South African export businesses in the machinery, vehicle manufacturing and platinum industries could be heavily impacted by the British withdrawal from the European Union (Brexit). So writes Lullu Krugel*, Chief Economist at KPMG South Africa, in an exclusive analysis for CFO.co.za. South African businesses also might have to consider moving their European offices from London to elsewhere in Europe to keep access to the EU Single Market. Ireland anyone?
Brexit - the most complex "divorce" in history?
Around three quarters of Britons that were eligible, turned out to vote in the June 23 'Brexit' referendum, and decided in favour of the United Kingdom (UK) leaving the European Union (EU). In a largely unexpected outcome, a small majority of 51.9% won: the 17,410,742 'leave' votes were 1.3 million more than the "remain" votes.
- Also read: Fear and uncertainty after #Brexit - Peregrine Group CFO Robert Katz
Economic impacts of Brexit
The immediate reaction was one of shock: Prime Minister David Cameron resigned, effective October 2016; UK banks lost around 18% to 22% of their market value on the 23rd of June 2016, an amount similar to the South African government's total budget; the British Pound depreciated by 10%; house prices in the UK are expected to decrease and KPMG UK Economics leaders are forecasting a reduction in GDP of 3% over what it would have been, for this year and next year until matters settle down. There is also speculation that the Bank of England will cut interest rates by .25% or even .5%.
After the initial shock, markets have started to adjust and consolidate over the past few days and we are now moving from speculation to planning for what might happen next, especially regarding the impact on business. It is certain that Brexit will inhibit economic activity in the UK, in fact, there has even been talk of recession, but the lack of any similar occurrence makes it difficult to quantify this impact at present.
With the key principles of the European Union largely about freedom of movement of people, services, capital and goods, these will be the areas that would have the most significant impact on the practical business side. As it is currently very unclear what form the new relationship between the UK and the EU will take, it is important that businesses and boards put plans in place to respond to potential challenges.
Key areas of impact and potential actions required
- Regarding the people aspects, EU nationals have not been required to have work permits/ visa's to work in the UK since the UK joined the EU 43 years ago and there is some uncertainty on their position going forward. Business needs to consider what support they will provide to such employees, particularly people in key roles who remain mobile and can move to any of the other 27 Member States.
- Brexiting the EU could require the UK to renegotiate many trade, investment and aid agreements with up to 100 countries worldwide. Of course, the UK could decide to merely replicate all existing trade, investment and aid agreements signed as part of the EU - essentially using EU documentation as templates for bilateral agreements. However, if the UK signed these agreements with reservations, a renewed round of bilateral talks. For South African export businesses in the machinery, vehicle manufacturing and platinum industries, the impact of potential changes of these agreements, needs to be taken into consideration. In 2015, South Africa exported vehicles and machinery to the value of R190 billion to the EU, including the UK. Economic Partnership Agreements (EPA) with the EU - one signed with Southern African countries a week before the Brexit vote would likely have to be renegotiated given that the UK was a signatory to these deals. This will affect import and export agreements between African states and both the UK and EU.
- The UK has also been - and will no longer be - a strong voice against the EU's pro-subsidy Common Agricultural Policy (CAP).
- In addition, for individual businesses, supply chain issues could result from the impact on the movement of goods: the EU is the UK's biggest export market and the impact of uncertainty on tariffs and clearance of goods needs to be given careful consideration. Business should also consider the impact on any upstream suppliers who may be negatively impacted, especially any critical supplies and they may need to consider alternatives from a business continuity perspective.
- London is one of the world's financial capitals. South African business that use The City as a base for accessing the EU market would have to rethink their office locations and financial commitments in the UK. This might require them to set up shop elsewhere in Europe, irrespective of how much time and money has been invested in London. Ireland with its 12.5% rate of Corporate Income Tax is seen as a popular location, and consideration of this option should be done early, especially if continued access to the EU Single Market is a business critical issue.
- Liquidity will be an issue for business as credit may become tighter as the banks deal with changes in capital adequacy ratios. The fall in spending will have widespread impact across the economy so business need to urgently review their liquidity and have discussions with their lenders.
The way forward
The vote is not necessarily binding on Parliament, but in the Prime Ministers Question Time in the House of Commons, the Prime Minister made it clear that Parliament should accept the decision in the referendum (so no re-run) but on all other matters, he deferred all decisions to the next Government.
The most significant questions are around timing: Article 50 of the Lisbon Treaty governs the application by a Member State to leave the Union. It provides for a two-year period in which to unwind the various agreements and provide for an orderly exit. Notably, it also prohibits any negotiations on new trade deals until the 2-year period has elapsed. However, it is up to the Member State wishing to exit to apply formally to do so, which then triggers the start of the 2 years, but it is silent on what forces them to make the application.
Therefore, the UK will remain a Member State until 2 years from the date of formal application under Article 50. David Cameron has said the making of the application should be done by his successor who will not take office until October, a move that has been described by some political commentators as a deliberate step to put the leaders of the "Leave" campaign in a very difficult position.
In addition, the Scottish National Party (SNP) has stated that it believes that Scotland must remain in the EU and has not ruled out another referendum on Scottish independence. This will likely fuel uncertainty over the future of the UK itself and whether or not Northern Ireland and Scotland would break away and remain in the EU. However, the EU is likely to apply pressure to bring that forward so as to end the uncertainty and restore stability. This week's meeting of the EU leaders must have been an interesting discussion.
*Lullu Krugel is the Chief Economist for KPMG South Africa and a director in the Financial Risk Management Business Unit of KPMG. For more information you can contact her on +27 82 708 2330 or [email protected]
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