## Reconciliation between flows and stocks

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### Background and motivation
- Reconciliation between flows from the balance of payments’ financial account and stocks from the international investment position (IIP) has become increasingly important for analytical and policy purposes as stocks of external assets and liabilities rose to record levels for many countries over the last decade.
- External assets and liabilities as a share of GDP have more than tripled from the early 1990s to the years preceding the COVID-19 crisis.
- Returns on assets and liabilities now play a significantly larger role in driving external flow and stock imbalances.
- IMF surveys show stock-flow reconciliation data are scarce:
  - Out of 52 countries, the compilation systems of only around 10 economies would support production of a complete set of integrated international accounts with full reconciliation between stocks and flows.
  - An additional 20 economies present stock-flow reconciliation and metadata details in a varying degree of completeness.
- In the absence of stock-flow reconciliation data, most studies rely on the numerical discrepancy between changes in the IIP and financial transactions to estimate revaluation components, disregarding market volatilities and statistical changes (e.g., discovery of new assets and liabilities).
- Lack of stock-flow reconciliation data limits understanding of the roles of exchange rate valuation changes, asset price valuation changes, and other changes (e.g., debt write-offs) for external stability.

### Conceptual framework and proposed emphasis for BPM7
- External statistics should be presented as three intertwined elements:
  - (i) the balance of payments,
  - (ii) the IIP,
  - (iii) accumulation accounts, which explain changes of the IIP between two points in time with transactions from the balance of payments’ financial account, revaluations, and other changes in volume.
- The accumulation accounts terminology is consistent with 2008 SNA paragraph 1.20 and refers to the components: transactions from the financial account, revaluations, and other changes in volume.
- Elevating the integrated IIP presentation will:
  - broaden reporting of granular data,
  - facilitate analysis of valuation changes and financial returns in net IIP dynamics,
  - support IMF analytical work such as the External Sector Report (ESR),
  - highlight the continued centrality of the current account for explaining IIP dynamics and calculating rates of return on net and gross IIP.

### Current BPM6 treatment and identified shortcomings
- BPM6 discusses stock-flow reconciliation across Chapters 2, 3, 7, 8, and 9 and includes expository examples (table 7.1 and Table 9.1 on the Other Changes in Financial Assets and Liabilities Account).
- Concerns and shortcomings:
  - The integrated IIP with full reconciliation is not a Standard Component in Appendix 9; tables 7.1 and 9.1 are expository and not explicitly included in Appendix 9, which may have contributed to limited reporting.
  - The OCA breakdown in BPM6 into “Exchange Rates Changes”, “Other Price Changes”, and “Other Changes in Volumes” is not sufficiently granular; “Other Changes in Volumes” can mix items with different economic significance (e.g., statistical reclassifications versus debt cancellation and write-offs).
  - BPM6 provides limited analytical guidance on how stock-flow reconciliation aids understanding of external sustainability, external vulnerability, financial interconnectedness, risk measurement, revaluation interpretation, and links between current account and IIP.
  - Terminology differences with 2008 SNA: adopting “Accumulation Accounts” clarifies that transactions, revaluations, and other changes in volume together account for differences between opening and closing positions.

### Options considered for BPM7 and Task Team recommendation
- Option 1 (less prominent integration):
  - Highlight the integrated presentation throughout the manual where relevant.
  - Add an analytical section on selected IIP issues to chapter 14.
  - Add the integrated IIP statement in Appendix 9C as additional analytical position data.
- Option 2 (central integrated framework) — recommended:
  - Present external statistics as three intertwined elements: balance of payments, IIP, and accumulation accounts.
  - Include the integrated IIP statement, with the same line items as existing standard components in Appendix 9B, as an additional standard component in BPM, Appendix 9.
  - Present “Other Changes in Volume” with a total and two encouraged “of which” categories: “Reclassifications” and “Debt Cancellation and Write-offs”.
  - Add an analytical section on selected IIP issues to Chapter 14 explaining the relevance of the current account within the new three-account framework and the analytical power of revaluations and other changes in volume.
  - Encourage sectoral presentation of stock-flow reconciliation for different financial instruments as encouraged reporting items to provide priorities for compilers.
- Rationale for Option 2:
  - Underscores sizable contribution of other flows (revaluations and other changes in volume of assets) to net changes in external positions.
  - Brings integrated presentation of flows and stocks to the forefront of BPM7 as a central piece.
  - Including the integrated IIP as a standard component signals importance and assists compilers in convincing policymakers to compile these data regularly.
- Implementation caveats:
  - Compiling integrated IIP information is a significant endeavor and may take considerable time and resources for many countries; it should be viewed as a medium-term aspiration.
  - Reporting of data on tables included under Option 2 is not mandatory; no immediate resource burden is envisaged for countries.
  - Separate reporting of debt cancellation and write-offs, and reclassifications under “Other Changes in Volumes” is encouraged.
- Decision: Option 2 was approved by the IMF Committee on Balance of Payments Statistics (BOPCOM) at its meeting, October 26–29, 2020.

