Britain voted to leave the European Union (EU), a decision which leaves the world’s fifth-biggest economy facing deep uncertainty about its growth prospects and its attractiveness to investors, and which could hurt other economies in Europe and beyond. Given the economic heft of Britain and the EU, panic generated by this “Brexit” made the markets crash and led to a loss of $2.1 trillion. Though the market tottered back to an even keel, the real ramifications of Britain’s divorce from the EU will be visible in months and years to come.
November 1, 1993, saw the beginning of a new era. After the Second World War, there was a need for friendly relations between Germany and France. It laid the kernel of the regional consortium called the EU. Following the Maastricht Treaty in 1993, the EU was established. Since then, it has grown in size. It is an economic and political union of 28 countries. The EU allows a single market, which allows the free movement of goods, trade, services, and people between the member states. As of January 2014, 507.4 million is the population of EU and it has an economy whose GDP is 14.303 trillion Euros.
In 1992, Britain was forced to withdraw from the European Exchange Mechanism, when it failed to stem intense currency speculation. In 1997, it took the decision of remaining outside the Euro. The final clash between the EU and David Cameron, Prime Minister of Britain, started in 2011. He wanted to introduce levy on banks and restrict British financial sector. This was the beginning of the tussle between Brussels and London. Cameron promised to organize a referendum to decide whether to stay with EU or not if he won the 2015 elections, which he did easily. So June 23 was decided to be the day when the referendum would be held and to everyone’s surprise, Britain decided to leave the EU to pave their own way towards development. The “Leave” campaign got 51.9% whereas “Remain” got 48.1% votes. This forced Cameron to resign.
Impact on Britain
Votes cast against staying in the EU will kill the illusion of inevitability of European integration. The impact of Brexit on trade of the UK will vastly depend on how the relations between the UK and the EU evolve. Regulatory divergence, which adds to the cost of trade is supposed to go up. This will damage the bilateral trade volumes, which in turn will decrease Britan’s position in Europe. This cost will have to be borne by British consumers and businesses. The EU is a more important trade partner to the UK than vice versa. Post-Brexit, the outcome of trade will be damaging for both the sides; trade might reduce and the cost of trade might increase. On the other hand, the UK runs the most bilateral deficits against many member states, so the UK’s demand is very important at the macro level for many EU countries.
Among the EU countries, the UK is the largest recipient of FDI. Brexit will definitely reduce its attraction as an entry point to the EU. This will reduce investments from other EU countries into the UK. This will also make it harder for Britain to attract corporate HQs. The EU was the source of 46% of the stock of FDI in the UK in 2013. This dependence has fallen somewhat in recent years, with the EU’s share down from 53% in 2009. A poll of British firms suggests the impact of Brexit will be damaging not only to FDI, but also to the investment intentions of UK firms, with 29% more saying it will have a negative than a positive impact. Many large MNCs have heavy investment in the UK. The commercial logic of this investment might get hurt due to Brexit. The UK may compete more aggressively by undercutting the EU on taxation to attract investment.
UK has championed the idea of single market, but outside EU it will have less effectiveness. There have been many critics in UK who has criticized the excessive regulations of EU. Most of these regulations were made to create a level playing field for everyone. The UK has also played a significant role of shaping policy debates in the EU in ways that matter irrespective of the UK’s voting weight. After Brexit UK will lose the influence without gaining much independence to regulate. The balance on economic policy debate in European Council will shift after Brexit. Countries will start opposing liberalization. If UK leaves the EU, this will shift the balance of power in the Council away from the liberalizers, who will find it harder to assemble a blocking minority, even with German support. The combined votes of Germany plus the ten most liberal states would by itself be insufficient to achieve the necessary 35% of votes. Germany, being a swing state in the debate, will become more exposed politically as it will have to lead the opposition to liberal measures.
