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In 2023, the UK economy recorded a 3.3% current account deficit, equivalent to £89 billion. The deficit has been going on for a while, in contrast to other nations like Germany, which have run a current account surplus for many years.
Why does the current account deficit matter? In particular, what effect can it have on the UK’s early-stage investment landscape (e.g. angel investing and startups)? Below, we explore these questions in more detail.
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What is the current account?
The current account is one aspect of the overall “balance of payments”. Think of the latter as a giant spreadsheet which records all money flows, both in and out of the UK, within a financial year. The current account is an umbrella term encompassing three key areas:
- Money flows in/out of the UK for goods and services.
- Portfolio transaction payments (e.g. dividends and interest on international investments).
- Money transfers (e.g. membership payments to international organisations, like the EU).
The first point tends to comprise the bulk of a country’s current account. As such, a current account deficit is often used synonymously with the phrase “trade deficit”. In other words, there is more money leaving the country to pay for goods and services than entering it.
Is a current account deficit a problem?
Some people think so. Those who place a high value on national sovereignty might be troubled by the UK being so dependent on imports. For instance, around 45% of the UK’s vegetables come from overseas (mainly the UK). If relations broke down with these trading partners, the UK could be left with severe shortages.
However, a current account deficit is not necessarily a problem. In particular, the situation necessarily entails running a surplus in the UK’s financial account (another part of the balance of payments). This encourages foreign investment into UK assets, such as government bonds (gilts). As such, a current account deficit can help the UK lean into its comparative advantages in financial services, IT and comms, tourism, business and professional services.
How can the deficit affect startups?
Before we proceed, it is important to clarify a common misunderstanding. The current account deficit is often confused with the fiscal deficit. The latter refers to a situation when the government spends more than it receives in tax revenues, while the former refers to an imbalance in payments leaving and entering the country.
A current account deficit is often a sign that an economy is uneven. In the UK, it has widely been interpreted as showing low productivity, low investment, and over-consumption. As such, the deficit might imply that the UK’s international competitiveness is sorely lacking.
If so, this certainly has important implications for UK startups, especially if they plan to expand overseas. Foreign consumers may see a British company as more expensive than other international rivals. However, UK startups can navigate this issue by competing on the basis of innovation rather than price.
If a British company can offer something new that solves consumer “pain points” worldwide faster and better than before, then issues such as a high exchange rate or a current account deficit will become less inhibiting.
Finding internationally-competitive startups
For early-stage investors, scaleability is a key issue to consider when evaluating any startup’s potential. What kind of market share could it capture in a “best-case scenario”? If the potential is limited to the UK market, then the current account deficit is still an important macroeconomic issue to consider.
For example, if global wholesale prices for key UK imports suddenly rise (e.g. energy), how might this affect supply lines and customer behaviour for the startup? However, international competitiveness is less of an issue since expansion will be concentrated domestically.
However, if a startup has ambitions for global expansion, then macro variables will need to be considered very carefully by founders and investors alike. For example, how might the exchange rate change (e.g. GBP to USD), and how could this impact the company’s future revenues and market share on the world stage?
Projections and contingency planning can be especially tricky for startups that rely on volatile imports (e.g., commodities). For example, an agri-tech startup could see its fortunes heavily dictated by sharp and sudden changes in world food prices.
Poor weather in a foreign wheat-producing country could lead to a huge rise in prices as the highly inelastic supply curve contracts. This happened in Ukraine following Russia’s invasion in 2022, resulting in a sharp fall in the former’s agricultural exports.
Investors should be bold in asking the hard questions to founders about how they imagine surmounting “macro challenges” such as these. The end result is higher confidence and trust amongst parties during the funding process and stronger due diligence for portfolio construction.
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