UK Balance of Payments, The Pink Book: 2018

• The UK current account deficit narrowed in 2017 to 3.9% of nominal gross domestic product (GDP) from a record 5.2% in 2016, the narrowest deficit since 2012.

• The narrowing in the current account deficit in 2017 was mostly caused by a narrowing in the primary income deficit from 2.5% to 1.6% of GDP which was driven by an improvement in net foreign direct investment (FDI) income.

• The trade deficit narrowed from 1.6% to 1.3% of GDP due to a widening in the services surplus which was driven by a widening in the financial services surplus and a narrowing in the travel services deficit.

• The current account deficit in 2017 was mainly funded by investments made into the UK which was primarily made up of “other investments” which were specifically deposits and loans; this contrasts with 2016, where the majority of investments made into the UK were foreign direct investments.

• The net international investment position (IIP) widened to negative 8.1% of nominal GDP in 2017 from negative 2.4% in 2016, as investments into the UK outweighed UK investments made abroad while the slight appreciation in sterling also decreased the sterling value of the stock of UK investments made abroad.

There have been a number of changes and improvements implemented for this Pink Book, which has led to a number of revisions between the years 1997 to 2017. The improvements having the largest impacts on the accounts were enhancements to trade in goods and services, including net spread earnings and the share ownership benchmarks. For more information on these changes please see our earlier article Detailed assessment of changes to balance of payments annual estimates, 1997 to 2016 released on 1 June.

For more detail on the methodology of the balance of payments please see our Quality and Methodology Information report.

There have also been several changes to the tables included in this Pink Book. The largest changes have been the withdrawal of tables 2.2 “Trade in goods: volume indices” and 2.3 “Trade in goods: price indices”. This is because improvements have been made to trade and these metrics have now been replaced with chain volume measurements and implied deflators which are available in a more timely manner in the monthly trade bulletin. Due to these changes, the adjustments table 2.4 has now been renamed Table 2.2. For a full list of all the changes included in this Pink Book please see the Pink book changes for more information.

This Pink Book also includes a new international investment position (IIP) geography map which showcases our IIP data with the UK’s major partners.

The balance of payments measures the economic transactions of the UK with the rest of the world. These transactions can be broken down into three main accounts: the current account, the capital account and the financial account.

The current account shows the flows of goods and services that comprise international trade, the cross-border income flows associated with the international ownership of financial assets, and current transfers between residents and non-residents. The sum of the balance on these accounts is known as the current account balance. The current account balance and capital account balance indicates whether the economy is a net lender to the rest of the world (surplus) or net borrower from the rest of the world (deficit).

The capital account consists of capital transfers and acquisition or disposal of non-produced, non-financial assets.

The financial account shows net acquisition or net incurrence of financial assets and liabilities and is the counterpart to the current account and capital account. If a country is running a current account deficit, the financial account records how the country is financing its borrowing from the rest of the world. While if a country is running a current account surplus, the country is lending to the rest of the world.

The international investment position (IIP) records the stock position of these financial investments. It shows at the end of the period the value of the stock of financial assets of residents of an economy that are claims on non-residents and the liabilities of residents of an economy to non-residents. The difference between the assets and liabilities is the net IIP.

This commentary gives an analytical overview of the main components of the current account, focusing on the components of primary income and trade, including geographical analysis. There is analysis on the financial account and how the UK has financed its current account deficit before and after the economic downturn. Finally, there is analysis on the IIP, this breaks down the elements that make up the IIP.

Figure 1 breaks down the current account balance, as a percentage of nominal gross domestic product (GDP), into the trade balance, the primary income balance and the secondary income balance. In 2017 the current account deficit narrowed to 3.9% of GDP, from the record high 5.2% in 2016. This is the largest narrowing of the current account deficit since 2011. Despite this, the current account deficit in 2017 still remains high compared with historical standards (see Figure 1).

The main driver was a narrowing in the primary income deficit from 2.5% to 1.6% of GDP. Deficits on both the trade balance and the secondary income balance also narrowed in 2017.

