ICAEW chart of the week: UK International Reserves

We take a look at the UK’s official international reserves that are held to safeguard sterling and support monetary policy.

Step chart showing components of the UK International Reserves.

Gross reserves: £101bn foreign currency securities and deposits, £36bn IMF, £15bn gold, £23bn other instruments.

Liabilities: (£109bn) other instruments

Net reserves: £66bn

Our chart this week is on the UK International Reserves, which comprise foreign currency securities and deposits, gold, investments in the International Monetary Fund (IMF), and other financial instruments primarily used to manage sterling as a national currency and support monetary policy.

As illustrated by the chart, the combined total of UK government and Bank of England international gross reserves was £175bn at 31 March 2022, comprising £101bn in foreign currency securities and deposits, £36bn invested in the IMF, £15bn in gold and £23bn in other financial instruments. This was offset by £109bn in liabilities to arrive at net reserves of £66bn.

According to the Bank of England, the £101bn in foreign currency securities consisted of £75bn in bonds and notes issued by foreign governments, £15bn in foreign government money market investments, £6bn in foreign central bank deposits and £5bn in private sector securities. The £36bn invested the IMF comprises £6bn in IMF reserves (effectively the IMF’s share capital) and £31bn in Special Drawing Rights (SDRs), a government-specific financial asset underpinned by a basket of currencies (US dollar, Euro, Chinese Yuan, Japanese Yen and sterling). The UK government also owned or had rights to 9,976,041 fine troy ounces of gold worth £15bn on 31 March 2022, while other financial instruments of £23bn included £20bn of claims against counterparties on account of reverse repo transactions.

Reserve assets were offset by £109bn in liabilities, comprising loans and securities used to finance reserve assets, repo obligations, and derivative financial instruments including foreign currency forwards, cross currency interest rate swaps and sterling interest rate swaps.

Not shown in the chart is the split between the UK government’s net reserves of £66bn, consisting of £151bn in gross assets less £85bn in liabilities, and the Bank of England’s approximately zero net reserve position, consisting of £24bn in gross assets (£12bn in foreign currency securities and bonds plus £12bn in other financial instruments) less £24bn in liabilities.

The Bank of England manages both its own foreign currency reserves, used to support its monetary policy objectives of controlling inflation, and the UK government’s international reserves, most of which sit in the Exchange Equalisation Account established in 1932 to provide a fund that can be used, when necessary, to regulate the exchange value of sterling. In normal circumstances the Bank of England’s main objectives in managing the reserves are to ensure the liquidity of sterling, the liquidity and security of the reserve assets themselves, and to ensure the reserves are managed in a cost-effective way.

In normal circumstances, the reserves are not used to actively intervene in foreign exchange markets, but are kept ‘in reserve’ on a precautionary basis in case there is any change in exchange rate policy in the future or in the event of any unexpected shocks. More prosaically, they are used to provide foreign currency services for government departments and agencies needing to transact in foreign currencies, as well as to buy, hold and sell SDRs as required by the UK’s membership of the IMF.

Although relatively small in the context of over £1trn a year in UK public spending and £2.3trn in public sector net debt, the UK’s international reserves provide HM Treasury and the Bank of England with a substantial amount of firepower in the foreign exchange markets should there ever be a need to intervene to support sterling. Fortunately, almost all of the foreign currency securities and deposits held in the reserves are invested in governments and central banks of allied countries, a contrast to the position of Russia, which has seen a substantial proportion of its international reserves frozen following its invasion of Ukraine.

One piece of good news amid all the economic gloom at the moment is that the UK International Reserves aren’t hitting the headlines. Because when they do, you really will know that all is not well.

This chart was originally published by ICAEW.

ICAEW chart of the week: IMF world economic outlook update

29 January 2021: The UK economy is expected to shrink over the three years from 2020 to 2022, compared with flat growth in the Eurozone, modest growth by the USA and relatively strong growth by China.

The IMF released updated economic forecasts this week, estimating the world economy shrank by 3.5% in 2020 with output projected to increase by 5.5% in 2021 and 4.2% in 2022. World output over the three years is now expected to see an average annualised growth rate of 2.0%.

The UK’s economy has been one of the hardest hit by the coronavirus pandemic, shrinking by an estimated 10.0% in 2020. Growth prospects are weak, with forecasts of 4.5% and 5.0% in 2021 and 2022 respectively bringing the annualised average growth rate over three years to a negative 0.4%. This contrasts with the 1.4% average growth forecast last year in the Spring Budget 2020, meaning that the UK economy is now projected to be around 4.7% smaller in 2022 than pre-pandemic expectations.

Prospects for the Eurozone countries are also disappointing, with forecast growth in 2021 and 2022 expected to bring their economies back to where they started and substantially below where they might have expected to have been without COVID-19. 

The USA economy appears to be more resilient, with growth in 2021 expected to offset the decline experienced in 2020 by a modest amount, bringing annualised growth over the three years to 1.3%.

In contrast, China expects to see annualised growth of 5.3% as it recovers from much slower than normal growth in 2020 as a consequence of the pandemic. While this is relatively strong compared with most other countries, China itself will consider this to be a relatively modest level of growth compared to the recent past. 

