On the 23rd of June 2016, in a referendum on whether to stay with or leave the European Union, the British voted by a narrow margin, with 51.9% voters choosing to end their association with the EU. This shook Europe and sent ripples across the global economic landscape, despite the referendum result not being binding on the UK parliament. The key takeaway of the referendum was that autonomy and sovereignty now rival economics as drivers of voter sentiments. The UK today is revealed as a country deeply divided – London, Scotland and Northern Ireland having overwhelmingly voted to stay put in the EU, a few larger cities also having chosen to remain though less emphatically; but smaller industrial towns, market towns, suburbs and the countryside – both left and right-leaning areas – having rallied to the ‘Leave’ campaign’s call for Britain to “take back control” from Brussels. A sharp generational divide has also come to the fore, with particularly students and graduates supporting ‘Remain’ and the elderly voting to ‘Leave’. The Indian Diaspora too seems divided on similar lines, with roughly an equal number for as against. S Ravi shares his analysis of the scenario with our readers.
Prime Minister David Cameron has announced his resignation and will step down as soon as a successor is elected. Jeremy Corbyn, the opposition leader, has been hit by a slew of resignations from his shadow-cabinet and a revolt against his leadership, which is likely to plunge the UK into a constitutional crisis. Scotland will probably think about a second go at a referendum on it’s independence, and could be joined by Northern Ireland and Wales, which may well lead to the possibility of a break-up of the United Kingdom as we know it today.
In large measure, Brexit has been prompted by rising concerns about the scale and impact of immigration, coupled with the sentiment among those whose standard of living has been slipping that they have been forgotten about. It is a signal of retreat from globalization, under way at least since 2008, when global finance nearly froze up and the Doha Round of negotiations for lower trade barriers collapsed. Like all the other previous geopolitical and financial contagions of the past including the disintegration of the USSR, the German reunification, the Arab Spring and the Greek debt crisis; Brexit has triggered an avalanche of short and long term crises within the UK and across the globe.
The EU is a large market for the UK, particularly for exports of services and goods, including components and fuels. More than half of the UK’s top 10 trading partners in services are EU countries, with Germany, Netherlands, Spain and France dominating. The UK is a major recipient of inward FDI and also an important investor in overseas economies. It had the world’s third highest stock of inward FDI in 2014, just behind the US and China. In 2014, EU countries accounted for just under half the stock of FDI in the UK (£ 496 billion out of a total of £ 1,034 billion, 48%), with EU’s share fluctuating between 47% and 53% over the last decade. In terms of UK’s investments abroad, the EU accounted for 40% of the total UK FDI stock in 2014. London’s financial sector includes over 250 banks (30.5% being EU banking institutions), all of whom currently enjoy free entry to the European single market. UK’s withdrawal from the Union would generate the relocation of banks to countries that allow them to maintain their free-access to the EU single market (for example Ireland & Netherlands). International investors see London as an intermediary between the US, EU and Asia. In the event of UK’s exit from the EU, London would lose a great deal of this influence.
David Cameron has announced that his successor would decide on when to invoke Article 50 of the Lisbon Treaty, which will then set in motion the formal legal process of withdrawing from EU. Senior officials from the remaining 27 EU states, after a meeting in Brussels on the 26th June, have agreed to wait, at least until the appointment of a new British Prime Minister, likely to be in September, for the formal notification of UK’s intention to quit EU. In his final address at the Brussels Summit on the 28th of June 2016, Cameron expressed the desire for having the closest possible relations with the EU and retain single market access with free movement of workers as entry price, which would set the stage for a face-off between UK and EU exit talks.
It is but obvious that UK’s signal to leave would prompt difficult internal negotiations among the 27 countries, including over the shrunken EU budget. The UK is the third-largest contributor to the Euro budget after Germany and France, providing about an eighth of its resources. EU capitals are also likely to start informal discussions on how to approach the negotiations with the UK in coming weeks. However, there will be no formal negotiations over what approach to take until Britain triggers Article 50. The UK will continue to abide by EU treaties and laws but not take part in any decision-making during the period of negotiating a withdrawal agreement and the terms of its relationship with the remaining 27 nations, which is expected to take place over a time-line of 2 years.
As markets take note of the uncertainties around the process and tenure of the UK exiting EU and given the abject lack of clarity on new regulations, stock markets are in for a bout of volatility. Currency markets in search of safe havens could make the US dollar and the Japanese Yen stronger, which in turn would make their exports costlier and British exports cheaper. It is unlikely to affect China’s immediate economic outlook, but prolonged currency market volatility could add to downward pressure on the Yuan and revive investors’ fears of competitive global devaluations. Brexit has already caused a slip in the rating by Fitch and S&P to AA, as well as Moody’s credit rating outlook going to negative. This is expected to raise borrowing costs in international financial markets. Till clarity prevails, both the Pound Sterling and the Euro could take a beating in the short term.
