be used as a guideline but not as an inflexible rule.)
A uniform basis of valuation for the international accounts (both real resources and financial claims and liabilities) is necessary for compiling, on a consistent basis, any aggregate of individual transactions and an asset/liability position consistent with such transactions. In this Manual, the basis of transaction valuations is generally actual market prices agreed upon by transactors.
In the BOP Manual and the System of National Accounts, the principle of accrual accounting governs the time of recording for transactions. Therefore, transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is change of ownership.
This introduces the concept of the balance of payment (BOP). The format of the balance of payment shall be presented as provided in the BOP Manual, 5th edition as approved by the International Monetary Fund.
Measurement of the external positions of member countries has been a central feature of International Monetary Fund operations since inception. Such measurement is conducted in the dual context of Fund responsibility for surveillance of countries’ economic policies and provision of financial assistance in support of adjustment measures to correct balance of payments disequilibria. Consequently, the Fund has a compelling interest in developing and promulgating appropriate international guidelines for the compilation of sound and timely balance of payments statistics. Such guidelines, which have evolved to meet changing circumstances, have been embodied in successive editions of the Balance of Payments Manual (the Manual) since the first edition was published in 1948. Because of the important relationship between external and domestic economic developments, timely, reliable, and comprehensive balance of payments statistics based on an appropriate and analytically oriented methodology are an indispensable tool for economic analysis and policy making. Indeed, with the growing interdependence of the world’s economies, the need for such statistics—which reflects in part the underlying movement towards greater liberalization and integration of markets—has increased over time.
The revised Manual has been prepared by the Fund’s Statistics Department in close consultation with balance of payments experts in member countries and international and regional organizations (including the Statistical Office of the European Communities, the Organisation for Economic Cooperation and Development, the United Nations, and the World Bank).
II. Concept
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.
It is a systematic record of a nation's total payments to foreign countries, including the price of imports and the outflow of capital and gold, along with the total receipts from abroad, including the price of exports and the inflow of capital and gold.
It also draws a series of balances between inward and outward transactions, provides a net flow of transactions between residents of one country and the rest of the world; and reports how that flow is funded. Economic transactions include:
• Exports and imports of goods, such as oil, agricultural products, other raw materials, machinery and transport equipment, computers, white goods and clothing
• Exports and imports of services such as international transport, travel, financial and business services
• Income flows, such as dividends and interest earned by foreigners on investments in a country and by such country investing abroad.
• Financial flows, such as direct investment, investment in shares, debt securities, loans and deposits
• Transfers, which are offsetting entries to any one-sided transactions listed above such as foreign aid and funds brought by migrants to the country.
As defined by the Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas, balance of payment systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world.
As one of the primary functions of the IMF is to prevent financial crises and assist countries in balance of payment difficulties, the collection of standardized, comparable balance of payment data is seen as a core task.
III. Conceptual Framework of the Balance of Payment (BOP)
Most entries in the balance of payments refer to transactions in which economic values are provided or received in exchange for other economic values. These economic values consist of real resources (goods, services and income) and financial items (recorded in the balance of payments at the prices at which the items are acquired or disposed of).
Economic Territory consists of a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely.
An institutional unit has a center of economic interest and is a resident unit of a country when, from some location (dwelling, place of production, or other premises) within the economic territory of the country, the unit engages and intends to continue engaging (indefinitely or for a finite period) in economic activities and transactions on a significant scale. (One year or more may be used as a guideline but not as an inflexible rule.)
A uniform basis of valuation for the international accounts (both real resources and financial claims and liabilities) is necessary for compiling, on a consistent basis, any aggregate of individual transactions and an asset/liability position consistent with such transactions. In this Manual, the basis of transaction valuations is generally actual market prices agreed upon by transactors.
In the BOP Manual and the System of National Accounts, the principle of accrual accounting governs the time of recording for transactions. Therefore, transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is change of ownership.
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