LEADING THE WAY OUT OF THE EU

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Thursday 2 November 

The UK’s balance of payments deficit is no cause for alarm, dig a little deeper and there is plenty of reason for optimism

On Tuesday, the Office for National Statistics published its account of the UK’s balance of payments for 2016.  Attention has been directed towards the largest ever current account deficit, part of a decades-long trend. At 5.9% of GDP, it is proportionately double the United States deficit which stands at 2.6%, the next largest in the G7. Germany, Italy and Japan are all in surplus, while France and Canada are only marginally in the red.

But a large deficit is nothing like as dangerous as Remoaners would like you to think. In fact, in sucking up cash from across Europe and refusing to reinvest it, Germany’s near 10% surplus has been a major cause of the EU’s sustained economic malaise.

Disappointment for the doomongers

The Pink Book, as the ONS’s annual report is known, offers respite for  Brexiteers tired of persistent economic pessimism. Australia and New Zealand have run successive deficits like the UK’s existing one for decades. So long as the currency is not overvalued, foreign exchange reserves are high, interest rates are low, loans are not being handed out like confetti, and trade is spread across a diverse set of commercial partners, there is no need for concern.

Britain is the model case. The referendum handily devalued the pound (more on that later); at $150 billion, foreign reserves are vast; interest rates are historically low (they rose to an insignificant 0.5% today); ten years on from the crisis, eagle-eyed regulators continue to constrain lending and in enabling Britain to go global, Brexit will help not inhibit the diversification of UK exports and imports.

Numbers don’t lie

The first place to look when inspecting an economy’s books is the financial account, which acts as the counterpart to the current account. If the latter is in deficit, the former shows how the shortfall is financed. A financial account made up of the international equivalent of wonga-style payday loans spells troublke. As a prime investment destination, this is not the case with the UK, although Pink Book’s authors still decided to pour scorn on Brexit without backing up their assertions:

Despite the economic uncertainties surrounding the EU referendum result in 2016, the UK remained attractive to outside investors and the UK was able to fund its current account deficit with investments into the UK”.

The amount of investment was not just high, but at £119.6 billion, was the highest on record. The ONS points out that the majority of inflows came in the form of direct investment, which are “frequently characterised by stable and long-lasting economic links”.

Increased FDI in the UK economy reflects its underlying strength. The ONS recorded an improvement in the aggregate rate of return on investment, up to 4.4% from 4.1%. This week, the World Bank placed the UK seventh in its flagship ease of doing business index, thirteen places ahead of Germany and twenty-four ahead of France. Perennial deficit runner New Zealand came first. In its prominent investment attractiveness survey for 2017 EY yet again placed the UK in first place in Europe with its overall score was even higher than last year’s, published before the referendum. Although the report was subtitled ‘Investors vote remain in Europe’.

Devaluation

The lowering of the Pound’s value, which only occurred half-way through 2016, has not been incorporated into the Pink Book’s methodology as traders will have hedged themselves against a lower pound until well into 2017. However, raw data in the form of the UK’s international investment position (IIP) did reflect the currency’s increased competitiveness and the benefits it brings.

Remarkably, the IIP, the sum of foreign assets and liabilities, dropped from a deficit of 18.4% of GDP to 1.1%, just shy of a surplus. Under normal circumstances, the deficit would have widened further as the UK economy piled up loans to fund the current account deficit, yet total assets increased by £1,356.7 billion to £10,944.7 billion, the highest in five years.

The ONS attributes the “substantial” improvement (see below) to a lower priced pound. By virtue of offshore assets being held in foreign currencies, their value relative to the Pound dramatically rose following its devaluation on referendum day.

Leverage and borders

The ONS substantially revised its methodologies this year because it had previously underestimated the amount of illegal drugs being imported into the UK, a reminder of the need for better-controlled borders once we unshackle ourselves from the EU.

Trade data also illustrated not only why we need to leave the EU, but also why we should be able to escape with a decent trade deal in place. The UK’s trade deficit in EU goods extended further in 2016, rising by a sensational £9.4bn to reach £96.5bn, meanwhile the UK’s services surplus with the EU increased (see below).

Goods face an array of tariff and non-tariff barriers, re-imposing them will make life much harder for manufacturing on the continent. By contrast, with the exception of financial passports for the City of London, a hard Brexit will have a less pronounced impact on UK services sector. Tariffs do not apply to services and with exception of finance, the EU has never bothered to take away the numerous barriers national government across the EU27 have put in place to protect their services from foreign – namely UK  competition. These arguments that resonated so strongly with the electorate in 2016 are even truer today.