The 10-year Treasury yield and other long term borrowing costs have already been triggered on the hope of a looser and easing policy on the part of the Bank of England, the European Central Bank, Bank of Japan and the US Federal Reserve deciding not to raise rates. Furthermore real estate in UK could receive a setback, with flows getting diverted to other countries offering stability. Lower rates could push against the hit that the economy takes on trades. However, there is a possibility that the crisis in the UK could expose unknown fragilities in global credit markets as well, and the uncertainty of having no functioning government, ineffective opposition and a lack of clarity on the process of Brexit, households and companies are sure to put their spending decisions on hold leading to lower GDP growth.
India’s chances of entering into a Free Trade Agreement with UK will now brighten. Among EU countries, UK is India’s third largest trading partner, and presently the second biggest source of FDI for Great Britain. India is already trying to build trade bridges with Netherlands, France, Germany and others, albeit in a small way. Work-related visa restrictions have already resulted in a fall in the number of Indian students studying in British universities. Given their tough stance on cutting immigration, a Brexit government could be expected to make such curbs more stringent. Brexit is likely to impact Indian companies in sectors like automobiles, IT, textiles, pharmaceuticals, gems and jewellery, leather, leather products and metals in multiple ways – they stand to lose their gateway into Europe, experience demand weakness due to potential slowdown in the EU and the UK, volatility in commodity prices, currency impact on account of potential depreciation of the rupee, euro and the pound, and a balance sheet impact on account of exposure to un-hedged overseas borrowings.
Britain’s role as a ‘balancer’ will be keenly missed. In case Scotland secedes from the UK, it will have major consequences for British defence policy, given the basing there of the nuclear deterrent. New stability will need to evolve, but is not so easy since Germany is already much more equal than the others in the Union. Vis-a-vis the United States, Britain’s exit from EU deals a body-blow to the US’ Transatlantic leadership, with the advantage going to China and Russia. A dishevelled, disoriented Europe makes for a weak negotiating partner. Combined with the strong ‘Russian lobby’ within Germany, and France, Italy and Greece, et al., it could become highly problematic for the US to keep sanctions against Russia going. The British vote also strikes some resonance within other EU member countries – especially in Germany, Italy, France, Netherlands, Poland and so on, who are sitting on the sidelines to watch if the Brits can pull off an EU exit with manageable damage. In case several other countries choose to leave the EU, which will then result in a core Eurozone with an outer ring of countries with tailored ties to Brussels with more fragmented international architecture, standards and security relations.
If and when Article 50 is triggered and the exit talks begin, the UK and the other 27 member states could begin discussing how the structures of EU law, regulation, fiscal transfers, open commerce, open borders and human rights that have been built over the past decades will be undone and reworked. This being the first ever time that article 50 could be invoked there is no clarity on the process of negotiation, combination of slow change and abrupt acts which would lead to the new relationship and regulatory framework between the UK and Europe. The long-term consequences of Brexit will depend upon the timing and substance of the withdrawal agreement that the UK negotiates with the EU. At a minimum, the EU will certainly make it expensive for Britain to participate on an ad hoc basis. The UK though, has some models (or a combination of them) to follow in negotiating an exit from the EU that could serve as precedents. The Norwegian Model – Following terms and conditions of the Agreement on the European Economic Area (EEA). This agreement was signed in 1992 between the EU Member States and several other member states of the European Free Trade Association (EFTA) and entered into force in 1994. The Swiss model (which is EFTA member, without being part of the EEA) – Following EFTA terms and conditions & signing bilateral treaties with the EU. The Turkish model – Following the terms and conditions of the EU Customs Union (EUCU). Bilateral agreements under WTO auspices. The implications of these options as in terms of movement of goods & service, capitals, people, contribution to budget, application of laws, control on certain resources, etc., is summarised below:
|GREAT BRITAIN’s OPTIONS IN THE EVENT OF WITHDRAWAL FROM THE EU|
|Free Movement of|
|Contributions to EU budget||Yes||Yes||Yes||No||No|
|Application of EU laws||Yes||Yes||Yes||Partial||No|
|New Regulations per year (EU legislation)||1000||350||0||0||0|
|Independently Negotiate Trade Agreements with EU||No||Yes||Yes||No||Yes|
|For home affairs||EU||GB||GB||GB||GB|
|In the Justice field||EU||GB||GB||GB||GB|
|Legal Basis for Int’l Trade||EU Treaties||EEA||EFTA / BA||EUCU/ BA||BA|
Source: Synthesis of authors based on the analysis of literature in the field (Randwyck van, Hugo (2013), Efta or EU, Qs and As, The Brouges Group; Randwyck van, Hugo (2013), Efta or EU, Qs, and As, The Brouges Group)
* GB – Great Britain * BA – Bilateral agreements
Immigration in the context of EU’s labour market liberalization is one of the main bugbears of the British people. Main British concerns are related to fewer jobs for British workers and wage cuts in some sectors; and the conditions under which immigrants become beneficiaries of public services provided by the British government. According to a recent study conducted in 2014 by Dustmann & Frattini, immigrants from EU have contributed to 64% more than they benefited from UK’s public finances (15 billion pounds) while immigrants from EU countries in Central and Eastern Europe have contributed to 12% more than they benefited (5 billion pounds). However, in the event of exit, the 3 million EU nationals already in UK are likely to be allowed to stay on, but the situation is less clear for those who move to the UK between now and the final exit date. Further, there is also a fear in the minds of UK nationals living in EU States about their easy access to public health services and pension portability. There is a possibility that migration between UK and other EU countries will slow down if not stop altogether. Free movement of persons and immigration is one of the key concern areas that would need to be addressed during exit negotiations.
