Story Of The Week

BREXIT: THE KNOWN UNKNOWN

On February 20, 2016 David Cameron, Britain’s prime minister, set June 23rd as the date for a referendum on the country’s membership of the European Union. His announcement followed a protracted renegotiation of the current conditions of Britain’s membership at a summit in Brussels. The move immediately prompted government ministers to declare their backing for either the “remain” or “leave” campaigns. In early 2015 the chances of “Brexit”— Britain departing from the European Union—seemed remote. Today, largely because of Europe’s migration crisis and the interminable euro mess, the polls have narrowed. Some recent surveys even find a majority of Britons wanting to leave.

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HISTORY BEHIND THE BREXIT:

David Cameron, leader of the Conservative Party and Prime Minister since 2010, announced support for a referendum on Britain’s EU membership in 2013. He said that the country would hold the vote before 2017 if the Conservatives were re-elected in the May 2015 general election. They were, and Cameron pursued a renegotiation of the terms of Britain’s membership, to be followed by a vote on Brexit.

Cameron supports the “in” or “remain” side, arguing that the renegotiated terms he secured with European Council President Donald Tusk are favorable to Britain. Sceptics on both sides see the renegotiation as political theatre, which Cameron was forced to perform as a result of his prior sympathy to anti-EU arguments.

The UK Independence Party in particular presented a challenge to the Conservatives leading up to the 2015 election. The movement was founded in 1991 (under a different name) to oppose Britain’s EU membership and saw its popularity surge in 2013. UKIP’s arguments and euroskepticism more generally, also appeal to elements of the Tory base, and following the renegotiation a number of prominent Conservatives have come out in support of the “leave” side. These include London Mayor Boris Johnson and Justice Secretary Michael Gove.

 ESSENCE OF THE DEBATE:

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OPTIONS AVAILABLE IF BRITAIN DECIDES TO LEAVE EU:

Broadly, there are five models to choose from:

  • The first is to join the European Economic Area (EEA), a solution adopted by all but one of the European Free Trade Association (EFTA) states that did not join the EU. But the EEA now consists of just one small country, Norway, and two toddlers, Iceland and Liechtenstein.
  • The second option is to try to emulate Switzerland, the remaining EFTA country. It is not in the EEA but instead has a string of over 20 major and 100 minor bilateral agreements with the EU.
  • The third is to seek to establish a customs union with the EU, as Turkey has done, or at least to strike a deep and comprehensive free-trade agreement.
  • The fourth is simply to rely on normal World Trade Organization (WTO) rules for access to the EU market.
  • The fifth, preferred by most Eurosceptics, is to negotiate a special deal for Britain alone that retains free trade with the EU but avoids the disadvantages of the other models, but it would be extremely hard or even impossible to negotiate this in an atmosphere, post-Brexit, that would hardly be a warm one.

GLOBAL IMPACT:

The possibility that Britain could exit the European Union (EU) could not only slow down the world’s economy, according to analysts but also have far-reaching consequences for politics, economy, defense, migration and diplomacy. Britain will regain its seat on the World Trade Organization – a platform for forming new trading relationships, especially with commonwealth nations replacing those with the EU. A ‘Brexit’ scenario has the potential to create volatility in global markets, especially in the currency markets.

IMPACT ON UK:

  • Regulatory divergence grows over time increasing the cost of trade, impacting on volumes and the UK place in supply chains
  • The UK is less attractive as a gateway to Europe, as a base for corporate HQs and as a location for investment from Europe
  • The UK loses influence over EU regulation without gaining much freedom to regulate independently
  • The UK gains flexibility over industrial policy, but loses the benefits from scale and influence in some areas
  • Immigration is tightened, damaging competitiveness, particularly of London, but how much depends on the Brexit model

IMPACT ON EUROPEAN UNION:

  • EU trade matters more for the UK than UK trade for the EU, but some states with big bilateral surpluses feel a macro chill from Brexit
  • Businesses find it costly to relocate investment from the UK and there is a risk the UK attempts to undercut the EU on standards to attract FDI
  • The balance in the European Council shifts away from liberalization and it becomes harder to form a blocking minority against illiberal measures
  • There could be a weakening of competition policy, looser collaboration in education and research and impacts on public procurement
  • The EU is a less attractive trade partner without the UK in the deal and loses a member state that puts its political weight behind negotiations

WHAT IT MEANS FOR INDIA?

 As far as India is concerned, in the near term it will heighten global volatility thereby impacting capital flows and in medium term we will most likely be impacted through currency exchange. India has a substantial trading corridor with EU. Any material depreciation of the Euro/Pound could lead to increased headaches for India in a sluggish export environment. Indian businesses have a material presence in both the UK & Europe. There are over 800 Indian companies in the UK, the top 10-15 of which contribute $4 billion to the British economy. Indian companies see the UK as the springboard to Europe. The language and legal system give Indians a comfort level. Many Indian information technology companies based in the UK with large work forces and offer services to Europe will be hit too.

Indian markets like their global counterparts are also feeling jitters over Brexit worries. The BSE Sensex and NSE Nifty fell for the third straight session on Monday i.e. June 13, 2016 on renewed worries about the impact of Britain’s June 23 referendum ahead of US Fed meet. Sensex closed 238.98 points down at 26,396.77, while Nifty 50 index settled 59.45 points down at 8,110.60.

CONCLUSION:

A referendum on Brexit is now certain though the outcome is far from a foregone conclusion. The impact of Brexit on British businesses, the UK economy and wider British interests would be severe and felt across multiple channels. Both the path and the endpoint, in terms of the new relationship between the UK and the rest of the EU, would be uncertain, compounding the costs to the UK. Brexit, if it happens, will have implications; UK Real estate prices may correct (on account of thinner capital flows from EU), inflation will climb on expensive imports, London’s financial centre status may get threatened if money flow and settlements are hampered. Goldman Sachs estimates 15-20% drop in the sterling as a response to Brexit. All member states would, however, feel the impact of Brexit, both politically and economically but would be affected in different ways and to different extents.

The long-term economic impact of Brexit is hard to discern, but the short term disruption while the UK negotiates and renegotiates is only likely to be bad news for both sterling and Euro assets. It is difficult to gauge the precise medium to long-term economic impact of Brexit on both the parties concerned. However, the outcome of Brexit is the biggest macro risk affecting fund managers and investors – bigger than oil price or even the Fed rate hike.

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