Following negotiations by the UK Prime Minister, David Cameron, for special status within the European Union (EU), the government has announced a historic “in-out” referendum will take place on 23rd June 2016. Deep divisions within the ruling party itself have revealed the extent of uncertainty surrounding the future of the UK within the EU and this will likely accentuate in the next four months of campaigning. This unpredictability will inevitably weigh on investor confidence and economic growth. Furthermore, this comes at a time when the global economy is already facing headwinds and heightened risk. As the world’s fifth largest economy (US$ terms), the issue of Brexit will be another cause for concern. The two biggest questions for the UK economy will be what impact a Brexit will have on future trade relations and Foreign Direct Investment (FDI) attractiveness.
Why does this matter?
- The UK is the EU’s second largest economy accounting for 17.7% of the union’s GDP in 2015 and second biggest population. As a comparison, Greece (with similar fears of a eurozone Grexit) contributed just 1.2% to regional GDP in the same year;
- The EU is the UK’s largest trade partner and any change in trade relations will impact not just UK exporters but imports from EU countries. The EU accounted for nearly 50% of the UK’s exports and 55.6% of imports in 2015;
- The UK is the leading destination for FDI in Europe and the fourth globally (US$72.2 billion as of 2014, latest year available) boosted by a large financial services sector in London and an open trade and investment environment. The inconclusiveness surrounding a UK future outside the EU will influence investment decisions;
- Euromonitor International forecasts that the UK will have the highest real GDP growth of the G7 countries in 2016 at 2.3%, boosted by sound economic fundamentals and declining unemployment. This figure could well be revised downwards in light of a referendum outcome not being reached until the end of the second quarter.
Global Economic Uncertainty Set to Worsen
Other risks facing the global economy in 2016 include a Chinese economic slowdown, Brazil and Russian recessions, the European migrant crisis, policy divergence in some of the world’s largest economies and ongoing geopolitical tensions. This is against the backdrop of a persistent low oil price all of which have contributed to significant financial market volatility. There is no doubt that the question of a Brexit will be an added pressure for the global economic outlook.
If a Brexit did take place, the value of the pound would plummet and import costs would rise which would hurt both consumer and business spending potential. Weaker spending and investment would hinder economic growth and damage the attempts to reduce government debt levels that the years of austerity since the global financial crisis of 2008-2009 aimed for. The cost to business to make the necessary bureaucratic changes that not being part of the EU would require would be significant. On the other side of the argument, a weaker currency would provide a boost to exports. The UK would certainly look to prioritise new trade deals with the EU and Norway and Switzerland are two examples often used to show it is possible to keep sovereignty and economic growth while being outside of the EU.
But it is the “what if” that will be the key issue for the rest of the first half of 2016, and such a historic referendum is also a Pandora’s box by prompting other countries in the region (and within the United Kingdom, notably Scotland) to demand the same. And the “what ifs” in a world of higher risk aversion since the global financial crisis can be just as damaging, not just for the UK, but for the global economy.