The UK's net international investment position
by William Baunton
Fri 27 Mar 2015
What the chart shows: The UK’s net international investment position from 1997-2014 as a percentage of GDP, as measured by the Office for National Statistics and the Bank of England.
Why it is important: The UK’s balance sheet with the rest of the world is a key indicator of the health of the economy. The net international investment position shows the stock excess of UK claims on the rest of the world over the rest of the world’s claims on the UK. These take four forms: direct investment, portfolio investment, other investment and reserve assets.
It is notoriously problematic to track NIIP accurately. The UK’s balance sheet is six times the size of annual GDP. The NIIP is the difference between gross assets and liabilities, so small errors or measurement disparities cause large swings and revisions when measured as a proportion of GDP.
The Office for National Statistics finds that the UK’s NIIP has been deteriorating since mid-2011. Its most recent figures estimate the UK to be a net debtor equal to 25.5% of GDP. According to the ONS, the UK was only briefly a net creditor in 2008 when the pound depreciated significantly as the crisis unfolded.
However, using a different method, the Bank of England finds the UK to be a net creditor of 31.6% of GDP, with positive net assets since 2005. The significant difference, aside from currency fluctuations, lies in the method of calculating the value of foreign direct investment stocks.
The ONS, like many others, uses book value, and where necessary, historical cost value. The alternative approach devised by the Bank of England is an estimate based on foreign direct investment measured using market value. This method in some cases increased the value of UK owned foreign assets by 75% and increased the value of foreign owned UK assets by 50%. By this metric, favourable net returns on overseas investments have allowed the UK to run current account deficits without becoming a net debtor.
The real story is in net positions between sectors of the economy. The distribution of assets and liabilities across sectors is vital to ascertaining whether the UK is vulnerable to external shocks. Foreign assets and liabilities may have different maturities or be denominated in different currencies, which pose potential risks, particularly in illiquid markets.
In the UK’s case, short-term external liabilities are held primarily by financial institutions (equal to about 25% of GDP) while long-term liabilities are held by the corporate and government sectors (30% and 25% of GDP respectively). The largest proportion of external assets is held by insurance companies and pension funds, which are long term and equal around 60% of GDP. This reveals a maturity mismatch.
The mismatch has improved significantly since the crisis, when large net short-term foreign currency liabilities were particularly pronounced and swap lines with the Fed were required to alleviate a shortage of dollars. Financial institutions have since reduced their net short-term foreign currency liabilities.
There is no rule dictating how large debt positions must be to leave a country vulnerable. Greece has a net debt position of around 120%. Ireland, Cyprus and Portugal have net positions exceeding 100% of GDP. The IMF estimates that vulnerability in advanced economies is heightened when the net liability position exceeds 60% of GDP.
The IMF predicts stock imbalances will rise from the current level of 40% of world GDP to 45% by 2019, enforcing the need for increased international focus on this issue and a coordinated effort to curtail this trend. The Bank of England’s measurement of the NIIP clearly shows healthier picture then shown by official estimates.