### Forward-looking implementation and country reporting coverage
- The Task Team considers the integrated IIP option as forward looking, to come into effect when BPM7 is launched in 2025.
- Including integrated IIP under standard components signals how external sector accounts are likely to evolve over the next 20 years.
- Current country reporting to the IMF:
  - 197 countries report balance of payments.
  - 172 countries report IIP.
  - Around 12 countries report the currency composition of IIP data to IMF (a necessary first step for full stock–flow reconciliation).
- Footnote on BPM6 adoption:
  - Of the 197 countries reporting balance of payments, 175 countries compile on a BPM6 basis.
  - Of the 172 countries reporting IIP, 158 countries compile on a BPM6 basis.
- The number of countries compiling and reporting balance of payments and IIP data to IMF has significantly increased over the last decade, and the number reporting currency composition is gradually increasing.

### Implementation strategy, guidance, and IMF role
- IMF should:
  - Develop detailed guidance for integrated IIP compilation.
  - Establish a medium to long-term implementation strategy focused on technical assistance/training.
  - Allow flexibility on reporting detailed components on a best-effort basis.
- Guidance should cover:
  - Compilation of the currency composition of IIP, including specifying a minimum set of currencies.
  - Compilation of other changes (e.g., in the case of direct investment).
  - Amending reporting requirements.
  - Templates for banking and securities holding statistics.
- Annex II of the Guidance Note includes proposed templates for implementation of Option 2.

### Accounting identities and analytical nexus between the current account and IIP
- Accumulation-account identity for change in net IIP (paragraph 14.14):
  - ∆IIP = NFA + VAL + OC     (13)
    - NFA = net financial account entries
    - VAL = net revaluation
    - OC = net other changes in volume
- Substituting yields (paragraph 14.14):
  - ∆IIP = CAB + KAB + VAL + OC     (14)
    - CAB = current account balance
    - KAB = capital account balance
  - Note: In practice, errors and omissions (EO) must enter equation (12) and consequently equation (14), so equation (14) would change into ∆IIP = CAB + KAB + VAL + OC + EO.
- Decomposition that isolates components dependent on existing IIP stock (paragraph 14.17):
  - ∆IIP = (CAB – II + KAB) + (II + VAL) + OC     (15)
    - II = investment income balance
  - Interpretations:
    - The first term might be labelled external primary balance (CAB + KAB – II).
    - The second term represents the net total return on a country’s net external position (II + VAL), where the total rate of return = income rate of return + revaluation rate of return.
    - The income rate of return = ratio of investment income to the corresponding average asset or liability position in the IIP.
    - The revaluation rate of return = ratio of revaluations (holding gains and losses) to the corresponding average asset or liability position.
- Policy implication (paragraph 14.16):
  - If an IIP is deemed out of balance with economic fundamentals, an adjustment requires a change in the current account balance; policy measures must therefore aim at the corresponding current account imbalance as an intermediate target.
  - Exchange rate depreciation can be a policy response to an unsustainable current account deficit and looming negative net IIP by supporting exports and reducing imports, thereby improving the current account and, over time, the IIP.
  - Valuation effects must be taken into account: whether revaluations support or hurt adjustment depends on the currency composition of the country’s balance sheet.

### Three-dimensional account system and numerical illustration
- The three-dimensional account system presents changes in the net IIP through three complementary accounts:
  - Generation (first pillar): breaks down total net IIP change into components according to (15) and shows the origin/source of the change in the IIP.
  - Instrument (second pillar): shows how changes in the net IIP are reflected in the various functional categories.
  - Sector (third pillar): allocates these instrument changes to the domestic sectors involved.
- Each account captures a specific aspect of the change in the net IIP in a given period (quarter, year, or multi-year).
- Numerical example:
  - Net IIP increased by 40 billion units in a given period.
  - Generation account documents that approx. 45 billion units originate from the current account balance, whereas valuation effects and other changes have a negative impact.
  - Instruments account identifies portfolio investment increasing by approx. 30 billion units.
- Sector account example findings:
  - External positions of the government sector and the non-financial corporations, households and NPISHs sector deteriorate.
  - Other financial corporations sector records a strong increase in net IIP.

