BREXIT: Understanding its Economic Impact

If you watch CNBC, the team over there was hyper-exuberant in calling BREXIT as the 2008-Crisis level. In fact, Mr. Udayan Mukherjee was vocal at the fall with Sensex down mostly 600 points at the start. The markets were trying to take stock of things; with most panelist been cautious stating this is an initial reaction only. The immediate impact on India was first a fall in stock market (coupled with other stocks) and secondly the fall in currency.

On Friday 24^th Jun 2016, Britain did what was most unexpected. The shocker was basically a ‘Huge Negative Surprise’; the stock markets globally tanked with estimates of $2tn being wiped in a single day (source Reuters). The worst hit was the Pound, which got Pounded.

In fact, just a personal opinion, its economic-idiotic-ness what the Brits have done and they have had it. It was stupid idea to have an entire population to vote for something that has far-reaching economic consequences. Its’ better for the politicians as they have no one fix responsibility, the beauty of democracy. The exit leaves everyone with both Economic Trouble & Uncertainty. Having things dawned upon people now post the vote, there is online petition to re-do the referendum given the margin was very low of 51.9% for Leave. That is a political affair.

So, with the votes in; and with a thin margin the BREXIT have won. The immediate impact were:

1. GBP/USD plunged 12.5% to a low of 1.3224 from a high of 1.5018.
2. Stock markets tanked globally in the range of 2.5% to 8%.
3. David Cameroon announces resignation to effect from Oct 2016
4. Crude oil prices fell sharply
5. Increase in risk led to sharp rise in Gold price

Source: Reuters

Analyzing the vote

Some interesting facts were emerged from the vote. It seems the younger population voted for BREMAIN. Financial Times did a good bit of infographics on the BREXIT analysis and following key facts emerge:

1. Areas with higher number of degree educated tended to vote for Remain
2. Area with higher number of jobs which required degree qualification tended to vote for Remain
3. Younger people voted for Remain however their % in total vote was lower
4. Highest leave votes came from low income area.

The following charts show key characteristics of vote for Leave, when measured across the 382 voting areas with each dot in the below chart representing an voting area.

Anyways, now, Everyone has an opinion on the Brexit, but frankly, no one is right or wrong. Hell, the writer can either be right or wrong. However, we are making a decent statistical and economic attempt to understand the impact. Our write up is aimed at understanding the impact of Brexit on India. However, before we jump to India, we focus on at the impact of the event on Britain.

Lets start with the tumultuous history of Britain and EU

History of Britain and EU

We worked out a tabulated synopsis based on an article from WEF which gives a good perspective of history Britain and EU.

Impact for UK

Government crisis. The first casualty of the BREXIT is resignation of Mr. David Cameroon. Mr. Cameroon’s departure signals rise of more conservative, a more Anti-EU tone party. The move will always be seen in a bad light by the heads of other EU states; and dealings which are anti-EU may see non-generous terms for Brits. Moreover, even US had warned that UK will have re-negotiate trade terms with them and be line. Rise of far right politics. The success of this move, has already led to murmurs of FREXIT, ITALEAVE, etc. This would be extremely negative for the global growth.

UK’s interdependence on EU – A quick take

1. >50% of UK’s exports are to EU, and >50% imports are from EU.
2. >50% of FDI in UK is from EU
3. >2 mn citizens from other EU member states live in the UK. ~1 mn UK citizens live in other EU nations.

Economic Impact on BREXIT

Albeit making predictions or impact is bit impossible, how multiple economic suggest the following:

1. Cost of BREXIT for UK would be about 0.6% to 3% of GDP per capita
2. A fallout of trade agreement depending on their soft impact or otherwise could be anywhere between 2% to 14%
3. Fiscal savings of 0.5% of GDP at the max
4. Economic uncertainty over the EU and UK would cause a rise in cost of capital, and turmoil in currency markets, impacting trade
5. With UK, exiting the contribution from other member nations to EU will have to increase. In fact, Germany’s losses are predicted to range from 0.1% to 3.0%; which is huge range. Germany would have to transfer additional at least EUR 2.5 bn to Brussels to compensate for UK.
6. UK would be hit in financial sector; London literally the financial capital; would take a hit. However, other EU nations see an opportunity to fill in for London.
7. S&P warns for downgrade in the UK’s credit rating post BREXIT
8. Financial institutions point to a 0.2% GDP growth in UK (revised down from 2.3%)

