Canada's current account surplus with the rest of the world, on a seasonally adjusted basis, decreased by $1.8 billion in the third quarter to $9.4 billion, its first drop since the fourth quarter of 2002. The change was due to the smaller surplus in goods while a better performance for services was offset by a larger deficit for investment income.

Chart 1
Current account balance

In the capital and financial account (not seasonally adjusted), Canada's foreign assets rose by more than its international liabilities with direct investment abroad again leading the way. After the record increase of the second quarter, Canadian direct investment advanced more moderately. Canadian liabilities with the rest of the world rose by a smaller amount as increases to direct and portfolio liabilities were partly offset by a reduction in other liabilities, primarily loans. By the end of the third quarter, the Canadian dollar jumped nearly 6% against the US dollar, closing above 79 US cents. The strong performance of the Canadian dollar during the quarter was also seen against other major currencies.

Current account

Goods surplus drops after two strong quarters

The surplus on trade in goods fell to $17.3 billion in the third quarter, down $1.8 billion from the second quarter. This reduction followed two strong quarterly increases in the surplus totalling $5.1 billion.

In the third quarter, the increase in imports surpassed the rise in exports leading to a smaller surplus. Once again, higher prices were responsible for the increase in the value of energy exports. Exports of automotive products shrunk by $0.9 billion after registering their highest values in almost two years during the second quarter.

The $2.3 billion increase in imports came largely from higher values for cars and trucks. Industrial goods, especially metal and metal ores, and crude petroleum were the other major components that contributed to the increase.

Services deficit falls

In the third quarter, the deficit on trade in services was reduced by $0.3 billion to $2.6 billion. The travel deficit decreased $0.2 billion as fewer Canadians travelled abroad. For the first time since the second quarter of 2003, the number of Canadians spending at least one evening abroad went down.

Chart 2
Goods and other Current Account balances

Globally, the number of foreign visitors to Canada dropped during the third quarter, but an increase in the number of non-US travellers caused travel revenues to remain at the same level as in the previous quarter.

The deficit on commercial services shrank $0.1 billion in the third quarter as imports decreased more than exports. The largest declines in imports came from royalties and from miscellaneous services.

Lower profits earned on Canadian direct investment abroad

The deficit on investment income grew by $0.3 billion to $5.4 billon as profits earned by Canadian direct investors abroad fell by $0.6 billion in the third quarter. This reduction came from lower dividend receipts.

Profits earned by foreign investors on their direct investments in Canada also went down as lower dividend payments were observed in the third quarter.

Interest paid on Canadian bonds was fairly stable in the third quarter, despite a stronger Canadian dollar, as new issues of bonds outpaced retirements.

Financial account

Direct investment abroad advances again

Canadian direct investors advanced a more moderate amount to foreign economies during the quarter, after the record expansion in the second quarter. The $11.1 billion investment went to both acquisitions and increases to working capital in foreign affiliates. Geographically, most (59%) was invested in the United States and a fifth of the total went to Asian economies. The investment was widely spread by industry of investor, led by companies classified to services and retailing.

Chart 3
Canadian direct investment abroad¹

Canadian investment in foreign securities almost entirely in bonds

Similar to the second quarter, most of the $3.5 billion investment in foreign securities was in bonds. However in contrast to that quarter, the $3 billion flowing to foreign bonds went primarily to overseas bonds as Canadian investors reduced their buying of US treasuries and corporate bonds. The small investment in foreign stocks repeated the theme thus far in 2004 where Canadians were buying American equities but selling some of their holdings of overseas shares.

Modest investment in Canada by foreign direct investors

Some $5.8 billion worth of foreign direct investment flowed into Canada during the quarter, up significantly from a restated negative investment in the second quarter. The investment was mainly in short-term liabilities and earnings reinvested for working capital purposes as acquisitions were again negative for the third time in the past four quarters. Negative acquisitions result when Canadians on balance repatriate companies from foreign investors. Four-fifths of investment in the third quarter came from US investors while on an industry basis the investment was spread, led by the machinery and transportation sector.

Chart 4
Foreign portfolio investment in Canada

Foreign investment in Canadian securities evenly split between bonds and stocks

Foreign portfolio investors upped their holdings of Canadian securities by $10.8 billion in the quarter. They bought equal amounts of bonds and equities but sold short-term instruments for the third time in the past five quarters.

