86-10E
BALANCE OF PAYMENTS
Prepared by:
Finn Poschmann, Rose Pelletier
Economics Division
Revised 19 July 1999
TABLE
OF CONTENTS
ISSUE
DEFINITION
BACKGROUND
AND ANALYSIS
A. Composition
of the Balance of Payments
B. Evolution
of the Balance of Payments Situation
C. Statistics
Canada Summary of Canada's Balance of International Payments
1.
Highlights (First Quarter 1999 - The Daily, 10 June 1999)
2.
Current Account (Seasonally Adjusted)
a.
Goods
b.
Services
3.
Financial Account (Unadjusted for Seasonal Variation)
a.
Canadian Portfolio Investments Abroad and Foreign-held Canadian Securities
b.
Direct Investment
c.
Official International Reserves
PARLIAMENTARY
ACTION
CHRONOLOGY
Current
Account
Capital
and Financial Accounts
SELECTED
REFERENCES
BALANCE OF PAYMENTS*
ISSUE
DEFINITION
Shifts
in the balance of payments accounts are always topical because they reflect
the countrys international trading performance and affect the foreign
exchange markets. The balance of payments data also affect the perception
of our economy on the international scene.
The
Canadian economy is very open, both in terms of the share of output traded
and the amounts of capital which flow in and out of the country. Since
Canada has a relatively small population base and limited domestic capital
available, it must look to foreign countries, such as the United States,
to meet the nations capital requirements.
The
balance of payments therefore takes on special significance. It constitutes
a statement of all transactions between Canada and the rest of the world
during a given year. The balance of payments also indicates whether or
not the country has sufficient foreign currency (or foreign currency earnings)
to cover its liabilities to foreign countries.
BACKGROUND
AND ANALYSIS
A.
Composition of the Balance of Payments
The
main components of the balance of international payments are:
The
current account records all receipts and payments from goods and
services transactions with foreigners. These transactions are divided
into three distinct categories: goods and services, investment income
and current transfers. In addition to various goods, "goods and services"
includes travel, transportation, commercial services and government services.
Investment income includes interest as well as profits and dividends on
direct investments, portfolio investments and other investments. Current
transfers include payments to individuals and institutions, including
pensions, withholding taxes and official contributions, such as Canadian
aid to other countries.
The
current account is affected by several factors. It will post a surplus,
or the deficit will shrink, if there is an increase in competitiveness
(measured by productivity and relative prices, based on the exchange rate)
or if economic growth is less vigorous than in other countries, which
would lead to lower import growth. Conversely, an economic decline in
foreign countries will negatively affect Canadas current account
balance, as the market for Canadian goods and services shrinks.
The
capital account is made up of capital transfers, (e.g. migrants
assets, public service superannuation benefits, debt forgiveness and inheritance
funds), and intangible assets (intellectual property rights, such as patents).
The
financial account records Canadas financial transactions
with foreign countries, including short-term (1 year or less) and
long-term movements of capital. There are two types of capital movements:
direct investments in the ownership or control of a business and portfolio
investments, which are purchases of company stocks and bonds, both public
and private. If a foreign resident purchases a Canadian firm or lends
money to the government, a credit, identified by a plus sign, will be
recorded in the balance of payments accounting process. In contrast, Canadian
residents purchases of foreign assets are recorded as debits, identified
by a minus sign in the balance of payments accounting process.
High
interest rates in Canada attract foreign capital while encouraging the
various levels of government to borrow abroad. Being more speculative
in nature, movements of short-term capital exhibit greater sensitivity
to short-term interest rates and to exchange rates.
The
statistical discrepancy (or errors and omissions) resolves divergences
between the balances of the current, capital and financial accounts. A
deficit on the current account may be exceeded by a surplus on the capital
and financial accounts and this will be partially reflected by a build-up
of official currency reserves (changes in such reserves are recorded in
the financial account). If, however, the net capital inflow is less than
the current account deficit, official reserves must be drawn upon. To
the extent that fluctuations in official reserves do not equal the difference
between the balances of the current, capital and financial accounts, an
allowance for errors and omissions must be made. Such discrepancies often
reflect movements of short-term capital which have not been captured by
the international financial accounting system. Another source of error
is illegal shipments, which, of course, are difficult to account for.
