A recent speech* by Kristin Forbes, an external MPC member and Professor of Management and Global Economics at MIT, points out that the burgeoning UK current account deficit has been more driven by a deterioration in the investment income account than by the trade account and that countries like the UK, with both foreign assets and liabilities of about 3.5 times GDP, are likely to find some automatic stabilisers in the investment income account affecting their current accounts.
Both propositions are true. But they do not mean that the UK current account deficit that has grown from 2.2% of GDP in 2000 to 7.0% at the end of 2015 can be ignored.
One might imagine that the UK trade deficit is either a new phenomenon or at least one that has enlarged substantially recently. Neither of these propositions is in fact true. The UK has run a persistent trade deficit in goods and services since 2000 of on average 2.4% of GDP. Since Q1 2000, the deficit in trade in goods has risen from 3.0% to 7.1% of GDP on the latest data but this has been offset by a rise in the surplus in trade in services from 1.3% of GDP to 4.5% of GDP. Given the success and untraceablility of the Flat White Economy – the digital and creative industries leading economic growth in the UK – it is possible that the latter figure is significantly understated. What has changed is that the net primary income account – largely investment income – has moved from a surplus of nearly 1% of GDP in 2000 to a deficit of 1.9% in 2015. Meanwhile the secondary income deficit (largely government net spending outside the UK) has also risen slightly but from 1% of GDP in 2000 to 1.3% of GDP in 2015.
With such huge foreign assets and liabilities, exchange rate movements are in theory balancing. More than 90% of the UK’s foreign assets are denominated in foreign currency whereas only 60% of foreign liabilities are. A currency movement revalues the assets in sterling terms by much more than it revalues the liabilities. And equally such a movement revalues the income streams. So a devaluation produces a quick revaluation gain plus an impact on the relative investment income flows. However, one should be careful not to imagine that one can get away with persistently devaluing the assets of inward investors without antagonising them in such a way as to create outward capital flows.
One reason for the UK’s persistent trade deficit is that the economic woes of our major trading partners, partly associated with the problems of the euro, have depressed demand for UK exports. But any likely solution to these woes in the short term could well impinge equally negatively on UK trade.
Our conclusion is that despite the potential assistance of the international account and capital flows, sterling is likely to have to be devalued in the coming years. Clearly this is a competitive business at present as other economies are attempting the same. But political shocks in London, Scotland or on Brexit might trigger a response. Our simulations using the Cebr model suggest that a devaluation of at least 10% of sterling’s trade weighted value is likely to be necessary to significantly improve the UK’s international financial position, especially as the recent data suggests the current account deficit is growing. Obviously the timing of this is as usual difficult to predict. But on balance, if one were a forex fund manager, one would be chary of taking a long position in sterling.
* The UK Current Account Deficit: Risky or Risk-Sharing? OMFIF, Vintner’s Hall, London 21 March 2016
| Douglas McWilliams President Centre for Economics and Business Research Direct: +44 (0)7710 083 652 |