Primary income includes investment income, compensation of employees and other primary income. In 2017, much of the narrowing of the primary income deficit was due to increased investment income of £17.2 billion (0.9% of nominal gross domestic product), the largest improvement since records began in 1946.

Investment income can be further broken down by type of investment:

• foreign direct investment (which is an investment into a company in which the investor has at least 10% or more of the ordinary shares or voting stock, and therefore has a controlling influence over the company)

• portfolio investment (which is where the investor doesn’t have a controlling influence, holding less than 10% of the equity capital and debt securities such as corporate bonds)

• other investment (mostly made up of deposits and loans)

• reserve assets (which are short-term assets which can be very quickly converted into cash such as holdings of monetary gold and convertible currencies)

Following five years of annual declines in the net foreign direct investment (FDI) income, the UK recorded its first deficit in FDI income in 2016. The improvement in 2017 returned net FDI income to surplus. Contributing to the improvement in the primary income balance was a slight increase in the rate of return earned on UK investments abroad from 1.7% to 2.0% (see Figure 3).

Figure 3 also includes net rate of return which became negative in 2012, then worsened up until 2016. This corresponds to total net investment income (Figure 2). The net investment income worsened between 2012 and 2016 and reflected in the worsening rate of return. In 2017, rate of return on net investments improved, though remaining negative. Partially offsetting the improvement in the FDI balance was a slight deterioration in the deficits on portfolio and other investment.

The net earnings of UK foreign direct investment (FDI) is a key component of the current account balance and has influenced its movement in recent years. This can be separated from primary income to assess the impact that net FDI earnings have had on the current account balance. This is shown in Figure 4, where primary income excluding FDI includes the other components of primary income – net earnings from portfolio investment, other investment and reserve assets. The balance on FDI earnings have been in surplus in every year since 1997 except in 2016. In fact, the surplus on FDI earnings narrowed considerably in recent years, going from a surplus of £53.5 billion in 2011 switching to a deficit of £1.6 billion in 2016.

Initial estimates from the quarterly FDI survey indicate that the balance of FDI returned to surplus with earnings increasing by £23.7 billion in 2017 compared with 2016. This was as a result of FDI credits (earnings on direct investment abroad by UK investors) increasing markedly which is reflected in the increase in the rate of return seen in Figure 3.

FDI debits (earnings on direct investment in the UK by overseas investors) have increased to a lesser extent (Figure 5) than credits between 2016 and 2017. The surplus in 2017 was similar to those recorded in 2014, 2009, 2000 and 1998. FDI debits have followed a slight upward trend since 2011 while that of credits has been downwards. This has seen the values converge to the point that the UK had a small deficit in 2016. The fall in UK FDI credits is partly explained by changes in the implied rates of return on UK FDI assets, which have been falling since 2011. Falling FDI credits from mining and quarrying industries have been an important factor in the overall trend in FDI credits. In contrast, returns on FDI liabilities have been relatively more resilient. Our previous analysis provides more detail on these trends between 2011 and 2015.

Further analysis of FDI can be found in our “UK foreign direct investment: trends and analysis” series. The latest edition was published in July 2018, covering the provisional estimates for 2017, the role of exchange rates and mergers and acquisitions activity in FDI and experimental statistics from linking FDI micro-data with other information.

The rate of return that investors receive on their investments influences investment flows. Typically, investors will be attracted to investments in countries where the rate of return is high. Expected rate of return isn’t the only factor that plays into investors decisions. Other factors will influence their decision to invest, like how safe the investment is seen to be. Figures 6 and 7 below show the rate of return for UK investments abroad and foreign investments in the UK respectively, broken down by continent.

In 2017 the rate of return for UK investments increased in every continent. With the rate of return on investments in Australasia and Oceania increasing the most. However, the rate of return on UK investments abroad has not yet returned to pre- economic downturn levels. The rate of return on UK investments have historically been higher and less stable in Africa, however stocks of investments have consistently been lowest in Africa. This might be because, although the rate of return is highest on African investments, investors see these investments as being riskier.