The $6.6 billion investment in bonds in the quarter was the largest by foreign investors in a year and a half. Similar to the second quarter, most (70%) went to bonds issued by Canadian corporations. The remaining investment was entirely in bonds issued by federal enterprises. The investment originated entirely from Europe and United States as Asian investors sold some of their holdings after acquiring bonds in the previous quarter. On a currency basis, roughly two-thirds was foreign currency denominated mainly in US-dollars with the remainder denominated in Canadian dollars.

In the third quarter, special events were again the principal cause of the $6.3 billion increase in holdings of Canadian shares. While the second quarter saw new Canadian shares issued mainly through a large acquisition of an American firm, the third quarter increase was led by the largest share offering in Canadian history and a corporate restructuring. US investors were the dominant purchasers as they bought four-fifths of the total. Canadian stock prices were up marginally in the quarter but made up all the lost ground from the previous quarter.

In the market for short-term instruments, the seesaw pattern of investment returned to a negative as foreign investors sold off $2.1 billion worth. The second quarter had seen an increase of $1.8 billion in foreign holdings of Canadian paper. The divestment in the third quarter was mainly in paper issued directly by the federal and provincial governments. Both Canadian and US short-term rates rose over the quarter, with the 0.8% spread continuing to favour investing in Canada.

Other investment

In the other investment category, net transactions resulted in a capital outflow entirely from a reduction in Canadian liabilities with non-residents. A large reduction in loans under repurchase agreements, reversing most of the previous quarter's increase, dominated the reduction in liabilities. Deposit liabilities were also reduced, mostly in foreign currencies between Canadian banks and their foreign affiliates.

On the asset side, transactions led to a small capital inflow as deposit and other assets mostly offset each other. Canada's international reserves increased modestly after a small reduction in the previous quarter. The increase was due to larger holdings of securities and deposits denominated in US dollars.

Reconciliation of the Canadian - U.S. current account, 2002 and 2003

By Patricia Abaroa, Edward Dozier, and Denis Caron ¹

On a reconciled basis, the published Canadian surplus, or U.S. deficit, is US$38.9 billion for 2002 and US$41.7 billion for 2003 ( table 1). ² The Canadian current account balance is a Canadian surplus of US$39.5 billion for 2002 and a Canadian surplus of US$44.7 billion for 2003. The corresponding U.S. published balance with Canada is a U.S. deficit of US$28.7 billion for 2002 and a U.S. deficit of US$32.1 billion for 2003. ³

The results of the reconciliation of the bilateral current account estimates of Canada and the United States for 2002 and 2003 are presented in this article. ⁴  Tables 2 and 3 present the published estimates, the estimates on a common basis (after the estimates have been adjusted for definitional and methodological differences), the reconciled estimates, and the amounts of the adjustments for each major current account component. Further details of the current account reconciliation for 2002 and 2003 are persented in supplementary tables included in the research paper Reconciliation of the Canadian - U.S. current account, 2002 and 2003 (catalogue # 67F0001M2004022). ⁵

Reconciled current account balances

In the Canadian current account, the reconciliation adjustments result in a decrease of US$0.6 billion in the Canadian surplus for 2002 and in a decrease of US$3.0 billion in the Canadian surplus for 2003. For both years, the decreases in the Canadian surplus reflect larger downward adjustments to the Canadian southbound estimates than to the Canadian northbound estimates. ⁶ For both years, the largest downward adjustments to the Canadian southbound estimates are from valuation adjustments to goods (definitional), from revisions to the published estimates of direct investment income (definitional adjustment), from the elimination of the withholding tax in current unilateral transfers (definitional adjustment), and from methodological adjustments to net some income of Canadian banks in "other" investment income. In the Canadian northbound estimates, the largest downward adjustments are from "other" investment income to eliminate withholding tax (definitional adjustment), to net some income of Canadian banks (methodological adjustment), and to eliminate statistical differences in income on U.S. holdings of Canadian bonds. For 2003, the reconciled estimates also reflect a large statistical adjustment in "other" services. Though the methodological adjustments explain part of the total adjustments to the northbound and the southbound estimates of "other" investment income, they do not affect the current account balance because the northbound and the southbound methodological adjustments are offsetting.

In the U.S. current account, the reconciliation adjustments result in an increase of US$10.2 billion in the U.S. deficit for 2002 and an increase of US$9.6 billion in the U.S. deficit for 2003. For both years, the increases reflect larger upward adjustments to the U.S. southbound estimates than to the U.S. northbound estimates. For both years, the largest increases in the U.S. southbound estimates result from the addition of Canadian reexports to U.S. goods imports (a definitional adjustment), from the valuation of U.S. natural gas imports to include inland freight (a definitional adjustment), from an increase for undercoverage of some southbound services (a statistical adjustment), and for 2002, from adjustments for statistical differences in direct investment income. For both years, the largest increases in the U.S. northbound estimates result from upward adjustments to investment income for undercoverage of income on U.S. holdings of Canadian bonds (statistical adjustments), and for 2003, from adjustments for statistical differences in direct investment income and in "other" services.

