The EU Referendum of June 23rd 2016 led to a non-binding result for the UK voting to leave the EU by 52% to 48%. Although the final exit is not expected to take place for at least two years, the event has led to a lot of uncertainty in the global economy and a lot of emotional reactions from both opponents and supporters of the referendum result.
The immediate reaction to the results was volatility in the UK market and in other international and domestic markets that have high exposure to the UK specifically and to the EU in general. These market volatilities are mainly due to the surprise factor and uncertainty as most people are unsure of the implications of a Brexit on their economies.
The apprehension evident from global and domestic markets is not unfounded considering the fact that the British economy, which is worth $3 trillion, is the fifth largest economy in the world and the second largest within the EU. This makes the UK, a major component of both the global economy and that of the EU, such that shocks to the British economy will have some effects on the global economy.
The debate on the gains and losses that will result from a Brexit centers on the pros and cons of economic integration. The justification for creating the EU was that there are gains for all parties concerned if there is freedom of movement of goods, services, capital and labour (persons) among the countries. The impact of a Brexit will therefore depend on the degree to which the barriers to these four freedoms are re-established between the UK and the EU. If the negotiations between both parties result in a more protectionist Britain, naturally this should have more dire consequences for the whole world than if Britain is able to retain access to the EU’s single market.
When article 50 is eventually triggered, the long term financial implications for the UK will be that London will no longer be viewed as the top financial centre of the world or of Europe for that matter. Potential investors may prefer to go for a city that is still in the EU because of the mobility of factors of production in and out of it. Likewise, global businesses previously head-quartered in London and which made significant contributions to the UK economy will now look to other European cities such as Paris, Frankfurt and Dublin whose future seem less uncertain than that of the UK.
In addition, a Brexit would mean that places in the UK (such as London) that are heavily dependent on EU buyers and capital would experience a slow down due to flight of EU capital, companies, jobs and workers. This will be especially bad for British financial institutions who will lose their access to the EU if there is no longer a single market. With the resulting slowdown in UK growth, the UK government will have less income to spend and so will have to implement tax increases and spending cuts. This might lead to a rise in unemployment, which will reduce the pressure on wages to rise.
Following the release of the EU referendum results, volatility also plagued some emerging and frontier markets in Africa due to their close ties with the UK and the EU. The three most important African countries with respect to relations with the UK and the EU are South Africa, Nigeria and Kenya, and a Brexit is expected to affect them in terms of Foreign Aid, Investment, Trade and Trade Agreements. The South African economy is the most exposed to the global economy.
While the UK has pledged to spend 0.7% of its Gross National Income (GNI) on development aid, there is a high probability that the absolute value of this would reduce if a Brexit leads to a recession in the UK. This would reduce development aid to Africa, even if temporarily, and the impact of this will be greatly felt since the UK has been contributing a lot of aid to the continent. In Nigeria, for instance, the UK Department for International Development (DFID) had a portfolio of 40 projects with a planned budget of £232 million for 2014 -2015. In addition, the contributions the UK makes to the World Bank makes its total investment up to about £400 million a year in development aid to Nigeria.
If the UK falls into a recession, that could reduce trade and investment between it and its African partners. This is not good news for emerging African countries that have a large portion of their exports go to the UK. For example, the UK is South Africa’s fourth-largest trading partner, and a majority of Kenya’s flower exports go to the UK. In addition, trade between Nigeria and the UK stood at £6 billion in 2015 and was projected to reach £20 billion by 2020. However, this amount may not be realized if bilateral trade between the UK and Nigeria falls.
Nigeria has gained from its relationship with the UK in the past. According to the National Bureau of Statistics, the UK was Nigeria’s largest source of FDI in 2015, with assets worth over $1.4 billion. In addition, remittances from Nigerian diaspora in the UK was $21 billion in 2015. If a Brexit causes a recession in the UK, all these figures may drop for Nigeria.
The Brexit comes at a bad time for Nigeria which is struggling with falling oil prices. A UK recession can lead to lower demand for oil, which can further lower oil prices and can cause EU nations to look to cheaper sources of oil such as Iran. In addition, the insurgency in the Niger Delta region, the newly liberalized FX market, and the fact that Nigeria was recently downgraded by Fitch means that global risk aversion towards Nigeria will be high at this point. Thus, while there are gains for Nigerian companies that can now import from the UK at a cheaper price, the risk aversion towards Nigeria means that new portfolio inflows into the country will not come at this period when risk-sensitive investors are looking outside the UK to invest in other economies.
Tochukwu Nwachukwu