### IIP and risk analysis: liquidity, currency, and credit risk
- Liquidity and interest-rate risk:
  - Distinguish listed vs unlisted equity; breakdown of deposits between overnight and other deposits.
  - Breakdown by original maturity for debt instruments provides an additional liquidity dimension but does not fully capture financing needs by maturity; collection of residual/remaining maturity information is necessary to comprehensively show financing needs due (e.g., within the year).
  - Classification by remaining maturity is encouraged in current standards for debt liabilities; short-term remaining maturity of debt liabilities by sector is requested in Table A9-IV of BPM6.
  - Duration is a complementary measure: longer duration implies greater gains or losses for any given change in interest rates; price revaluations are intrinsically related to portfolio duration.
- Currency risk:
  - Currency mismatches are frequent macroeconomic risks, particularly for emerging market and developing economies.
  - Data needs and initiatives:
    - Currency breakdown of debt liabilities is crucial.
    - IMF FSIs include foreign-currency-denominated loans and liabilities indicators for deposit-taking corporations.
    - ESRB risk dashboard reports currency risk via percentage of total loans denominated in foreign currency.
    - G-20 Data Gaps Initiative: IMF/FSB/BIS sponsor collection of data defined in Table A9-I of BPM6 requesting assets and liabilities broken down by sector and original maturity and foreign currency derivatives (notional amounts) to adjust for hedged exposures.
    - Notional amounts of derivatives are a rough proxy because underlying purpose (hedging or speculation) is not available.
  - Analytical limitations:
    - IIP by currency and foreign currency derivatives gives structural exposure but not an immediate assessment of impact on net external position; analysis requires price revaluations of foreign currency derivatives and net impact of exchange-rate-driven revaluations.
    - Impact of currency-driven revaluations generally negative for economies with a net liability position in foreign currency and relative inflationary processes causing domestic currency depreciation.
- Credit risk:
  - IIP statistics by counterpart area/geographical detail can inform counterparty country risk.
  - Counterpart sector detail is generally available only for portfolio investment; sometimes for direct investment (SPEs vs non-SPEs) and other investment.
  - Cross-classification by instrument, counterpart country, and sector is powerful for assessing portfolio or credit risk.
  - Additional data needed: existence of credit derivatives, guarantees (notional value of underlying debt), rating information, and breakdown of portfolio investment by rating grade.
  - Price revaluations and other changes: price revaluations inform impact of credit dimensions on tradable portfolio values; write-offs and write-downs in the other changes in volume account indicate credit risk of loan portfolios.

### Valuation paradox and interpretation of revaluations
- Cautions in interpreting revaluations:
  - IIP stocks are reported at market values where possible; recorded values do not necessarily reflect realized gains or losses.
  - IIP captures only external part of a sector’s balance sheet; external losses may be offset by domestic gains.
  - Hedging operations transferring open positions across sectors are not always captured.
- Valuation paradox:
  - A country’s net IIP might improve even when on the verge of insolvency because falling government bond prices reduce valuation of liabilities in the IIP while payment obligations remain unchanged.
  - The paradox can be more pronounced in currency unions that restrict exchange rate adjustments, though expected bailouts may dampen bond price responses.
  - The mechanism applies beyond government bonds to other bond liabilities; rising bond prices can increase recorded liabilities and show a lower net IIP despite unchanged payment obligations.

### Empirical findings on the role of revaluations and stock–flow adjustments
- Several studies report the growing importance of revaluations and other changes in volume in NIIP dynamics:
  - ONS (2020) and Bergant (2014) note increased importance; Bergant (2014) finds stock–flow adjustment moved in a stabilizing direction post-crisis and that countries with the lowest NIIP experienced the most positive valuation changes.
  - Adler and Garcia-Macia (2018) emphasize the role of returns on net foreign assets, including revaluation components, in stabilizing the NIIP.
  - Balli et al. (2011), and Lane and Milesi-Ferretti (2001, 2007) show stock–flow adjustment importance has grown tremendously since 1980; in some cases valuation changes significantly dominated capital flows.

### Consistency with national accounts, accumulation accounts, and rates of return
- Rest of the world sector in national accounts and the BOP/IIP portray the same economic reality and alignment facilitates integration of cross-border flows and positions with domestic counterparts.
- Accumulation accounts (transactions, revaluations, other changes in volume) enable detailed analysis of asset value accumulation and determinants of net worth; developing a similar accumulation framework in BOP deepens analytical synergies with SNA.
- Rates of return:
  - Income rate of return = investment income / corresponding average asset or liability position in the IIP.
  - Revaluation rate of return = revaluations / corresponding average asset or liability position.
  - Total rate of return = income rate of return + revaluation rate of return.
  - Rates of return can be computed for assets excluding financial derivatives and for liabilities excluding financial derivatives.
  - Special considerations:
    - Estimation of pure interest on loans and deposits when FISIM is excluded from investment income will cause rates of return on loans and deposits to differ from rates estimated from actual interest.
    - Estimating rates using both pure interest and actual interest provides a more complete analytical picture.
  - Rate differentials (rate of return on assets − rate of return on liabilities) influence a destabilizing feedback loop between the current account and the financial account and affect current account deficit sustainability.
- Scope and limitations:
  - Financial derivatives are omitted from the suggested rates-of-return framework because they do not pay interest income and capital gains are difficult to relate to an original principal; revaluation rates of return on financial derivatives are a topic for additional research.

