Sunday, 3 April 2016

25 multinationals and a big fat deficit

Awful balance of payments data fuel all sorts of responses - the UK doesn't make or export enough, or consumes too much. Is reliant on the kindness of strangers to finance the deficit, (Mark Carney) and is need of foreign direct investment that in turn probably depends on staying in the EU (David Smith). All fine arguments. But the surge in the  deficit in recent years is largely a result of the falling foreign income of a handful of huge multinational companies, whose incomes have fallen step by step with falling commodity prices. They finance themselves in international markets and are owned by international shareholders: Does that make a difference?

Heading for £100 per annum.... an awfully big hole 
The UK’s current account deficit reached £32.7bn in Q4 2015, which equates to 7% GDP and is the biggest deficit since records began. It takes the annual deficit to £96.2bn, 5.2% GDP. The £12.6bn deterioration from Q3 to Q4 was due to a £3.3bn increase in the deficit in goods and services to £12.2bn, a £2bn increase in the deficit in secondary income to £5.4bn and a £7.3bn increase in the deficit on primary income, to £13.1bn. It’s worth noting in passing that the UK’s net investment position now is in liability to the tune of £65,9bn, In other words, foreigners own £65.9bn-worth of UK assets more than UK investors own of foreign assets. All other things being equal over time, the bigger the net liability, the bigger the net investment income deficit will be.

The ONS’ chart of the overall make-up of the current account balance is below.

The trade account includes goods (a deficit) and services (a surplus). It's been pretty steady in recent years, though still significantly in deficit. The secondary income balance includes transfers provided with no expectation of payment, so things like bilateral aid and of course, payments to or from the EU. This series is volatile on a quarterly basis but not so much over a longer period. The primary income balance includes compensation of staff, rents, taxes and most of all, investment income.  Here’s a chart of that, and its constituent parts:

The primary income balance was in surplus as recently as mid-2013 and just glancing at the chart you can see that its deterioration coincides with a dramatic shift in the balance of direct investment income. The ONS took the trouble to publish an article to  explain what’s going on and the link is here:

If reading it all is too much bother on a sunny Sunday morning, the main points are as follows:

More than 80% of the deterioration in the current account since 2011is attributable to falls in net foreign direct investment (FDI) earnings.

Falling FDI credits over this period explain just under 80% of the decline in net FDI earnings, and the majority of that is attributable to the largest 25 multinational companies. This partly reflects the fact that UK FDI assets are exposed to movements in global commodity prices – most notably crude oil.

In my day job, I mostly ignore these niceties. The current account deficit is huge and leaves the UK dependent on foreign investors’ confidence in and appetite for UK assets. In the middle of a toxic debate about whether or not to remain in the EU, that’s bad for confidence and particularly bad for the pound. I’ve written extensively on that and the pound has indeed, fallen sharply in recent months and since the latest data were released.

But two questions are posed by the data. The first is whether we will see the current account deficit recover as an when oil and other commodity prices stabilize (or bounce)? The second is whether what 25 big multinationals do matters at a national level?

The UK still had a current account deficit, albeit a smaller one, when the commodity boom was in full flight. So in 2011 when the deficit was 1.7% GDP and commodity prices were at their peak, the headline figure masked the poor underlying  situation. Q4’s 7% deficit may overstate how bad things are, but I could average between the 1.7% of 2011 and the 5.2% of 2015 and conclude that 3 ½% GDP is a truer reflection of the underlying position. And that’s only small comfort. It’s still, in today’s money, an annualized international borrowing need of GBP 65bn.

I might be tempted to say that the UK’s £65bn underlying deficit is just the other side of the coin with regard to the Eurozone's near-£200bn current account surplus.

I might also conclude that the commodity cycle is far more volatile than FX trends, and so the idea that a weaker pound will magically solve the UK’s balance of payments problems is absurd. It would improve them a bit, but the parts that have caused the deterioration are not terrible senstivie to sterling exchange rates.

But are big global companies different? 
The second question is more difficult. Imagine a large UK-domiciled multi-national that used to earn huge amounts on its foreigh investments, but is now no longer doing so as a result of falling oil prices. So, instead of repatriating income and paying a dividend to its (global) shareholders, it will borrow money or run down cash reserves until prices recover. ,It may well also save money by reducing employment overseas, which helps improve the situation on the balance of payments without having much impact on the UK economy. If it borrows by issuing debt, does that really have much impact on the UK? Once upon a time a large UK multinational issuing sterling bonds might have been considered to squeeze out other buyers of gilts, say, but I’m not even sure that’s a relevant factor anymore.

I’m not going to argue this doesn’t affect the national accounts – it does.  A multinational that earns money abroad is bringing pounds back home and one that issues debt is adding to the demand the rest of the UK makes on the global investor community. But to what degree does a multinational borrowing money really squeeze out the UK Government? To what extent does paying dividends to global shareholders boost the UK? And while huge changes in commodity prices have clearly been a driver of the direct investment income balance, it’s also true that whether a company reinvests in its foreign businesses, or brings cash home, is a decision determined by all sorts of factors, with international tax regulations  often at the top of the pile.

All this is framed as a question and that’s why this is a blog rather than an investment bank's sell-side research note. I’m not sure I’m aloud to write ‘I don’t know’ this often in the day job!  The UK’s 7% GDP current account deficit is frankly, embarrassingly huge. There are no positives in the data but if someone asks just how hard it will be to find foreign financing for the defiit, and whether it will go on growing in the years ahead, all I can really say is that I don’t know, because that depends on the decisions of the management of a couple of dozen huge global  companies who may think that this is a good time to be borrowing at super low rates, even if that does drive the UK’s current account deficit up.

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