The income account balance is equal to the credits the UK generates on its overseas investments (‘assets’), less the debits it pays overseas investors who own UK-based assets (‘liabilities’). In order to construct these forecasts, we split both assets and liabilities into four groups:
- foreign direct investment (FDI)
- ‘other’ investment, including bank loans
Our approach to forecasting both credits and debits for these items involves two steps. We forecast the stock of each group of assets and liabilities and we forecast the associated average rate of return (calculated as the income flow divided by the stock). Taken together, these elements provide a forecast for the income credits from UK assets abroad and the income debits from UK-based assets held by overseas investors.
The change in the value of the stocks of assets and liabilities reflects both revaluation effects and the net acquisition of those assets and liabilities. Our forecasts for revaluations include the effect of exchange rate movements on each of the four groups of assets and liabilities included in our income account forecast. For equities we also incorporate the effects of changes in world and domestic equity prices. The net acquisition of assets and liabilities is forecast using a number of behavioural equations in our macroeconomic model. These are typically linked to our forecasts for other balance sheet variables in the economic forecast. For example, UK holdings of foreign equities are partly determined by our forecast of households’ acquisition of equity, while holdings of debt are related to households’ acquisition of pension and insurance assets.
Rates of return
Forecasts for the rates of return on each group of assets and liabilities are informed by several factors. Rates of return on FDI are very difficult to model, so we draw on factors including the outlook for domestic profit margins, relative growth prospects in the UK and overseas, historical trends in relative rates of return and any specific factors, such as fines that UK-based firms pay in other countries. Rates of return on equities are informed by our forecast for domestic equity returns (dividends relative to the stock of equity) and our assumptions about world equity prices. Rates of return on bonds are informed by our assumptions about domestic and world interest rates. Rates of return on ‘other’ assets and liabilities are generally modelled using a combination of domestic and world short-term interest rates, since most of these ‘other’ assets and liabilities are loans between financial institutions that typically pay these interest rates.
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