Brexit will adversely impact countless areas of the economy – mergers, laws, contractual disputes and enforcement, tax and financial services to name just a few. The extent to which these will be affected by the UK’s withdrawal from EU will depend on the model of relationship that the UK and the EU adopt following the negotiations for separation. Here’s a snapshot of the potential legal impact of Brexit:
- Merger & Competition: Any company doing business in the EU will still be subject to EU rules. This could increase the regulatory burden as compliance with both the EU and UK regimes would be necessary.
- Data Privacy & Security: The UK may not be required to adopt the newly overhauled EU data-privacy laws expected to come in force in 2018, but there will be a desire to ensure that data can still flow freely between the UK and EU.
- Taxes: Brexit could impinge upon VAT, customs duties and the taxation of payments between EU group companies in particular.
- Intellectual Property Rights: The UK would no longer be part of EU’s “community” trademark regime that offers rights protection across the continent.
- Insurance: It is possible that UK insurers may need to face a complicated regulatory regime, relocate, or open new branches inside the EU to underwrite business in EU member states.
- Contractual Disputes & Enforcement: As a EU member-state, the UK is part of a framework for deciding jurisdiction in disputes, recognizing judgements of other member states and deciding the governing law of contracts. Following Brexit, UK may no longer be part of this framework, which may affect jurisdiction and governing law choices in transaction documents.
- Financial Services: One of the largest identifiable risks to the financial sector is the potential loss of ‘passport’ rights for firms based in the UK looking to sell services in the EU. A requirement for visas and work permits may create a barrier that could weaken the UK, whilst strengthening other more welcoming financial centres.
Breaking away from EU legislation and creating appropriate new UK legislations would be a massive and time consuming task and may take decades to complete. Foreign firms doing business with UK companies and companies operating in the UK from around the globe banking upon easy entry into the EU would find they have challenging times ahead.
They would require to spend considerable time and money to draw up new contracts and structure transactions upon reintroduction of UK custom duties and tariff, new taxation laws, regulations controlling mergers, evaluate shifting of bases, etc., which implies taking a hit on both the top-line as well as the bottom-line in their books.
Markets would witness short-term volatility and currency fluctuation but these are not the real issues. In coming years, both Britain and the EU will be consumed with the challenges of severance, and therefore more self-absorbed. However, while the terms are worked out, there will be considerable turmoil both within the United Kingdom and around the globe. However, if the United Kingdom and EU adopt a withdrawal agreement that allows the UK to continue to be part of the European Union’s “single market,” many of the short-term problems will be mitigated.
The Euro will most likely not serve to be of much utility in Greece, Italy, Spain, and many other current Eurozone countries. The EU, notwithstanding all its flaws, has helped keep the peace in Europe for decades. In case other EU states choose to follow the Brexit model, one could well witness what has been experienced in history – physical attacks on one another, which would allow Russia and China to exploit opportunities presented by the weakening of the West and require the US to rebalance its foreign policy towards Asia.
From an American perspective, it will be an EU less intrinsically connected to them and less willing to develop and defend common approaches to global issues, and a Britain less able to affect Europe. One could expect foreign assistance and defence spending to reduce as EU governments look to shift resources to domestic claims in the hopes of placating a public now understood to be annoyed. Non-EU institutions — principally the NATO, IMF and even the UN — will gain as venues for British influence. The fissures in the EU today may also pave a way to bolster NATO as the forum for manifesting European weight internationally.
The world today seems to be enjoying a populist and anti-globalization movement. Be it the US, UK or EU, the underlying concerns are easy immigration and visa norms hurting the middle class and less educated older citizens. For businesses and investors, every election in coming years could come with the risk of more nationalist policies that could further impair the free flow of goods, services, capital and people.