*Source: Guidance Note prepared by Bureau of Economic Analysis US, Deutsche Bundesbank, European Central Bank, International Monetary Fund, and Statistics Canada; approved by the IMF Committee on Balance of Payments Statistics (BOPCOM) at its meeting, October 26–29, 2020.*

### SECTION I: THE ISSUE

### SECTION I: THE ISSUE

### Background and motivation
- Reconciliation between flows from the balance of payments’ financial account and stocks from the international investment position (IIP) has become increasingly important for analytical and policy purposes, driven by increases to record levels in stocks of external assets and liabilities for many countries over the last decade.
- External assets and liabilities as a share of GDP have more than tripled from the early 1990s to the years preceding the COVID-19 crisis.
- Returns on assets and liabilities now play a significantly larger role in driving external flow and stock imbalances.
- IMF surveys show stock-flow reconciliation data are scarce:
  - Out of 52 countries, the compilation systems of only around 10 economies would support production of a complete set of integrated international accounts with full reconciliation between stocks and flows.
  - An additional 20 economies present stock-flow reconciliation and metadata details in a varying degree of completeness.
- In the absence of stock-flow reconciliation data, most studies rely on the numerical discrepancy between changes in the IIP and financial transactions to estimate revaluation components, thereby disregarding market volatilities and statistical changes (e.g., discovery of new assets and liabilities).
- Lack of stock-flow reconciliation data limits understanding of the roles of exchange rate valuation changes, asset price valuation changes, and other changes (e.g., debt write-offs) for external stability.

### Conceptual framework and proposed emphasis for BPM7
- The integrated IIP presentation should be elevated in the updated Manual (BPM7) by presenting external statistics as composed of three intertwined elements:
  - (i) the balance of payments,
  - (ii) the IIP,
  - (iii) accumulation accounts, which explain changes of the IIP between two points in time with transactions from the balance of payments’ financial account, revaluations, and other changes in volume.
- The accumulation accounts terminology is consistent with 2008 SNA paragraph 1.20 and refers to the components: transactions from the financial account, revaluations, and other changes in volume.
- Emphasizing the integrated IIP presentation will:
  - broaden reporting of granular data,
  - facilitate analysis of valuation changes and financial returns in net IIP dynamics,
  - support IMF analytical work such as the External Sector Report (ESR),
  - highlight the continued centrality of the current account for explaining IIP dynamics and calculating rates of return on net and gross IIP.

### Current state in international statistical standards (BPM6)
- BPM6 discusses stock-flow reconciliation across Chapters 2, 3, 7, 8, and 9:
  - Chapter 2 (paragraph 2.10) briefly explains the integrated IIP statement and links to Chapters 7–9.
  - Chapter 3 (paragraphs 3.19–3.21) defines other flows and distinguishes (a) other changes in volume and (b) revaluations.
  - Chapter 7 includes an example integrated IIP presentation (table 7.1) and references the IIP’s analytical relevance (paragraphs 7.5, 7.7, 7.8, 7.13).
  - Chapter 8 (paragraph 8.5) notes the contribution of the financial account within the integrated framework.
  - Chapter 9 focuses on changes other than transactions and includes Table 9.1 on the Other Changes in Financial Assets and Liabilities Account (OCA).
- Chapter 14 covers selected BOP and IIP analysis but emphasizes BOP issues; only Section G focuses on the balance sheet approach and IIP data.

### Concerns and shortcomings in current standards
- The integrated IIP with full reconciliation is not a Standard Component in Appendix 9; tables 7.1 and 9.1 are expository and not explicitly included in Appendix 9, which may have contributed to limited reporting of stock-flow reconciliation information by many countries.
- The OCA breakdown in BPM6 is not sufficiently granular:
  - BPM6 divides OCA into “Exchange Rates Changes”, “Other Price Changes”, and “Other Changes in Volumes”.
  - “Other Changes in Volumes” can mix items with different economic significance (e.g., statistical reclassifications versus debt cancellation and write-offs), while only the latter have clear economic implications for external sustainability.
- Terminology differences with 2008 SNA: adopting the term “Accumulation Accounts” (2008 SNA paragraph 1.20) clarifies that transactions, revaluations, and other changes in volume together account for differences between opening and closing positions.
- BPM6 provides limited elaboration on analytical value of integrated flows and stocks:
  - Missing dedicated analytical guidance on how stock-flow reconciliation aids understanding of external sustainability, external vulnerability, financial interconnectedness, risk measurement, revaluation interpretation, and links between current account and IIP.
- Specific analytical gaps identified:
  - Risk measurement: BPM6 lacks guidance on using the IIP and revaluation account for forward-looking risk analysis.
  - Valuation paradox: Market valuation can produce counterintuitive outcomes (e.g., sovereign bond price declines can lower reported liabilities and thereby improve net IIP even as solvency worsens), and BPM6 provides little guidance on interpretation.
  - Nexus between current account and IIP: BPM6 mentions the nexus but lacks a dedicated section summarizing aspects and analytical value; reconciliation with current account flows can provide additional insights and alternative presentation schemes can visualize how current account and IIP interact.
  - Rates of return: BPM6 mentions rates of return but lacks a dedicated section; definitions noted:
    - Income rate of return = investment income / corresponding average asset or liability position in the IIP.
    - Revaluation rate of return = revaluations (holding gains and losses) / corresponding average asset or liability position.
    - Total rate of return = income rate of return + revaluation rate of return.