Summary of reconciliation methodology

In reconciling the Canadian and U.S published bilateral current account estimates, the estimates are first restated to a common basis, that is, they are adjusted for definitional and methodological differences; the remaining adjustments that are needed to reach the reconciled values are the statistical adjustments. The framework for reconciling the Canadian and U.S. estimates to a common basis mainly follows the international standards published in the International Monetary Fund's Balance of Payments Manual (fifth edition). The Canadian and U.S. published estimates now largely conform to the international standards, but that some differences with the international standards, and between the Canadian and U.S. estimates, remain in the published estimates because of data limitations, difficulties in determining country attribution, and differences in classification, and because in a few cases, international standards provide for more than one acceptable treatment.

The definitional adjustments mainly reflect data limitations and differences in country attribution. For example, as part of the reconciliation, U.S. published estimates of imports of goods from Canada are adjusted to include Canadian reexports to the United States (goods imported by Canada from third countries and then reexported to the United States without substantial changes) because U.S. imports of goods are recorded on a country of origin basis. Another example of a definitional adjustment is that the Canadian estimates, mainly investment income, are adjusted to a basis that is net of withholding taxes because the U.S. withholding tax estimates, which are included on a global basis in the U.S. published accounts, cannot be allocated by country for comparison with the Canadian estimates.

The methodological adjustments mainly reflect differences in classification. For example, parts of the U.S. estimates of film rentals and courier services are recorded in various services accounts; for reconciliation, they are reclassified to a single account. A few Canadian and U.S. accounts, mainly interest income, are adjusted to a net or gross basis for comparability.

Statistical differences reflect the use of different source data in Canada and the United States, the difficulty in determining country attribution because of insufficient data, the preliminary nature of some of the data (particularly for the most recent year), and the use of sample data between benchmarks. For both the northbound and the southbound estimates, most of the statistical differences are in Canadian and the U.S. estimates of "other" services and of investment income.

Note on the Canadian - U.S. current account reconciliation

The Canadian-U.S. current account reconciliation, which explains the differences between the estimates of the bilateral current account published by Statistics Canada and those published by the U.S. Bureau of Economic Analysis (BEA), is undertaken because of the extensive economic links between Canada and the United States. The reconciled estimates are intended to assist analysts who use both countries' statistics and to show how the current account estimates would appear if both countries used common definitions, methodologies, and data sources. ⁷

In principle, the bilateral current account of one country should mirror the bilateral current account of the other country. Differences occur in the published estimates of the U.S. and Canadian current accounts because of variations in the definitions, methodologies, and statistical sources that are used by each country. Some of the differences for 2003 are in components of the current account for which data are still preliminary and subject to revision; these differences may be eliminated when final data for these components become available.

The longstanding Canadian-U.S. current account reconciliation is among the leading examples of the benefits of international data exchanges. As a part of the reconciliation process, Canada and the United States have evaluated the accuracy of each other's estimates, and as a result, each country now includes in its published estimates some data that are provided by the other country. The exchange of data between Canada and the United States for transactions such as trade in goods, travel, passenger fares, Canadian and U.S. Government transactions, and some large transportation transactions covers a substantial portion of the value of the Canadian and U.S. current account and has eliminated some of the differences in the Canadian and U.S. published estimates. In addition, the reconciliation process has highlighted areas where errors and omissions may exist in each country's estimates, which has helped in targeting data improvement efforts.

Although the Canadian and U.S. published estimates are reconciled and there is extensive exchange of data between Canada and the United States, differences in the published estimates remain. Complete substitution of the reconciled estimates for published estimates and complete exchange of data are not feasible for several reasons. For trade in goods, imports in the U.S. accounts would be affected because the United States attributes Canadian reexports to the country of origin rather than to Canada, the last country of shipment. For some accounts, the protection of the confidentiality of the source data bars the exchange of data. Finally, a few differences are attributable to different requirements for integrating the international and national (domestic) accounts in each country.

Text table 1
Major Canada - United States balances

Text table 2
U.S.-Canadian current account reconciliation, northbound

Text table 3
U.S.-Canadian current account reconciliation, southbound