Where will Brexit leave LAC?

Antigua and Barbados may have most to lose

Simone Hudson-Bernard

Friday, November 11, 2016

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Brexit and its potential negative impact for Latin American and the Caribbean’s (LAC) main export products and trade relations have been on the minds of many. The results of the June referendum sent shockwaves throughout the global financial markets in the immediate aftermath.


Fresh waves of uncertainty reverberated across the market following the new Prime Minister Theresa May’s pronouncement in October that she would invoke Article 50 of the Lisbon Treaty (the statute that governs the protocol for countries who wish to exit) by March 2017 to begin the formal withdrawal process.


Expectations are that the United Kingdom’s (UK) economic activity will be severely affected by the uncertainty, as well as the possibility of having less favourable trade agreements than it currently enjoys as part of the European Union (EU).


Declining demand in the UK will undoubtedly present negative implications for tourism in the Caribbean, given that the UK is a primary source market for some countries in the region.


LAC interests are also concerned that overseas development assistance and their representation in the EU would be diminished.


While the impact of the fallout may be minimal for some countries, others that have had historically close ties with the UK may have a very bumpy ride over the next few years. This is especially true for Barbados and Antigua, which rely heavily on the UK as a source market for tourism income.


UK GROWTH PROSPECTS


From a macroeconomic perspective, the Brexit vote implies a significant increase in economic, political, and institutional uncertainty for the UK.


One of the main areas of concern is the nature of the trade agreements the UK will be able to negotiate with the EU and the rest of the world. The prime minister noted that she will be seeking to negotiate the best possible exit terms, but she faces an uphill battle.


The UK’s goal is to negotiate a free trade agreement with the EU that is as close as possible to the terms it currently has, without the automatic adoption of EU regulations and the associated cost.


At the same time, it is in the best interest of the EU to play hardball with the UK in an effort to discourage similar actions by other member states. UK’s trade negotiations with the rest of the world may also be difficult, given that it will lack the backing of the larger EU.


While the trade impact will be felt in the medium term (it will take approximately two years to complete the withdrawal), the country is suffering the consequences of the uncertainty it has created.


Following the vote, the pound has declined precipitously and the growth prospects for the EU have dimmed. The pound dipped to a 30-year low in the immediate aftermath of the vote and has lost 17 per cent against the US dollar since the start of the year, making it the worst-performing developed market currency.


The decline in the value of the pound is expected to reduce the purchasing power of Britons. British importers, vacationers and expatriates are among the groups that will be most affected by the decline in the value of the currency.


Further, the International Monetary Fund (IMF) believes that the risk to the UK economy is significant as the uncertainty over the impact of severed ties to the EU will depress consumer spending, business investment and hiring decisions. The IMF has cut its 2017 forecast from 2.2 per cent prior to the referendum to 1.1 per cent. The changes to the IMF’s forecasts echo those of London-based economists, many of whom are expecting a sharp slowdown in economic activity.


IMPACT TO BE GREATER


Lower output and weaker purchasing power will reduce UK’s demand for exports, but this will be a bigger problem for the Caribbean than it will be for Latin America.


Broadly speaking, the direct trade exposure of countries in Latin America is small as the region has historically had stronger ties with other EU member countries such as Spain and Portugal. The UK accounts for less than one per cent of the region’s exports.


As it relates to the Caribbean, the UK is among the top 10 Caribbean Community trading partners, but accounts for just 1.9 per cent of its total export market. That said, the impact will be most significant for a key product — tourism, a mainstay in the Caribbean, where the dependence on the UK is greater. As such, while the more diversified economies will be better able to weather a UK downturn, those with significant gross domestic product (GDP) contributors from tourism will find the going tough.


Several Caribbean countries are heavily dependent on UK tourism. The most vulnerable are Antigua and Barbuda, Barbados, Grenada, St Lucia, and St Vincent and the Grenadines.


The risk to Antigua and Barbados is the most significant given that UK’s tourism contribution to GDP is 17.7 per cent and 14.4 per cent, respectively. These territories also benefit from remittance receipts from the UK as well as the large population of UK expats. The decline in the value of the pound will dampen these benefits.


Of note, with these economies only now beginning to recover from the financial crisis, frail current conditions may not be able to withstand the gale-force headwinds from Brexit.


For Latin America, a direct fallout from Brexit may not be as significant given a much smaller trade exposure. Colombia is the country with the most at stake. Some 2.5 per cent of its exports (mostly coal) go to the United Kingdom. For Brazil the figure is 1.7 per cent and Mexico, 0.65 per cent.


That said, to the extent that most of Latin American countries are heavy commodity exporters and a slowdown in Europe could depress commodity prices, a small direct exposure does not mean total insulation from the negative effects.


The Caribbean will also be losing its voice in the EU, as for many years Britain had served as a voice for the Caribbean in council meetings in Brussels with the European Commission and many other EU institutions. This helped to ensure that the region has had stronger representation among the group of member states that, for the most part, did not have strong ties with the region. This voice is likely to be silenced with the final execution of Brexit.


Importantly, British overseas territories (BOTs) could suffer a loss of preferential trade partner status and EU structural funds. As such, countries like Anguilla, Montserrat and Turks & Caicos which receive direct funding from EU could experience worsening fiscal positions, which will potentially undermine long-term growth.


Brexit remains a major global concern, and the region is not expected to escape unscathed. While the direct impact of Brexit on Latin America and the Caribbean on a whole is muted by the fact that Latin America’s dependence on the UK and EU has been fairly low, some Caribbean territories such as Antigua and Barbados, which rely heavily on the strength of the UK economy and the pound, will be hit hard if the UK gets a raw deal.


As such, if this is not yet on the cards, plans should be put in place to minimise the potential economic impact.





Simone Hudson-Bernard is manager of Research & Structured Products at NCB Capital Markets.

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