### Issues for discussion and options considered
- The Task Team (TT) recommends greater prominence for the integrated IIP presentation in BPM7 while balancing policy needs and countries’ compilation capacity.
- Two options considered:
  - Option 1:
    - Highlight the integrated presentation throughout the manual where relevant.
    - Add an analytical section on selected IIP issues to chapter 14.
    - Add the integrated IIP statement in Appendix 9C as additional analytical position data.
  - Option 2:
    - Place the integrated presentation at the center of the new Manual by presenting external statistics as three intertwined elements: balance of payments, IIP, and accumulation accounts.
    - Include the integrated IIP statement, with the same line items as existing standard components in Appendix 9B, as an additional standard component in BPM, Appendix 9.
    - Present “Other Changes in Volume” with a total and two encouraged “of which” categories: “Reclassifications” and “Debt Cancellation and Write-offs”.
    - Add an analytical section on selected IIP issues to Chapter 14 explaining the relevance of the current account within the new three-account framework and the analytical power of revaluations and other changes in volume.
    - Encourage sectoral presentation of stock-flow reconciliation for different financial instruments as encouraged reporting items to provide priorities for compilers.

### Outcomes and recommendations
- Option 2 is recommended and was approved by the IMF Committee on Balance of Payments Statistics (the Committee, BOPCOM) at its meeting, October 26–29, 2020.
  - Rationale: Underscoring the sizable contribution of other flows (revaluations and other changes in volume of assets) to net changes in external positions and the analytical importance of stock-flow reconciliation, Option 2 brings the integrated presentation of flows and stocks to the forefront of BPM7 as a central piece.
  - Including the integrated IIP as a standard component sends a stronger message on its importance and will assist compilers in convincing policymakers of the need to compile these data regularly.
- Implementation considerations:
  - Compiling integrated IIP information is a significant endeavor and may take considerable time and resources for many countries; it should be viewed as a medium-term aspiration.
  - Reporting of data on tables included under Option 2 is not mandatory; no immediate resource burden is envisaged for countries.
  - Separate reporting of debt cancellation and write-offs, and reclassifications under “Other Changes in Volumes” is encouraged to support external sustainability analysis.
  - Sectoral presentation of stock-flow reconciliation for different financial instruments is included under encouraged reporting items to provide compilers with priorities.
- Rejected proposals:
  - The Committee discussed but rejected introducing an “unallocated” item in the integrated IIP template, citing inconsistency with 2008 SNA categories and concluding that the potential advantage of easing reporting for countries with limited capacity can be achieved without a new “unallocated” category.

*Source: Guidance Note prepared by Bureau of Economic Analysis US, Deutsche Bundesbank, European Central Bank, International Monetary Fund, and Statistics Canada; approved by the IMF Committee on Balance of Payments Statistics (BOPCOM) at its meeting, October 26–29, 2020.*

### 20.       While bearing in mind that many countries have limited resources and low statistical

### Reconciliation between flows and stocks (BPM7 implementation)

### Forward-looking implementation and country reporting coverage
- The TT considers the integrated IIP option as forward looking, to come into effect when BPM7 is launched in 2025.
- Including integrated IIP under standard components signals how external sector accounts are likely to evolve over the next 20 years.
- Current country reporting to the IMF:
  - 197 countries report balance of payments.
  - 172 countries report IIP.
  - Around 12 countries report the currency composition of IIP data to IMF (a necessary first step for full stock–flow reconciliation).
- Footnote details on BPM6 adoption:
  - Of the 197 countries reporting balance of payments, 175 countries compile on a BPM6 basis.
  - Of the 172 countries reporting IIP, 158 countries compile on a BPM6 basis.
- The number of countries compiling and reporting balance of payments and IIP data to IMF has significantly increased over the last decade, and the number reporting currency composition is gradually increasing.

### Implementation strategy, guidance, and technical assistance
- The IMF should play a key role in:
  - Developing detailed guidance for integrated IIP compilation.
  - Establishing a medium to long-term implementation strategy focused on technical assistance/training.
  - Allowing flexibility on reporting detailed components on a best-effort basis.
- Guidance should cover:
  - Compilation of the currency composition of IIP, including specifying a minimum set of currencies to be considered.
  - Compilation of other changes (e.g., in the case of direct investment).
  - Amending reporting requirements.
  - Templates for banking and securities holding statistics.
- Annex II includes proposed templates for implementation of option 2.