UK industries benefit from research collaborations in Europe. UK would gain flexibility over industrial policy outside the EU but will lose benefits in areas such as energy. The UK receives more funding from the European Research Council than any other country and 50% more than Germany, allowing UK universities to fund more than 10% of project-based research from EU contributions. The UK would gain leeway to run a more active industrial policy unconstrained by EU state aid rules under some models. This might include reinstating a public interest test for takeovers, or introducing more comprehensive R&D tax credits. Industrial policy in EU is dependent on the Brexit model. A weakening collaboration in education research might be seen after Brexit. The UK may adopt a different approach to procurement following Brexit with government discretion being used more freely, particularly when under political pressure. The UK’s influence over the culture and style of regulation in key sectors, including the utilities, would be likely to diminish following Brexit. Access to UK universities could become more difficult for publicly-funded students, who benefit from the Erasmus programme, and privately-funded students, given the risk that the UK tightens migration controls.
Some countries might face impacts on the labour supply and flow of remittances. The biggest risk would be of political contagion in Europe if UK tightens its border controls. The biggest costs from UK controls will be borne by EU firms invested in the UK as operations based outside the UK, can always substitute for UK labour. There would be a significant effect on countries that are major sources of immigration to the UK, such as Poland. It would impact positively on skills and the supply of labour, but negatively on remittances. The biggest risk for the rest of the EU is that UK restrictions increase hostility towards immigration in other states, both because of deflected immigration and how UK policies impact on the policy debate elsewhere. Residents of the EU are free to travel and live in any other country in the bloc. Those from countries like Romania, Poland, Spain with either high unemployment, low pat or both have often sought opportunities in Britain. Controlling Britain’s borders has been central to the Brexit push.
Present EU regulations would make it hard for UK to stand in the European market mainly in retail products and Euro trading. Under the Swiss or FTA models, the UK must negotiate access to EU markets in financial services. The EU only allows access to countries with equivalent regulations. The Swiss experience highlights the risks to the UK. They have equivalence under AIFMD, are being assessed under Solvency II and will try under MIFID. The UK is the leader in euro-denominated wholesale banking, but Euro zone countries and institutions want this activity to move to the Euro zone and be overseen by the ECB. This would be much more likely following Brexit, as the UK would no longer be protected by ECJ enforcement of single market rules. Brexit will impact location, liquidity, and cost of financial services in Europe, if UK’s competitive position is undermined. London is not just a European financial centre – it is an international centre with a dominant position in many product areas. The most likely beneficiaries in the EU are Paris, Frankfurt, Amsterdam, and Dublin. But they cannot replicate overnight the advantages of the London ‘ecosystem’ supporting financial services, including skilled staff, legal services and market infrastructure. Brexit would likely change the balance of financial regulatory debates in Europe. UK would be free to set its own policy regarding trade priorities. However, it might not be much different from that of the EU. The liberalizing approach to trade policy of EU is much due to the influence of UK. Except UK, EU would not have been an attractive partner for trade agreements.
The Bank of England, after the publication of results said that some market volatility can be expected following the UK’s decision to leave the EU, “but we’re prepared for this”. As a back-up and to support the functioning of the markets, the Bank of England stands ready to provide more than £250 billion of additional funds for its normal market operations.
The biggest drawback of the leave campaign is that they have not decided the future path of Britain after leaving EU. There is no strong plan regarding the relationship of Britain with the EU after the break away. Due to Brexit global market volatility is inevitable. India cannot stay immune to that. The Pound will definitely depreciate against many major currencies. Sensex and Nifty will tumble in the short-run.
Impact on India
India presently is the second largest source of FDI in Britain. This might be because of the historic and cultural ties of India with Britain along with Britain being the gateway for the rest of Europe. The free market system of the EU helped Indian companies to set up factories in the UK and sell their products throughout Europe. On the other hand, Britain would not want to lose investments from India, so it might try harder to keep it up. Britain’s exit from the EU will make India lose its gateway to Europe. So India might search for new allies in the EU for good results in the long run. India is in a process of developing stronger relations with the Netherlands, France, Germany and other countries. As of now, the Netherlands is India’s top FDI destination. Brexit will force India to have a trade partnership with other EU nations to have access to the EU market.