The rate of return on investments in the UK are relatively consistent between continents. However, investments from Australasia and Oceania have received a lower rate of return for the past six years. This was due to declining profits from direct investment in the UK. Again, rate of return on UK investments have not returned to pre- economic downturn levels.

With the majority of investments in and by the UK happening with countries in the European Union (EU), it is interesting to look at these countries in more detail and see how the breakdown of EU investments have changed over recent years.

Use the interactive map below to see how investment stocks have changed with different EU countries. Simply hover over the country.

The interactive map below also explores investment level data and how levels have changed for the UK’s largest counterpart countries. Simply hover over your desired country, or select it from the drop-down menu.

For all the data used in this interactive map please see table 10.

Please note this map is experimental and is something which can be developed further with the help of your feedback. Don’t hesitate to get in touch.

Figure 8 shows the UK’s trade balances as a percentage of nominal gross domestic product (GDP) from 1997 to 2017. The total trade deficit, the difference between exports and imports, narrowed to 1.3% of GDP in 2017 from 1.6% in 2016. The improvement to the total deficit was due to a widening of the trade in services surplus as a percentage of GDP, from 5.2% to 5.5% of GDP in 2017. The goods deficit remained unchanged in 2017 at 6.7% of GDP.

Figure 9 shows the UK’s trade surplus in services along with exports and imports of services from 1997 to 2017. The trade in services surplus improved by £9.8 billion to £111.6 billion in 2017, due primarily to growth in exports of services which increased £19.2 billion to £277.0 billion. Services imports rose by a lesser £9.4 billion to £165.5 billion.

The improvement to the services surplus in 2017 followed a £10.9 billion widening of the services surplus in 2016 due to a £25.0 billion rise in services exports.

Financial services were the largest contributor to the increase in the trade in services surplus in 2017. Financial services accounted for 21.5% and 9.2% of total UK services exports and imports respectively in 2017.

Figure 10 shows UK exports, imports and the trade surplus for financial services from 1997 to 2017. Exports of financial services increased £3.6 billion in 2017, whereas there was a relatively small increase of £0.1 billion for imports. This resulted in a £3.5 billion increase to the UK’s surplus in financial services.

Figure 11 shows contributions by region to the UK’s surplus in financial services. The £3.5 billion improvement in the financial services surplus in 2017 was mainly due to a £2.9 billion widening of the financial services surplus with Europe. Exports of financial services to Europe increased by £2.2 billion whilst imports fell £0.7 billion. The surplus with Americas improved by £0.8 billion, while it worsened by £0.3 billion with Asia.

There has been an upward trend in the financial services balance since 2015. A £2.6 billion improvement to the financial services surplus in 2016 was due to exports of financial services rising by £4.0 billion and imports increasing by £1.4 billion, of which Europe contributed £1.7 billion to the export rise and £1.3 billion to the import increase.

Figure 12 shows exports, imports and the UK trade balance in travel services from 1997 to 2017. A travel service import is when a UK resident travels abroad and consumes a service in that country such as staying in a hotel or eating in a restaurant. Conversely, a travel export is when a foreign resident travels to the UK and consumes travel related services in the UK.

Travel services was the UK’s largest service import in 2017, accounting for 33.5% (£55.5 billion) of total UK imports. For the entirety of the period between 1997 and 2017 the travel services balance was in deficit, due to the UK importing more travel services than it exports.

A narrowing of the travel services deficit was the reason for travel services being a key contributor to the improvement in the total services surplus in 2017. Exports of travel services in 2017 increased by £4.3 billion, which is the largest increase since 2006. Travel service imports increased by a lesser £1.3 billion meaning the travel services deficit narrowed by £3.0 billion to £15.7 billion.

As reported in our latest Travel Trends: 2017 release there were 39.2 million visits by overseas residents to the UK in 2017 (that is exports), which is 4% more than in 2016 and the highest figure ever recorded.

Figure 13 shows contributions by geographical region to the travel services trade deficit from 1997 to 2017. The £3.0 billion narrowing to the travel services deficit in 2017 was mainly due to a £1.5 billion narrowing of the UK’s travel services deficit with Europe; exports to Europe increased by £2.4 billion, while imports increased by a lesser £0.8 billion.