### Policy choice: Option 2 favored; Option 1 rejected
- Option 2 is favored because stock–flow reconciliation enhances overall quality of external sector statistics and should be prominent in the updated manual.
- Option 1 is rejected: embedding an integrated IIP among many supplementary tables would lower its prominence and undermine the aim of making integrated IIP a central piece of BPM7.
- Option 2 would enhance consistency with the 2008 SNA by assigning the integrated balance sheet the same level of importance as other accounts in the sequence of institutional sector accounts.
- Aligning BPM7 with the 2025 SNA is expected to strengthen the balance of payments/IIP and the rest-of-world sector account.
- Some advanced economies, including the Euro Area member states, already compile integrated IIP data regularly and others are moving toward it; without standardized guidelines content and format may differ across countries and across national accounts and balance of payments publications, affecting comparability.

### Accounting identities and analytical nexus between the current account and IIP
- Accumulation-account identity for change in net IIP (paragraph 14.14):
  - ∆IIP = NFA + VAL + OC     (13)
    - NFA = net financial account entries
    - VAL = net revaluation
    - OC = net other changes in volume
- Substituting yields (paragraph 14.14):
  - ∆IIP = CAB + KAB + VAL + OC     (14)
    - CAB = current account balance
    - KAB = capital account balance
  - Note: In practice, errors and omissions (EO) must enter equation (12) and consequently equation (14), so equation (14) would change into ∆IIP = CAB + KAB + VAL + OC + EO.
- Decomposition that isolates components dependent on existing IIP stock (paragraph 14.17):
  - ∆IIP = (CAB – II + KAB) + (II + VAL) + OC     (15)
    - II = investment income balance
  - Interpretations:
    - The first term might be labelled external primary balance (CAB + KAB – II).
    - The second term represents the net total return on a country’s net external position (II + VAL), where the total rate of return = income rate of return + revaluation rate of return.
    - The income rate of return = ratio of investment income to the corresponding average asset or liability position in the IIP.
    - The revaluation rate of return = ratio of revaluations (holding gains and losses) to the corresponding average asset or liability position.
- Policy implication (paragraph 14.16):
  - If an IIP is deemed out of balance with economic fundamentals, an adjustment requires a change in the current account balance; policy measures must therefore aim at the corresponding current account imbalance as an intermediate target.
  - Exchange rate depreciation can be a policy response to an unsustainable current account deficit and looming negative net IIP by supporting exports and reducing imports, thereby improving the current account and, over time, the IIP.
  - Valuation effects must be taken into account: whether revaluations support or hurt adjustment depends on the currency composition of the country’s balance sheet.

### Empirical and analytical background on the role of revaluations and stock–flow adjustments
- Several studies highlight the growing importance of revaluations and other changes in volume in recent years and their role in NIIP dynamics:
  - ONS (2020) and Bergant (2014) note the increased importance of revaluations and other changes in volume; Bergant (2014) finds stock–flow adjustment moved in a stabilizing direction post-crisis and that countries with the lowest NIIP experienced the most positive valuation changes.
  - Adler and Garcia-Macia (2018) emphasize the role of returns on net foreign assets, including revaluation components, in stabilizing the NIIP.
  - Balli et al. (2011), and Lane and Milesi-Ferretti (2001, 2007) show that the importance of stock–flow adjustment has grown tremendously since 1980; in some cases valuation changes significantly dominated capital flows.

*International Monetary Fund*

### 14.18    The three-dimensional account system presenting changes in the net IIP visualizes the nexus

### b4-reconciliation-between-flows-and-stocks - 14.18    The three-dimensional account system presenting changes in the net IIP visualizes the nexus

### Three-dimensional account system and decomposition of net IIP changes
- The three-dimensional account system presents changes in the net IIP through three complementary accounts:
  - Generation (first pillar): breaks down the total net IIP change into components according to (15) and shows the origin/source of the change in the IIP.
  - Instrument (second pillar): shows how changes in the net IIP are reflected in the various functional categories.
  - Sector (third pillar): allocates these instrument changes to the domestic sectors involved.
- Each account captures a specific aspect of the change in the net IIP in a given period (quarter, year, or multi-year).
- Numerical example:
  - Net IIP increased by 40 billion units in a given period.
  - Generation account documents that approx. 45 billion units originate from the current account balance, whereas valuation effects and other changes have a negative impact.
  - Instruments account identifies portfolio investment increasing by approx. 30 billion units.
- Sector account example findings:
  - External positions of the government sector and the non-financial corporations, households and NPISHs sector deteriorate.
  - Other financial corporations sector records a strong increase in net IIP.

### IIP and risk analysis: analytical role of IIP and revaluation account
- BPM6 integrated view of flows and stocks makes IIP an analytical tool for forward-looking vulnerabilities analysis.
- The review focuses on the link between transactions and positions and the analytical power of revaluations and other changes in volume.
- Considerations for developing IIP and the revaluation account to increase analytical value for risk analysis are provided.

