Impact of Brexit On The World Economy

Impact of Brexit on the world economy
23 February 2016
Author: Chutima Tontarawongsa, Ph.D.
British Prime Minister David Cameron set the date of June 23 this year for a referendum
to decide whether the United Kingdom (UK) will stay with the European Union (EU), setting
stage for a potential Brexit (British Exit). The announcement came after Cameron completed
a negotiation with other EU leaders on the EU membership of the UK on February, 19. The
deal secures the UK special status in the EU that includes the continued use of pound sterling
and the right to deny further integration such as political integration. It also unlocks the
condition regarding benefits for migrant workers, easing the UKs burden from the influx of
refugees. This issue is considered one of the factors pressuring the UK to leave the EU.
The risk of the UK leaving the EU increases financial market volatility in the short
term, but remains much less severe than the case of Greece. After the announcement of
the referendum date, the British pound weakened 2.3% against the US dollar, lowest in 7
years. The UK government bond yields however did not change. EIC views these movements
as short-term volatility with a predetermined timeline. If the UK chooses to stay with the EU
in June, the outcome will reaffirm its status as an EU member. However, in the case of an exit
outcome, the Lisbon Treaty (2009) specifies that once the member state notifies the European
Council of its intention to exit, it will take at least 2 years before the membership ends. This
time lag allows for both sides to formulate a transition plan as well as negotiate for new deals.
Note that the case of Brexit differs greatly from the Grexit risk in 2015. In the case of Greece,
the main cause was the possibility of Greece defaulting on its debt, while Brexit is not related
to financial problems.
EIC maintains that the possibility of Brexit is low due to large potential negative
consequences. At present, opinion polls suggest that in votes are leading out votes at
43% to 40% (17% are undecided). The votes to exit have been gathering momentum since
mid-2015 partly due to the migration problem in Europe and the pressure on EU members to
share refugee burden. Other factors that support the UK to leave the EU include the fiscal
burden to prop up weaker economies within the EU and restrictions on some political issues.
However, EIC views that the outcome of the referendum is likely for the UK to stay. The
newly negotiated deal helps ease concerns over burden from migrant workers and reduce also
pressure for further integration. Although an influential politician like Boris Johnson, Mayor
of London, has joined the Brexit campaign, the exit could prompt another referendum in
Scotland whether to split from the UK as most Scots prefer to stay with the EU. Past episodes
show that most English do not want Scotland to depart from the UK. Moreover, recent
volatility in the economy in response to the possibility of Brexit could sway the undecided
group towards staying votes more.
The case of Brexit will hurt both the UK and the Eurozone economies especially
through the uncertainty over trade and labor movement agreements. The UK exit from
the EU could hurt trade between the two sides, as their trade flow accounts for a third of all
international trade from the UK. This is because the uncertainty on whether they will be able
to renegotiate to maintain the "single market" condition. For the UK, trade agreements with
other counties that it has signed as a member of the EU could be in jeopardize; this includes
free-trade agreements with Switzerland, South Korea, and some Scandinavian countries.
Furthermore, the end of free labor movement may prompt multinational corporations to
relocate their headquarters away from London, the current financial hub of Europe. HSBC, a
large international bank, has recently threatened to move its investment banking office to
Paris in the case of Brexit. Additionally, Fitch Ratings and Moody's, international credit rating
agencies, have warned of lowering the UK's rating, which would affect its financial market
significantly. These aforementioned factors could put both the UK and the EU economies into
recession.
The UK referendum adds uncertainty to the global economy on top of existing

fragility. The weakening of the euro and pound from the increasing Brexit possibility reveals
market concerns over negative consequences on both economies. EIC assesses that recent
developments reflect short-term market panic rather than fundamental changes. A correction
should occur as the panic subsides. Despite being short-term, the increase in market volatility
could hurt business sentiment in terms of economic prospect and investment, adding pressure
to the recovery of the overall European economies. Therefore, the likelihood of the ECB
expanding its QE program in March has increased.
Impact on the Thai baht and export remains limited. Thai exports to the UK are about
2% of total Thai exports. Therefore, the short-term direct effect on trade is limited. Also, the
effect of the Brexit risk on THB/USD is small. Nonetheless, the referendum remains on a list
to be closely monitored. The unlikely event of Brexit could put the EU and UK economies in
recession. This could have a strong consequence on Thailand's export sector because
combined exports from Thailand to the EU and the UK account for 12% of total exports.
Additionally, the ongoing free trade negotiation between Thailand and the EU (currently
suspended since mid-2014) will not cover the UK and will require a separate talk

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The UK referendum adds uncertainty to the global economy on top of existing

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