The world as a whole records a balance of payments deficit which is mathematically
and theoretically impossible. It can be explained by timing differences
in accounting for goods in transit, and the possibility that some countries
record illegal payments from other countries as receipts.
In
the medium term, the value of the balances of the current, capital and
financial accounts should be nearly equal in order to prevent structural
imbalance. A balance of payments "deficit" forces Canadian dollars
on the international market, placing downward pressure on the domestic
currency. Since official reserves for repurchase of such funds are not
unlimited, interest rates are typically raised to attract foreign capital
and protect the value of the dollar. High interest rates retard economic
growth -- lowering import levels -- and the balance of payments difficulties
are thus resolved. The costs of excessive interest rates mount over time
(being revealed by a growth rate lower than that of comparable industrial
nations). Interest rates that are too low relative to other industrial
nations make foreign-source capital difficult to obtain; this, too, retards
growth.
B.
Evolution of the Balance of Payments Situation
Since
the 1950s, the current account has typically been in a deficit position;
however, in 1970, 1982 and 1996, it posted a surplus. The trade surplus
recorded in 1982 was undoubtedly caused by the recession, which slowed
the import of goods and services. During this period, the balance of
trade in goods generally posted a surplus, while a substantial deficit
persisted in other components of the current account, particularly in
services and investment income.
The
surplus balance in the goods trade and the deficit on services, investment
income and transfers have tended to grow since the mid 70s (see
Chart I). The goods trade surplus, which can be attributed largely
to exports by the automobile industry as well as energy and forestry products,
has usually been overwhelmed by the deficit on services, investment income
and transfers, resulting in a deficit on the current account (see Chart
II). The deficit on the services, investment income and transfers accounts
has usually been caused by large interest payments for outstanding foreign
debt.
In
1998, the current account deficit rose to $16.4 billion, an increase of
$2.1 billion over 1997. During the same year, exports increased by $20.9
billion while imports grew by $25.7 billion. The more rapid growth of
imports than of exports resulted in a smaller goods trade surplus in 1998
than in 1997; it declined from $23.7 billion to $18.9 billion. The lower
goods trade surplus was partially offset, however, by a decline in the
deficit for the other components of the current account.
The
surplus traditionally posted in the capital and financial account (see
Chart III) reflects the continuing need of the Canadian economy (and
governments) for foreign capital. In 1998, the capital account posted
a $5.0 billion surplus, a considerable drop from the 1997 level of $7.5
billion. The financial account showed a $9.5 billion surplus, a $1.1 billion
decline from the 1997 level. Since the early 80s, portfolio investments
in Canada have been notably higher than foreign direct investments in
Canada. However, since 1997 the levels of these two types of investment
have been similar.
International
capital flows are separated by Statistics Canada into direct investment
and portfolio investment. An investment is classified as direct when it
allows the investor to influence the management of an enterprise. An ownership
level of at least 10% is assumed to provide this ability. Since 1975,
increases in Canadian direct investment abroad have been greater than
increases in foreign direct investment in Canada. In 1998, Canadian
direct investments abroad amounted to $39.4 billion, while foreign direct
investments in Canada amounted to $24.5 billion.
Portfolio
investments are transactions in bonds and stocks (other than direct investment
transactions), official international reserves and foreign investments
made by Canadian chartered banks. Net purchases of foreign securities
are defined here as total purchases of foreign securities minus total
sales of foreign securities. In 1998, net purchases of foreign stocks
by Canadians amounted to $15.2 billion, more than three times the 1997
level of $4.5 billion. Foreigners bought Canadian stocks with a total
value of $13.5 billion in 1998, up from the $7.5 billion purchased in
1997. Net purchases of Canadian bonds by foreigners totalled $11.8 billion,
almost twice the level of the preceding year.
In
looking at the current account and the financial account we have to review
the net fluctuations in the official reserves before calculating errors
and omissions. The official reserves level fell by $7.5 billion in
1998, whereas in 1997 it had increased by $3.4 billion. Reserve fluctuations
are caused chiefly by the Bank of Canadas desire to prevent substantial
shifts in the value of the Canadian dollar and are included in the financial
account. Errors and omissions represented +$1.9 billion in 1998, compared
to -$3.8 billion in 1997.
