Question

Brexit. Essay

Answer 1

BREXIT – Disintegration at the time of Crisis

Background

United Kingdom decided to join European Union on 1^st January, 1973. It was now an integral part of European community, which meant any economic, political and sovereign issues faced by a European Union member would directly affect the activities in Britain. Europe as a whole was expected to do extremely well at that time and the benefits were expected to be riped by all the nations. Yet, many nations did not realize the repercussions they would have to face if even one economy crumbled, or if one economy did not cooperate.

This came as a blow to many nations when situation in Greece deteriorated in 2010, while the leaders of the nation refused to cooperate and implement austerity measures. Germany was adversely hit when the PIIGS nations (Portugal, Italy, Ireland, Greece and Spain) were facing slowdown, while some were on the verge of being bankrupt, other were actually bankrupt and were looking to exiting the European conglomerate. Yet, the collective efforts taken, such as European Financial Stability Facility (EFSF) & European Stability Mechanism (ESM), and the debts given by the ECB, the US Federal Reserve, the central banks of Canada, Japan, Britain & the Swiss National Bank helped these nations to survive for a longer period of time. However, the economic scenario in Europe remained weak.

In the midst of the European Sovereign Debt Crisis, the leaders of United Kingdom decided to vote whether it wants to stay in Europe, or wants to leave it. The issue of exiting the European Union was put to vote on June 23, 2016, in which 51.9 per cent of the voters, without realising the consequences, decided to exit European Union – giving birth to a well known term today – BREXIT.

The present article attempts to identify the key reasons for Britain’s exit; its expected impact on Britain, major world economies, and currency; the new challenges that the world faces now and the road ahead.

Why BREXIT?

One of the major reasons that caused BREXIT was the shrinking dominance of European Union on the World Economy, and the shrinking influence of United Kingdom on European Union decisions. For example, contribution of European Union to World GDP is expected to decline from 37 per cent in 1973, to 22 per cent in 2025.

The fear of rising immigrants was another major reason Brits opted for BREXIT. Being a part of European Union meant that the nationals of other European Union member countries could freely move in and out of Britain. This led to a huge increase in the immigrant population in UK. It is widely believed that it is the fear of immigrants snatching the domestic jobs in UK that led to Brits deciding in the favour of leaving European Union.

Immediate Impact

When the results of poll were declared against the expectations, there was a turmoil in global financial markets, with high volatility felt across the equity, bond, currency and commodity market. Effectively, UK’s domestic currency depreciated tremendously, hitting a 30-year low – 1.389 Pound/ USD. While the Pound Sterling depreciated by 11.08 per cent, Euro, Australian Dollar, Swiss Franc, Canadian Dollar, Chinese Yuan and Indian rupee depreciated by 4.15 per cent, 4.03 per cent, 2.34 per cent, 2.32 per cent, 2.08 per cent and 1.43 per cent respectively. On the contrary, Japanese Yen appreciated by 6.73 per cent.

Further, investments in safer assets rose sharply and the riskier ones declined, because of which prices of assets like gold rose sharply, and that of G-Secs declined.

Impact of BREXIT on World Economy

Post BREXIT, the negative reaction received worldwide by the major players has indicated the unexpected quotient of the event. Given the strong United Kingdom – Europe trade ties, BREXIT was totally unanticipated; as the costs that both may have to bear would obviously outweigh the possible gains. Yet, when the Brits failed to see these costs, there was a global unrest amongst the investors. However, even though global GDP growth may initially witness a decline due to the strong UK-EU trade relations, as the time passes, these extra costs will be incorporated, and become implicit.

BREXIT may lead to continuous devaluation (over and above what has already happened) of Pound Sterling. This is because, as the UK trade declines, the economy weakens, leading to weakening in the currency. Further, it may be considered that weakness in pound sterling would lead to strengthening of the US Dollar, and other currencies, relatively. This would make goods produced in UK cheaper, leading to a rise in exports. Given such a situation, one cannot claim with confidence whether the net effect would be a rise in trade, or decline in the long run. But in the short run, the net trade would decline, leading to a slow growth of UK economy.

Further, it is necessary to point out that the World Economy is already weak, and was showing signs of recovery when BREXIT took place. This further pressurized the struggling world economy. Fortunately, the global financial markets recovered very soon, yet, the net effect of BREXIT is still to be seen.

Impact of BREXIT on Europe

United Kingdom is a very special nation for European Union, as it contributes over 16 per cent to the European Union GDP. Clearly, Britain’s exit from Europe will lead to weakening of the Union’s clout. Further, BREXIT may give the nudge to existing deflationary tendencies in the fragile European economy.

However, as the rest of the financial instruments may weaken, sovereign bonds of Germany and France are expected to benefit, as they are considered to be safe investments.

Impact of BREXIT on United Kingdom

The growth of GDP of United Kingdom is already being trimmed, hurt by the fears of possible repercussions of BREXIT amongst its trading partners. It registered a growth of 0.4 per cent on Quarter-on-Quarter basis, which is lowest since 2012.

Further, fears of BREXIT have kept a lot of capex spending on hold. The clear impact of the event would be clear only when these investments are made, and the economy improves.

Challenges Triggered

United Kingdom is expected to witness economic and political volatility as the newly formed government would have to navigate the consequences of withdrawal from European Union very efficiently. Also, a major 48 per cent of the Brits voted to stay with European Union. It would be a difficult task for the government to convince these people as to the progress of the nation.

Further, the newly formed government would be facing huge expectations of delivering better economic growth and prosperity, where two-thirds of the investment in the nation was made by European Union. In such a scenario, European Union may become more agile and flexible as an economic block to the growth of the country.

Clearly, volatility in the financial markets is expected to exist and may move higher, leading to increased volatility across asset classes. Bank of England may be considering rate cut, yet the outcomes of it are unknown, and can only be speculated. On the other hand, the demand for US treasury is likely to surge sharply, thereby depressing yield further and pushing rate hike expectations in US even lower for 2016.