### Liquidity and interest rate risk
- Liquidity dimensions in statistics:
  - Distinction between listed and unlisted equity; breakdown of deposits between overnight and other deposits.
  - Breakdown by original maturity for debt instruments provides an additional liquidity dimension but does not fully capture liquidity needs by maturity.
  - Collection of residual/remaining maturity information is necessary to comprehensively show financing needs due (e.g., within the year).
  - Classification by remaining maturity is encouraged in current standards for debt liabilities; short-term remaining maturity of debt liabilities by sector is requested in Table A9-IV of BPM6.
- Duration as complementary liquidity/interest-rate risk measure:
  - Duration defined as the weighted average term to maturity and measures sensitivity of instrument value to interest rate changes.
  - Price revaluations (holding gains and losses) are intrinsically related to portfolio duration; sign depends on slope of the yield curve.
  - Longer duration implies greater gains or losses for any given change in interest rates.
  - Mismatched durations of assets and liabilities expose corporations to gains or losses as interest rates change.

### Currency risk
- Currency mismatches (differences in currency composition of assets and liabilities vis-à-vis the rest-of-the-world) are frequent macroeconomic risks, particularly for emerging market and developing economies.
- Risks from large positions in foreign-currency-denominated debt when foreign currency inflows diminish and fixed debt payment schedules are due; may exacerbate currency pressures.
- Data needs and existing initiatives:
  - Currency breakdown of debt liabilities is crucial for investors and macroprudential analysis.
  - IMF financial soundness indicators (FSI) include foreign-currency-denominated loans and liabilities indicators for deposit-taking corporations.
  - ESRB risk dashboard reports currency risk via percentage of total loans denominated in foreign currency.
  - G-20 Data Gaps Initiative: IMF/FSB/BIS sponsor collection of data defined in Table A9-I of BPM6 requesting assets and liabilities broken down by sector and original maturity and foreign currency derivatives (notional amounts) to adjust for hedged exposures.
  - Notional amounts of derivatives are a rough proxy because underlying purpose (hedging or speculation) is not available.
- Analytical limitations and uses:
  - IIP broken down by currency and foreign currency derivatives gives structural exposure but not immediate assessment of impact on net external position.
  - Analysis supported by price revaluations of foreign currency derivatives and net impact of exchange-rate-driven revaluations.
  - Impact of currency-driven revaluations generally negative for economies with a net liability position in foreign currency and relative inflationary processes causing domestic currency depreciation.
  - Impact depends on whether a country has a net asset or liability position in foreign currency and on domestic currency stability.

### Credit risk
- Credit risk defined as possibility of loss from borrower failure to meet debt obligations; arises from liquidity, currency, and other considerations.
- IIP statistics by counterpart area/geographical detail can inform counterparty country risk (country risk includes political/social stability, rule of law, corruption).
- Counterpart sector detail:
  - Counterpart sector information is generally available only for portfolio investment; sometimes for direct investment (SPEs vs non-SPEs) and other investment.
  - Cross-classification by instrument, counterpart country, and sector is powerful for assessing portfolio or credit risk.
- Additional relevant data for comprehensive credit risk assessment:
  - Existence of credit derivatives (e.g., credit default swaps) or guarantees can change portfolio risk; notional amounts for derivatives broken down by counterpart area and sector are necessary.
  - For guarantees, the underlying (notional) value of the debt being guaranteed is the relevant metric rather than market value of guarantees.
  - Rating information and breakdown of portfolio investment by rating grade would improve creditworthiness assessment; such information is generally missing in IIP statistics.
- Role of price revaluations and other changes:
  - Price revaluations provide information on impact of credit dimensions on tradable portfolio values; relatively high(/low) price revaluations correspond to high(/low) risk portfolios.
  - Comparative analysis could use “revaluation return” versus benchmark equity (e.g., Dow Jones) and/or debt securities portfolios.
  - For non-tradable instruments (particularly loans), historical analysis of write-offs and write-downs (other changes in volume account) indicates credit risk of loan portfolios.

### Valuation paradox and interpretation of revaluations
- Revaluation effects require caution when used as measures of gains and losses:
  - IIP stocks are reported at market values wherever possible; recorded values do not necessarily reflect realized gains or losses.
  - IIP captures only external part of a sector’s balance sheet; external losses may be offset by domestic gains.
  - Hedging operations that transfer open positions to other domestic or foreign sectors are not always captured.
- Valuation paradox:
  - A country’s net IIP might improve even when on the verge of insolvency because falling prices for government bonds reduce valuation of liabilities in the IIP while payment obligations remain unchanged.
  - The paradox can be more pronounced in currency unions that restrict exchange rate adjustments, though expected bailouts may dampen bond price responses.
  - The mechanism applies beyond government bonds to other bond liabilities; the paradox works in reverse when rising bond prices (e.g., due to better rating) increase liabilities and thus show a lower net IIP despite unchanged payment obligations.