As
described earlier, one means of compensating for a deficit is to draw
down official reserves. Other options open to officials include increasing
interest rates in order to attract capital and devaluing the currency
to rebalance the current account (this may lead to inflationary pressures).
Raising
interest rates also tends to restrain domestic aggregate demand, thereby
lowering import levels and moving the current account towards balance.
Restrictive fiscal measures, by curbing domestic demand, may also serve
the same end but at some cost to economic growth and employment levels.
In
summary:
The
current account has traditionally posted a deficit, primarily because
of the services and transfers accounts (particularly interest and dividends
payments). However, the increase in the goods trade balance was so great
in 1982 and 1996 that a surplus was recorded in the current account
for these two years.
A
surplus has traditionally been recorded in the capital and financial
accounts. However, even if errors and omissions in the net movements
of short-term capital are taken into account, the Bank of Canada must
occasionally draw upon the official reserves to offset the current account
deficit.
In
general, financial and capital accounts surpluses have covered this
countrys current account deficit. However, capital inflows represent
increases in Canadian debt to foreigners and if used simply to finance
current consumption, this debt can place an undue burden on future generations.
On the other hand, foreign borrowing to finance the building of long-lived
capital assets such as hospitals, schools, highways, etc. may yield
future benefits greater than the resulting interest payments. Therefore,
whether Canadas present balance of payments structure (current
account deficit and capital and financial accounts surplus) will leave
a net burden for future generations is largely dependent on how wisely
these borrowed funds are spent.
C.
Statistics Canada Summary of Canada's Balance of International Payments
1.
Highlights (First Quarter 1999 - The Daily, 10 June 1999)
In
the first quarter of 1999, the current account deficit sharply declined
to $1.4 billion, whereas during the six preceding quarters it had hovered
at between $4 billion and $6 billion. This means that, although Canadian
residents continued to spend more abroad than they earned from goods,
services, investment income and current transfers abroad, they did so
at a considerably slower pace. The deficit reduction in the first quarter
was largely due to the steady rise in exports, while imports showed the
first significant decline since 1996.
The
net transactions on the financial and capital accounts cancelled each
other out in the first quarter. Canadian investors continued to acquire
foreign securities, and the federal government increased its international
reserves for a second consecutive quarter. There was, however, a reduction
in foreigners holdings of Canadian securities. As well, the banks
engaged in significant transactions which reduced their net deposit assets
abroad.
2.
Current Account (Seasonally Adjusted)
a. Goods
Canadas
surplus on goods expanded strongly, by $2.7 billion to $7.7 billion during
the first quarter of 1999. There was a moderate rise in exports with an
equivalent decline in imports. This was in contrast to the strong demand
for foreign products evidenced in the fourth quarter. Nearly all these
changes in exports and imports took place in trade with the United States.
b. Services
Led
by a lower deficit on travel, the deficit on services reached an 11-year
low of $1.5 billion in the first quarter. The travel deficit moved below
$0.2 billion for the first time in over 12 years, mainly due to record
spending by visitors from the United States, which increased for the third
consecutive quarter.
The
investment-income deficit edged up to $7.9 billion in the first quarter,
however. This modest rise reflected lower profits on Canadian direct investment
abroad.
3.
Financial Account (Unadjusted for Seasonal Variation)
a.
Canadian Portfolio Investments Abroad and Foreign-held Canadian Securities
Canadian
portfolio investment in foreign securities was again substantial at $5.1
billion, but stood at only 60% of the record fourth quarter investment.
Most of the acquisition activity, led by mutual funds, was concentrated
in foreign stocks. Canadian investors also continued to increase their
holdings of foreign bonds, mainly U.S. treasury bonds.
After
six quarters of increasing their holdings of Canadian debt and equity
instruments, foreign investors sold $6.7 billion in Canadian securities.
Most of this divestment comprised money market instruments, with the exception
of Government of Canada Treasury bills. The decline in the level of foreign
investment was largely accounted for by U.S. residents. Canadian stock
prices, although up marginally in the quarter, have consistently lagged
behind their American counterparts in recent years.
b.
Direct Investment
Canadian
companies continue to invest abroad, although at a considerably slower
pace than in the two previous quarters. Canadian direct investment went
mainly to the United States and Asia, and was focused on the finance and
insurance industry.
Foreign
companies similarly invested a moderate amount in Canada in the quarter.