In a first response, GBP 250 bn of additional funds shall be released by Bank of England to counter any short term crisis. US FED rate hike is off the table for 2016.  With UK walking off an uncertainty reigns in, the possibility of wiping off ~0.5% to 1.0% of GDP growth in the region is not ruled out. Merill Lynch expects the GDP growth in the region to be 1.1% (from 1.6% earlier) until mid-2017. Despite what people are saying, this is not 2008-Crisis. The memories of 2008 crisis are so etched in our minds that all falls get described at 2008 fall. The 2008-crisis saw a fall in the entire banking system in the USA. Multiple banks collapsed due to extremely high leverage in their balance sheets. The huge bailout was announced which led to moving out the economic revival.

Will other nations follow suit?

Survey by the Ipsos-Mori shows that among EU members nations, in Italy and France >50% population wants a referendum on EU membership; and other nations the numbers overwhelming too. This cannot be taken as yes for a referendum but this shall fuel the anti-EU parties in the European region to start making noises. Depending on the kind of economic shield, other EU nations are also trying to ask for better European integration initiatives to demonstrate in their countries and other economic forces that the Brexit would not lead to failure of the EU project. Pew Research Centre sample poll suggests 1 in 4 Germans and 1 in 5 Italians currently want to see more EU integration; while 40% of the French would like to be more powers at the national level then the EU level. The next major threat is that Italy is moving to a constitutional referendum in the autumn, and elections are due in the Netherlands, France and Germany next year. Ruling out a rise of far-right or anti-EU parties to push for such projects would be foolhardy. The priority should right now be preventing further cracks in the EU; given the economic non-sense in the current global recessionary scenario.

The near term economic impacts are right now ball-park numbers. The ability of UK and EU to storm out this crisis situation shall be critical. How the heads of the remaining 27 EU nations come together and fix will be watched with batted breath. Both the nation groups would not get into petty politics and try to run off other at the risk of global turmoil. With EU break post the BREXIT, is a question worth pondering. But, assuming EU zone would break on issues of Immigration would be foolhardy. Noises shall be made, but the economic interdependence over the past 30 years is far outweighs the benefits of been a non-EU nation. Moreover, the UK-EXIT model would be a case study for generations to come. If it garners successful results say 3 year or 4 years down the line, EU would be doomed. If its turns disastrous for UK, the nation shall all the more be better focused on EU. It is a great learning experience how emotions meddle with economics and lead to uncertainties which has far-reaching consequences.

Closing note; we are working on an India centric piece as well. We thought lets first have an assessment of UK / EU impact and then come with India related working.

Source & Further readings

DBS Research group report Brexit First Impact dt. 24 Jun 2016

BoFA-ML report titled ‘Liquid Insight – Brexit When the Dust Settles’ dt. 24 Jun 2016

http://blogs.ft.com/ftdata/2016/06/24/brxit-demographic-divide-eu-referendum-results/

https://www.weforum.org/agenda/2016/03/what-would-brxit-mean-for-the-uk-economy/

https://www.weforum.org/agenda/2016/06/10-must-read-economics-stories-of-the-week-brxiutm_content=buffer9d74d&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

http://graphics.wsj.com/brxit-whos-voting-what/

https://www.weforum.org/agenda/2016/06/the-big-questions-after-the-brxit-vote?utm_content=buffer55617&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

http://www.reuters.com/article/us-global-markets-idUSKCN0Z92MZ

http://cep.lse.ac.uk/pubs/download/breit01.pdf

https://www.cer.org.uk/sites/default/files/bulletin_105_st_article1.pdf

http://www.iea.org.uk/sites/default/files/publications/files/Clement%20BRXIT%20entry_for%20web_0.pdf

https://www.bertelsmann-stiftung.de/fileadmin/files/BSt/Publikationen/GrauePublikationen/BRXIT_EN.pdf