Analyse the UK’s balance of payments for a period of 10 years (data given in Tables 1 and 2). The analysis should include examinations (presentations of statistical data with discussion based on theory, journal articles, and examples from the market) of the current account balance and capital/financial account balance. Document the trends and investigate the causes.
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“The Balance of Payment records one nation’s transactions with the rest of the world. This not only includes the conventional flows of good and services that make up international trade, but also cross-border payments associated with the international ownership of financial assets and current transfers, including remittances by workers from one country to another” (Economic and Labour Market Review, 2009). “The UK balance of payments is a statistical statement designed to provide a systematic record of the UK’s economic transactions with the rest of the world and is described as a system of consolidated accounts in which the accounting entity is the UK economy and the entries refer to economic transactions between residents of the UK and residents of the rest of the world” (The Pink Book, 2010).
Hence, in the Balance of Payment, sources of funds are recorded as positive and uses of funds are recoded as negative. All things being equal Balance of Payment sums to zero with no overall surplus or deficit but if a country is importing more than its exports, then its trade balance will be in deficit, but if a country is exporting more than its imports, then its trade balance will be in surplus. Balance of payment includes a wide range of economic transaction which comprises exports and imports of goods, export and imports of services, income flows, and financial flows like direct investment, investment in shares, debt securities, loans and deposits etc.
The main Balance of Payment can be classified into two main groups of accounts called the current account and the capital/financial account. However, the current account incudes different transaction such as goods and services, income and current account transfers. While, the capital account transfers and the net acquisition or disposal of non-produced, non-financial assets are included in capital/financial account. Moreover, transaction in financial assets and liabilities including reserves and gold are includes in the financial account.
UK BALANCE OF PAYMENT
The UK has recorded a current account surplus in 1980 to 1983, and since the last surplus was recorded in 1983, the UK has recorded a current account deficit since 1984. There have been four main phases in the current account development since 1984. The first phase is from 1984 to 1989, the current account deficit increased gradually until 1989. During the Second phase (1990 to 1997), the current account deficit declined to lowest in 1997 (The Pink Book, 2010). From the figure 4.1 below, from 1998 to 2006, the current account deficit extended sharply and hit the highest point in 2006. Trade in goods has main component part of the UK’s Balance of Payment. In 2007 and 2008, once more there was a change in the movement of current account balance. However, in 2009 the fall in the current account deficit broadly matched with the decreased in trade in goods deficit (Chamberlin G, 2009).
Figure 4.1- Current Account USD (Billions)
TRADE IN GOODS AND SERVICES
The last trade in goods account recorded net surplus in the year 1982, largely because of the growth in export of North Sea Oil. Since then the trade in goods account remained in deficit. The deficit grew considerably in the late 1980s and reaches its peak in 1989 before narrowing in 1990s (Whitaker S, 2006). In Figure 4.2 the deficit jumped significantly from 1998 and before falling in 2009, it reached its high in 2008. Events in the financial sector may have affected business sentiments and investment decisions. It can be seen that trade was rising while the first signs of the financial crisis became artificial (The Pink Book, 2009) and this may be due to businesses exporting orders which has been received before the crisis. Trade in goods peaked in July 2008 fell dramatically until 2009 (Chamberlin G, 2009, The Pink Book, 2009)
A Surplus has been recorded for trade in services in every year since 1966 but there was a downfall in the surplus from 2008 and 2009. This may be due to the impact of the financial crises.
Figure 4.2 Trades in Goods and Services Credit less Debit – Billion (USDs)
FLOW OF INCOME
As Figure 4.3 shows the UK economy has been seen surplus in balance of income from 2000 to 2002. And was around the same level until 2005 and fell in 2006, before increasing over the next three years till 2009 with reach its high in 2008. The income surplus movement from 2000 to 2007 was due to the net earning on direct investment while in 2009 income surplus is because of the net earning deficit on the other investments (The Pink Book, 2009). Until 2001, earning on both investment abroad and investment in the UK approximately doubled but in 2002 both fell suddenly and fundamentally due to cuts in official interest rates and later falls in payment receipt and payment on loans and deposits (Whitaker S, 2006). From 2003 to 2007 the income was almost two and a half times the income seen in 2002.
Figure 4.3 Flow of Income
Credit less Debit – Billion (USDs)
UK CURRENT TRANSFER
As chart 4.4, the UK economy is facing continuous deficit in current transfers since 1960. And current transfers were almost doubled in 2000 as compared to 1997. After 2000, the deficit subsequently increased again in every year till 2009 with the highest in 2007. The deficit in general government transfer extended in 2008 and increased until 2009 while in the same period the deficit for other sectors decreased extremely in 2008 but recovered in 2009 (The Pink Book, 2009).