Acquisitions, which had been the driving force behind record inflows in
1998, were negligible. The direct investment came solely from the United
States.
Canadian
financial institutions, principally banks, channelled a record $16.3 billion
back to Canada, more than reversing the substantial outflow of the previous
quarter. The reduction in deposit assets in foreign currency abroad reflected
mainly those with foreign affiliates, primarily branches located offshore
as well as in the United States and Japan.
At the
same time, the substantial $10.1-billion outflow from Canada was largely
made up of foreign currency deposits through Canadian banking affiliates,
although one-half of the smaller Canadian currency portion was accounted
for by non-affiliated banks.
c.
Official International Reserves
Official
international reserves rose for a second consecutive quarter, as the Canadian
dollar closed higher against most major foreign currencies. The increase
went largely to securities denominated in U.S. dollars, a change from
the two previous quarters where the emphasis was on increases in deposits
and securities in other denominations.
PARLIAMENTARY
ACTION
The
Bank of Canada is responsible for managing the balance of payments; this
responsibility is not handled directly by the government or by Parliament.
When interest rates experienced a dramatic rise in 1979, however, the
Standing Committee on Finance, Trade and Economy considered the issue.
CHRONOLOGY
Current
Account
1964-1981 - Current account
deficits, which had increased gradually to $15.0 billion,were replaced
by a small surplus in 1970.
1982 - Surplus of $2.3 billion.
1983 - Deficit of $3.1 billion.
1984 - Deficit of $1.7 billion.
1985 - Deficit of $7.8 billion.
1986 - Deficit of $15.5
billion.
1987 - Deficit of $17.8
billion.
1988 - Deficit of $18.3
billion.
1989 - Deficit of $25.8
billion.
1990 - Deficit of $23.1
billion.
1991 - Deficit of $25.6
billion.
1992 - Deficit of $25.4
billion.
1993 - Deficit of $28.1
billion.
1994 - Deficit of $17.7
billion.
1995 - Deficit of $6.1 billion.
1996 - Surplus of $4.5 billion.
1997 - Deficit of $14.3
billion.
1998 - Deficit of $16.4 billion.
Capital
and Financial Accounts
1964 - 1973 - Apart from
a small $0.3-billion surplus in 1964, a small $0.3-billion deficit in
1970, and a $3.8-billion surplus in 1972, the surplus on the financial
and capital accounts generally fluctuated around the $2 billion mark.
1974 - 1979 - The surplus
increased to more than $11 billion in 1978 and 1979.
1980 - Surplus of $7.0 billion.
1981 - Surplus of $19.4
billion.
1982 - Deficit of $0.027
billion.
1983 - Surplus of $6.5 billion.
1984 - Surplus of $9.0
billion.
1985 - Surplus of $13.7
billion.
1986 - Surplus of $17.4
billion.
1987 - Surplus of $20.9
billion.
1988 - Surplus of $17.8
billion.
1989 - Surplus of $27.6
billion.
1990 - Surplus of $25.2
billion.
1991 - Surplus of $25.8
billion.
1992 - Surplus of $21.9
billion.
1993 - Surplus of $34.5
billion.
1994 - Surplus of $17.8
billion.
1995 - Surplus of $1.3 billion.
1996 - Deficit of $11.8
billion.
1997 - Surplus of $18.1
billion.
1998 - Surplus of $14.4
billion.
SELECTED
REFERENCES
Bank
of Canada. "Canadas Balance of Payments in the 1970s: A Perspective."
Bank of Canada Review, Ottawa, March 1979.
Statistics
Canada. Canadas International Investment Position. Publication
67-202 (annual, four-year reporting lag).
Statistics
Canada. Corporations and Labour Union Returns Act - Part I: Corporations.
Publication 61-210 (annual, three-year reporting lag). Contains detailed
analysis of foreign ownership control; also breakdown of many professional
fees, etc. found in the "other" subaccount of the service section
of the current account.
Statistics
Canada. Quarterly Estimates of the Canadian Balance of International
Payments. Publication 67-001 (quarterly, one-quarter reporting lag).
Note:
All data in the text and following tables are based on the most recent
Statistics Canada publication 67-001 available when this review was updated.
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*
The original version of this Current Issue Review was published in
April 1986; the paper has been regularly updated since that time.
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