The trade deficit in travel services with Americas narrowed £0.6 billion due to exports increasing by £0.8 billion to £7.3 billion and imports only increasing by £0.2 billion to £8.6 billion. The trade deficit with “other countries”, which is mainly comprised of Australia, widened by £0.2 billion.

The UK had a trade surplus in travel services with Asia between 1997 and 2001 and between 2011 and 2017. The largest surplus with Asia was in 2014 when it reached £2.4 billion before narrowing to £0.2 billion in 2016. In 2017 the surplus with Asia widened £0.6 billion mainly due to a £0.8 billion increase in exports.

The trade in goods balance widened by £4.8 billion to £137.4 billion in 2017. Imports of goods increased £44.6 billion in 2017, while exports rose by a lesser £39.8 billion.

For more information about our methods and how we compile these statistics, please see Trade in goods, country-by-commodity experimental data: 2011 to 2016. Users should note that the data published alongside this Pink Book release are no longer experimental.

What goods does the UK trade with the rest of the world? For the first time, our data breaks down UK trade in goods with 234 countries by 125 commodities.

Use our map to get a better understanding of UK trade in goods with a particular country. Select a country by hovering over it or using the drop-down menu.

The trade data used in this interactive map is available on our website.

What about trade in a particular commodity? What percentage of UK car exports goes to the EU? Where does the UK's imported tea and coffee come from?

Use our interactive tools to understand UK trade of a particular commodity.

Select a commodity from the drop-down menu, or click through the levels to explore the data.

UK trade in goods by commodity with the rest of the world, imports and exports, 2012 to 2017

UK exports, 2017

UK imports, 2017

Throughout this section when we refer to investments we use the three main types of investments (direct, portfolio and other) excluding financial derivatives and employee stock options and reserve assets.

In the run-up to the economic downturn in 2008, the current account deficit was being funded by net investments made into the UK (see figure 15). During this time, investments into the UK were mainly made up of other investments (see Figure 16).

In 2008 and 2009, the current account deficit was being funded by the selling of UK external assets which outpaced the selling of foreign investments made in the UK (see Figure 15). The current account deficit was also financed this way during the years 2012, 2013 and 2015.

In recent years, investments into the UK from foreign investors has increased and outpaced UK investments made abroad, with 2017 seeing investment into the UK from abroad more than tripling from 2016 (see Figure 15).

In 2016 foreign direct investment (FDI) in the UK represented the majority of all investments made into the UK (see Figure 16). FDI and to a lesser extent portfolio investments are considered to be a more stable type of investment as they tend to be a longer-term investment.

However, in 2017 investments into the UK mainly consisted of other investments, which are primarily deposits and loans. These types of investments tend to be more speculative in comparison to direct and portfolio investments.

Flows from FDI can vary from year to year. This reflects the nature of cross-border direct investments, where a few companies can greatly affect the value reported for a calendar year (Figure 16). The largest annual increase for FDI liability flows since 1997 was in 2016, where inward flows went from £30.1 billion in 2015 to £199.0 billion. This reflects a few very-high-value inward acquisitions of UK companies that completed in 2016 – such as the acquisition of SABMiller PLC (UK) by Anheuser-Busch InBev (Belgium). Mergers and acquisitions in context: 2016 provides more details on these inwards deals. This then made the initial estimate for the fall in the value of FDI liability flows in 2017 the second-largest change since 1997, which at £50.8 billion were £148.2 billion lower than the previous year. This brought the value of inward FDI flows in 2017 slightly higher than flows between 2010 and 2015 and similar to those in the early 2000s.

A similar situation occurred for FDI asset flows in 2017, which went from £37.1 billion in 2016 to £114.2 billion in 2017. This increase of £77.1 billion was also supported by two very-high-value outward acquisitions: Reckitt Benckiser acquired Mead Johnson Inc. and British American Tobacco acquired Reynolds American Inc. Our Mergers and acquisitions in context: 2017 article provides more details on outward deals in 2017 as well as the change for inward mergers and acquisitions between 2016 and 2017.