According to SBI Chairman, Arundhati Bhattacharya, “Uncertainty of any sort results in volatility and Brexit will be no exception. As risk aversion sets in, there would be a decline in financial markets and India would see this impact along with other nations. However as trade strategies are reworked there could be potential advantages in the form of better market access for India to EU and the UK.”
Britain is one of the most attractive destinations for Indian students who want to study abroad. Presently, the UK is forced to offer subsidized rate for EU citizens. Brexit will enable the universities to free up funds for students from other countries. This in turn might help many students from India to get scholarships.
Indian companies, which have huge exposure in Britain and in the EU like Tata Motors (JLR), Tata Steal Europe and Motherson Sumi are expected to face falling sales, high operation costs, and immigration barriers. The actual exit from the EU will take few years time. Companies like these will have to make different arrangements to sell their products in the EU. JLR sells 25% of its products made in the UK to rest of Europe and it is in the process of setting up another plant in Slovakia to cater to the demand. Tata Steel UK is in the process of selling its UK business and is negotiating with the British government to retain part of its operations. Motherson Sumi’s Chairman V.Cl Sehgal said, “We are planning to set up third plant in the UK – Brexit or no Brexit.” Pharmaceutical companies like Lupin and Cipla would also be negatively impacted as it would earn less when exports. While it may be bad news for Indian companies, which have exposure in the region, local companies which have taken loans in British currency will get a bonanza as Pound fell by almost 10% on the day of declaring the results. Prabal Banerjee, CFO of Bajaj Group, said, “This immediately shaves off 10% from the cost of funds as companies will now have to pay less when they are repaying loans.”
The broad pattern is consistent with the reaction of the Indian diaspora to Brexit. In terms of country of origin of immigrants to the UK, Indians are at the very top. While opinion polls keep changing like British weather, a recent poll suggests 52% of Indian-origin voters are against Brexit, with 28% being in support, and the remaining undecided. Indians in the UK tend to be young, highly educated and employed as professionals or skilled workers for whom trade and migration in an integrated market is a net-plus.
Professor Purushottam Bhattacharya, an expert on Inter-national Relations, told BE that the existing immigrants from India in the UK will not face any difficulty. The problem is mostly regarding the EU migrants. The UK will open its door for only that much of skilled labourer they need. If they have a proper offer letter from the employer, then they will easily get a work visa. The border will be tightened for EU immigrants. Till date, people from the EU did not require visa to enter the UK as it was a part of the EU, but from now they will need one as for the last twelve years it has become very difficult to stop European migrants to the UK.
The economy will definitely be affected by this decision. According to Professor Bhattacharya, the EU is almost like
a single country. So India need not negotiate with the countries separately but from now on India will have to negotiate with Britain and the EU separately in case of trade and other functions.
According to Raghuram Rajan, Governor of RBI, “Indian economy has good fundamentals, low short term external debt, and sizeable foreign reserves.” Indian Finance Minister Arun Jaitley has nearly same opinion as Rajan. He said, “India is well prepared to deal with the outcome of Britain’s referendum on leaving the European Union. India is strongly committed to macro-economic stability, while its fundamentals were sound with a very comfortable external position, a rock-solid commitment to fiscal discipline and declining inflation.”
Following Brexit, Scotland is willing to go through another referendum. Wilder in Holland for sure would ask for an exit referendum. General elections in France and Germany would be crucial, especially since France is undergoing a huge turmoil. Germany is also stressed enough about the refugee crisis. On the western front, there is a high chance that US Republican Party’s presumptive presidential nominee Donald Trump might get voted to power and a more closed-door policy to immigrants might not be improbable. The rise of strong right wing, hyper national forces might portend a step back for a hyper-connected world.