With a month to go until the UK’s referendum on its membership of the European Union, opinion polls still suggest that the outcome will be very close. Clearly the impact of Brexit on the UK economy could be very significant, but it will also have knock-on effects across the rest of the EU, and eventually some of these effects may also be felt in other regions, including in the Gulf.
The possibility that the UK could leave the biggest single market in the world raises considerable questions about UK growth, interest rates, currency movements, trade, capital flows and foreign direct investment, as well as about security and numerous other political issues and risks.
While the debate in the UK has understandably been dominated by reports and studies about the economic consequences of Brexit for companies and the man in the street, probably the most significant and immediate impact for those outside of the UK will be felt through the impact on financial markets, and in particular the effect on the sterling.
The Bank of England, the International Monetary Fund (IMF) and other prominent global policy makers and think tanks have all opined noisily about the financial market volatility that would likely ensue after a Brexit vote, with the US Federal Reserve even thought to be considering delaying a further interest rate hike in June partly because of these risks.
The pound has already been the weakest performer among the major currencies so far in 2016, falling over 2 percent against the dollar, and at one point reaching 1.3834 after the referendum was announced in late February. However, there is potential for it to be much weaker in the event that the UK actually decides on the June 23 to leave the EU.
At a time when the US Fed is likely to be considering a second rate hike, Brexit could be the issue that consigns sterling to much lower levels. This would have potentially both positive and negative effects for regional economies.
Depending on how long such currency weakness lasts it could significantly impact on tourist flows to the Gulf, which have already been negatively affected by the weakness of other currencies such as the Russian ruble and the Chinese yuan.
At the same time, however, GCC investments into the UK may begin to look much more attractive considering the exceptionally weak sterling levels that might be seen, representing something of a once-in-a-life-time opportunity to purchase UK assets. Unlike other regions, GCC investments into the UK are for the most part not made with the motive of accessing European markets, but rather they are standalone investments made in their own right.
Certainly there would be the potential for significant volatility in currency markets following a Brexit decision, which would also likely have a bearing on other asset markets such as commodities, as well as on global monetary policy settings, all of which would have an impact on this region. From a more micro perspective as well, regional companies would have to get used to such currency volatility which in and of itself, and almost regardless of direction, could make a strong case for greater use of currency hedging tools requiring regional corporate treasuries to become more sophisticated.
Other than these arguments, however, the bilateral trading landscape between the GCC and the UK may not necessarily be harmed by Brexit. The EU has been unable to reach a Free Trade Agreement with the GCC, despite negotiations going back to 1988. They are currently stalled. In theory, at least, it may be possible for the UK to strike beneficial bilateral trade deals with GCC governments, something the UK may have an incentive to conclude. The UK only last month signed a Double Taxation Agreement with the UAE, demonstrating that bilateral deals might actually be preferred and more easily achieved.
But even without bilateral trade agreements, the alternative of continuing to trade under World Trade Organisation (WTO) rules need not hinder trade flows. In fact it seems likely that British trade policy could become more assertive outside of the EU as Britain strives to make deals and win orders all over the world to compensate for the loss of access to the EU internal market. British multinationals could thereby become more ambitious especially in prominent regional trading hubs such as Dubai, as they seek to establish a more prominent footprint across this region, and into others.
Untangling some of the existing frameworks related to British membership of the EU might in the event of Brexit initially be quite complicated and time consuming, and there would no doubt be a high degree of uncertainty. Financial market volatility would probably only add to that uncertainty, but once the dust has settled, it may well be that any weakness in the sterling will be seen as generating significant new opportunities. Furthermore, extracting itself out of the EU-GCC stalled FTA process may actually breathe new life into the UK’s trading relationships with the Gulf, as well as with other parts of the world.
Tim Fox, chief economist and head of research at Emirates NBD.
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