The international investment position (IIP) measures the stock of assets and liabilities at the end of period, and is the sum of the opening balance, financial flows and other changes (including price changes, currency changes and so on). All else remaining the same, the narrowing in the current account deficit means the UK is less reliant on incurring net financial liabilities to finance its borrowing from the rest of the world and therefore the net liability would be expected to narrow.

However, the net IIP (NIIP) widened from negative 2.4% of nominal gross domestic product (GDP) in 2016 to negative 8.1% in 2017 (see Figure 17), which was a result of total assets decreasing by £235.8 billion, while liabilities only fell by £118.7 billion and remained a higher value than assets. However, due to the composition of the IIP, revaluation effects need to be considered in explaining movements in the NIIP.

Throughout this section when we refer to investments we use the three main types of investments (direct, portfolio and other) excluding financial derivatives and employee stock options and reserve assets. This is because it is possible to estimate the impact of both currency and price changes on the three main types of investments.

Financial flows are one of the main components driving the change in IIP UK assets and liabilities. However, the change in stock not only reflects the accumulation of new assets and liabilities, but also the revaluation of existing ones and changes in the sterling exchange rate, which affect UK assets abroad as they are mainly held in foreign currencies. Changes in the sterling exchange rate will have an impact on the sterling value of these foreign assets. Another factor that could impact upon the revaluation of these assets and liabilities are equity price movements, which impact upon the value not the underlying volume.

In 2017, the sterling exchange rate appreciated, which in 2016 was at its lowest level in eight years¹ primarily caused by the vote to leave the European Union. The appreciation in the effective exchange rate by 1.0% from 2016 led to a lower revaluation in the stocks held abroad when converted back into sterling. This is the opposite of what happened during 2016, with currency changes causing a higher revaluation in the stocks held aboard when converted back into sterling (see Figure 18).

To obtain the exchange rate impact, we have calculated currency changes by calculating sterling exchange rate movements against a basket of currencies. Meanwhile, price changes are modelled using a combination of stocks and bond indices, including end-quarter share prices for the Dow Jones, Euro Stoxx, FT-SE and Nikkei exchanges (for more information on the methodology see our article on analysis of the UK’s international investment position, which was released July 2016).

From Figure 18 we can see that in the year 2017, currency changes were the main factor behind the decline in the value of UK stocks from 2016. This was despite financial flows (UK investment abroad) increasing to the highest level in 10 years and price changes leading to a higher revaluation of stock. Currency changes also had a large impact on assets in 2016 and at the start of the economic downturn in 2008 (See Figure 18).

The same impacts will affect the liabilities side, although only other investment will be impacted by the sterling exchange rate as the majority of these investments are held in foreign currency due to the UK’s large banking sector. Using the same method as described previously, we can split out the total changes into main impacts (that is, other changes, currency changes, price changes and flows).

Looking at Figure 19, levels of investments made into the UK from abroad declined slightly from 2016 and this was mainly due to the appreciation in pound sterling which led to a lower revaluation of stock held in the UK when converted by into sterling. This was despite flows (investments made into the UK) increasing to the highest level in ten years and price changes leading to a higher revaluation of stocks held in the UK. Similar to the assets side, currency changes had a large impact on total changes in liabilities during 2016 and at the start of the economic downturn (2008).

In conclusion, the net IIP deficit widened slightly in 2017, going from a net liability of negative £47.5 billion in 2016 to a negative £164.5 billion in 2017. This is despite UK investments made abroad (financial flows) increasing to the highest level in ten years. This widening was mainly driven by increased investment made into the UK which outpaced UK investments made abroad and the slight appreciation in sterling leading to a lower revaluation of assets (see Figure 18).

Notes for: IIP net liability widens due to an increase in investments made in the UK from abroad and sterling appreciation

1. Throughout this section when we refer to the sterling exchange rate we use the sterling end year effective exchange rate from the Bank of England.

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