*International Monetary Fund (BPM6 chapter text).*

### Box 14.X

### Box 14.X

### Consistency between Balance of Payments / IIP and National Accounts
- The rest of the world sector in national accounts (RoW) and the balance of payments/international investment position (IIP) portray the same economic reality: the economic flows and balance-sheets between residents and non-residents in an economic territory.
- Efforts to develop common statistical approaches during the preparation of BPM6 and the 2008 SNA, and reinforced for this review round, have:
  - Facilitated integration of cross-border flows and positions with domestic counterparts.
  - Enabled analysis of interactions between sector and geographical imbalances, propagation of international shocks to domestic agents, and cross-border second and higher order exposures and interdependencies.
  - Brought clarity to overall economic statistics and eased communication with policy makers and the public.
  - Favored development of common data sources, methods, and institutional arrangements that enhanced data accuracy, reliability, and consistency, thereby increasing combined analytical value.

### Accumulation accounts, stock/flow reconciliation, and analytical synergies
- The national accounts framework represents changes in balance-sheets through accumulation accounts where flows (changes in stocks) are broken down into:
  - Transactions
  - Revaluations
  - Other changes in volume of assets
- This decomposition:
  - Allows detailed analysis of asset value accumulation and determinants of net worth.
  - Facilitates monitoring feedback links between balance-sheets and non-financial transactions by separating sources for asset change.
- Developing a similar accumulation framework in the BOP context would deepen analytical synergies with national accounts by:
  - Improving monitoring of financial risk exposures through integrated cross-border assets/liabilities and their sources of change.
  - Enhancing household wealth analysis by linking savings, the current account, and direct/indirect effects on asset prices connected to external positions.
  - Shedding light on the “valuation paradox” by complementing external debt price dynamics with information on all asset dynamics, including non-financial assets.
- Recommendation: Enhance balance of payments stock/flow reconciliation tools to aim for broad consistency with the SNA framework so numerical consistency is facilitated and analytical synergies are fully exploited between the two domains.

### Calculating and Using Rates of Return
- Rates of return are important for understanding:
  - Allocation of capital between economies.
  - Differences in sustainability of current account deficits.
  - Behavior over time of the current account, the financial account, and the IIP.
- Current-account investment income transactions, financial-account transactions, and other changes in volume of financial assets and liabilities are interrelated and influence economic outcomes through rates of return.
- Suggested integrated presentation: integrated IIP, investment income, and rates of return (referenced as Table 14.X).
  - The income rate of return = investment income / corresponding average asset or liability position in the IIP.
  - The revaluation rate of return = revaluations / corresponding average asset or liability position.
  - Revaluations are holding gains and losses arising from changes in financial instrument prices including exchange rates.
  - The total rate of return = income rate of return + revaluation rate of return.
  - Rates of return can be computed for assets excluding financial derivatives and for liabilities excluding financial derivatives.
- Practical guidance: refer to the [updated] BPM Compilation Guide (paragraph reference: 28).
- Special considerations:
  - Estimation of pure interest on loans and deposits when FISIM is excluded from investment income will cause rates of return on loans and deposits to differ from rates estimated from actual interest.
  - Estimating rates of return using both pure interest and actual interest (interest before FISIM) provides a more complete analytical picture.
  - Systematic estimation of rates of return across the IIP reveals differences in investment characteristics across functional categories (e.g., equity vs. debt within portfolio investment and direct investment).
  - BPM6 focused primarily on income rates of return, but revaluation rates of return are also important for analyses such as the valuation paradox and effects on direct investment positions when marked to market versus book value.
- Rate differentials and macroeconomic feedback:
  - Rate of return differentials = rate of return on assets − rate of return on liabilities.
  - The income rate of return differential is relevant to a destabilizing feedback loop between the current account and the financial account (BPM6, paragraph 14.35):
    - A current account deficit must be financed by a decrease in net foreign assets, which can increase the current account deficit through a reduction in net investment income.
    - Impact of a decrease in net foreign assets on net investment income depends on the income rate of return differential:
      - Positive differential reduces the impact on net investment income.
      - Neutral differential means change in net investment income is proportional to change in net foreign assets.
      - Negative differential increases the impact on net investment income.
    - Thus, the income rate of return differential can moderate or exacerbate this potential source of instability.
  - Rates of return and their impact on financial flows are important for comprehensive analysis of current account deficit sustainability (BPM6, paragraph 14.36).
  - Income and revaluation rates of return, along with tax rates and expected future price changes, determine expected real after-tax total rates of return on foreign assets and liabilities.

### Scope and limitations
- Financial derivatives are omitted from the suggested rates-of-return framework:
  - They do not pay interest income and capital gains are difficult to relate to an original principal investment.
  - Therefore, rates of return on financial derivatives would not be reliable if computed using the same framework.
  - Revaluation rates of return on financial derivatives are noted as a topic for additional research (footnote reference: 29).

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_Source: https://www.imf.org/-/media/files/data/statistics/bpm6/approved-guidance-notes/b4-reconciliation-between-flows-and-stocks.pdf_