Figure 4.4 UK Current Transfers
Credit less Debit – Billion (USDs)
UK FINANCIAL ACCOUNTS
The impact of globalisation on the world economy explains why investment abroad and into the UK increased in the mid-1990s but recorded net disinvestment as the global financial crisis deepened, leading to a reduction in loans internationally and a repatriation of deposits (The Pink Book 2009).
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In 2005 and 2006, direct investment in the UK exceeded direct investment abroad. However from 2007 to 2009, direct investment abroad exceeded direct investment in the UK. Hence, within this three-year period, net outward direct investment had narrowed each year driven by a net outflow of reinvested earnings and other capital transactions and partially been offset by a net inflow of equity capital (The Pink Book, 2009). In 2009 the net foreign direct investment outflow decreased from that recorded in 2008 as a result of reduced reinvested earnings outflow, driven by a reduction in reinvested earnings abroad combined with an increase in reinvested earnings in the UK (Economic & Labour review, 2009).
In 2006 and 2007, due to the UK’s relatively high interest rate, the attractiveness of UK debt securities to foreign investors led to net inward portfolio investment in the UK and this position was maintained as the acceleration of the global financial crisis drove up demand for less risky long- term debt securities, even though interest rates had dropped considerably in the UK, while UK equity offered greater value for money to international investors as sterling depreciated (The Pink Book, 2009) but in 2009 investors also returned to short-term debt issued by monetary financial institutions as confidence improved in the UK banking sector.
Figure 4.5 Capital/ Financial Accounts Billion (USDs)
As a result of Mergers and Acquisition activity direct investments abroad peaked at USD 246.27 billion. The largest abroad acquisition was the investment in Mannesmann AG by Vodafone Airtouch for a £100 billion (The Pink Book, 2009). From 2002 the direct investment abroad declined before recovering to a high in 2007. Since 2007, because of global recession, direct investment abroad has decreased every year and in 2009 the direct investment abroad reached its lowest due to the lower investment in equity capital, lower reinvested earnings, and a switch from net outflows to net inflows of other capital (The Pink Book 2009).
Figure 4.6 Direct Investments Billion (USDs)
On the other hand direct investment inwards shows a similar pattern like direct investment abroad. This may be due to the slowdown in global merger and acquisition activities. In 2003, direct investment fell and after which there was a considerable increase in the amount of inward acquisition, including the purchase of Abbey National by Banco Santander in 2004 (The Pink Book, 2009). Investments in the UK declined throughout the 2008, and dropped considerably in 2009. This was due to lesser investment in equity capital together with the net outflows of other capital investments for example the acquisition of Barclays Global Investors by Blackrock Inc. which was one of the most significant acquisitions in 2009 (The Pink Book, 2009).
As indicated in figure 4.7, there has been a net inflow of portfolio investment into the UK due to investment into the UK exceeding investment abroad with investments in debt generally exceeding investment in equities. In 2008 however, portfolio investment abroad showed net disinvestment as the global financial crisis deepened. The disinvestment was almost equally shared between equities and debt securities but 2009 portfolio investment abroad recovered strongly. The switch from net disinvestment to net investment for debt securities was mainly due to a reduction in disinvestment by UK monetary financial institutions and an increase in investment by UK securities dealers (The Pink Book, 2009).
Figure 4.7 UK Portfolio Investments Billion (USDs)
In conclusion “the Balance of Payments essentially records one nation’s transactions with the rest of the world – relating to conventional trade in goods and services, income flows and the transfer in ownership of financial assets across borders. The International Investment Position, or net asset position, is the part of the Balance of Payments that records net stocks of the UK’s foreign assets and liabilities” (Chamberlin G, 2009).
Chamberlin, G. (2009) ‘The Balance of Payment’ Method Explained, 3 (9), pp. 44-51 Economic and Labour Market Review [Online]. Available at: http://www.statistics.gov.uk/elmr/09_09/dow nloads/ELMR_Sep09_Chamberlin.pdf (Accessed: 24 April 2011).
Office for National Statistics (2010), Pink Book 2009, England: Palgrave Macmillan
Office for National Statistics (2010), Pink Book 2010, England: Palgrave Macmillan.
Palgrave Macmillan (2009) Income. Available at: http://www.palgrave-journals.com/ukbp/journal/v2009/n1/abs/ukbp20095a.html (Accessed: 25 April 2011).
Whitaker, S. (2006) The UK International Investment Position [Online]. Available at: http://www.bankofengland.co.uk/publications/quarterlybulletin/qb060301.pdf (Accessed: 23 April 2011).