IMF World Economic Outlook Update – summary and selected countries

  2020 2021 2022 Average
 World output (1) -3.5% +5.5% +4.2% +2.0%
 World growth at market exchange rates -3.8% +5.1% +3.8% +1.6%
 Emerging and developing economies -2.4% +6.3% +5.0% +2.9%
 Advanced economies -4.9% +4.3% +3.1% +0.8%
 Eurozone -7.2% +4.2% +3.6% +0.0%
 Argentina -10.4% +4.5% +2.7% -1,3%
 Australia -2.9% +3.5% +2.9% +1.1%
 Brazil -4.5% +3.6% +2.6% +0.5%
 Canada -5.5% +3.6% +4.1% +0.6%
 China +2.3% +8.1% +5.6% +5.3%
 Egypt (2) +3.6% +2.8% +5.5% +4.0%
 France -9.0% +5.5% +4.1% +0.0%
 Germany -5.4% +3.5% +3.1% +0.3%
 India (2) -8.0% +11.5% +6.8% +3.1%
 Indonesia -1.9% +4.8% +6.0% +2.9%
 Iran (2) -1.5% +3.0% +2.0% +1.1%
 Italy -9.2% +3.0% +3.6% -1.1%
 Japan -5.1% +3.1% +2.4% +0.1%
 Kazakhstan -2.7% +3.3% +3.6% +1.4%
 Korea -1.1% +3.1% +2.9% +1.6%
 Malaysia -5.8% +7.0% +6.0% +2.2%
 Mexico -8.5% +4.3% +2.5% -0.7%
 Netherlands -4.1% +3.0% +2.9% +0.5%
 Nigeria -3.2% +1.5% +2.5% +0.3%
 Pakistan (2) -0.4% +1.5% +4.0% +1.7%
 Philippines -9.6% +6.6% +6.5% +0.9%
 Poland -3.4% +2.7% +5.1% +1.4%
 Russia -3.6% +3.0% +3.9% +1.0%
 Saudi Arabia -3.9% +2.6% +4.0% +0.8%
 South Africa -7.5% +2.8% +1.4% -1.2%
 Spain -11.1% +5.9% +4.7% -0.5%
 Thailand -6.6% +2.7% +4.6% +0.1%
 Turkey +1.2% +6.0% +3.5% +3.5%
 UK -10.0% +4.5% +5.0% -0.4%
 USA -3.4% +5.1% +2.5% +1.3%

For more information, read the IMF World Economic Outlook Update.

This chart was originally published by ICAEW.

OBR: deficit could reach £273bn or more

15 April 2020: a report from the Office for Budget Responsibility (OBR) indicates that the fiscal deficit could increase to £273bn in 2020-21, but it cautions that this is only one of many plausible scenarios.

The OBR has produced its first analysis of the potential economic and fiscal impact of the coronavirus, based on a three-month lockdown followed by restrictions for a further three months. 

At the same time, the International Monetary Fund has warned that the global economic contraction underway is likely to be the worst since the Great Depression, dwarfing the financial crisis twelve years ago.  

In its ‘coronavirus reference scenario’, the OBR indicates that the UK economy could fall by 35% in the second quarter of 2020, before bouncing back to leave the economy 13% smaller in 2020 than in 2019. 

The consequence would be an increase in the deficit for the fiscal year ending 31 March 2021 to £273bn or 14% of GDP, while public sector net debt could be £384bn higher than budgeted for, reaching £2.2tn or 95% of GDP by the end of the fiscal year.

The OBR says that the economic impact of the coronavirus will derive much less from people falling ill or dying, than from the public health restrictions and social distancing required to limit its spread, severely reducing demand and supply at the same time. That means lower incomes, less spending and weaker asset prices, all of which reduce tax revenues, while job losses will raise public spending.

Once the crisis has passed and policy interventions have unwound, the OBR thinks that annual borrowing could return to roughly the Spring Budget 2020 forecast. However, net debt would continue to be much higher, potentially £260bn (10% of GDP) more than the baseline forecast by 31 March 2025. 

The OBR analysis assumes that increased public spending, tax cuts and holidays, loans and guarantees, and actions taken by the Bank of England, designed to support household incomes and to limit business failures and layoffs, will help prevent greater economic and fiscal damage in the long term. However, it warns that the longer the disruption lasts, the more likely it is that the economy’s future potential output will be ‘scarred’ with adverse consequences for future deficits and for fiscal policy.

The International Monetary Fund (IMF) now predicts that the global economy will contract by 3.0% in 2020, much worse than the 0.1% contraction seen during the financial crisis in 2009 and a cut of 6.3% from its previous prediction in January. The IMF prediction is based on a shallower, but longer recession than the OBR’s scenario for the UK. Overall, the IMF believes that the cumulative output loss in 2020 and 2021 from the pandemic could be as much as $9tn.

Alison Ring, Director, Public Sector for ICAEW, commented: “The analysis published by the OBR is not a forecast, but the scenario it presents is pretty startling; making clear that whatever actually happens, the damage to public finances from the coronavirus pandemic will be extremely severe.

“While the OBR suggests that the economy and tax receipts could recover relatively quickly, the additional debt burden will weigh on the public finances for many years for come.”

Fiscal deficit 2020-21: £55bn Spring Budget +£130bn lower receipts +£88bn higher spending = £273bn Reference scenario.  Net debt: £1,819bn +£384bn = £2,203bn.

This article was originally published by ICAEW.