Following the UK referendum vote to leave the EU, IHS Markit has lowered its GDP growth forecast for the United Kingdom and European Union for 2016 and 2017.
The impact on Asia Pacific economies is not expected to be significant in 2016. But IHS has cut its overall Asia-Pacific GDP growth forecast for 2017 from 4.7% to 4.5%, taking into account the transmission effects of Brexit.
Asia-Pacific nations are not significantly exposed directly to the effect of any sharp slowdown in UK imports in 2017. However, the wider effect of the forecast EU slowdown is much more significant
The effect of the UK Referendum decision to leave the European Union has created political upheaval in the United Kingdom, with the resignation of David Cameron as UK prime minister.
There are initial indications that the Scottish Government may seek a possible second independence referendum and that Northern Ireland may want a possible referendum for unification with Ireland, in order to rejoin the EU. Incoming UK Prime Minister Theresa May has reshuffled the UK cabinet, with many significant changes in key portfolios.
Since the first half of 2016 is already over, the immediate economic effect during 2016 may be limited. But IHS Markit has lowered its GDP forecast for the UK in 2017 from 2.4% to just 0.2%, owing to the ongoing political and economic uncertainty that will affect consumer and business confidence and sharply reduce investment in 2017.
Following the Brexit referendum, the IHS Markit UK Purchasing Managers Composite Output Index fell sharply in July to its lowest level in 87 months. Also in July, new orders for both manufacturing and services showed significant declines, signaling weakening conditions for manufacturing, services and construction.
The overall Eurozone GDP growth forecast has also been cut from 1.8% to around 1.1% for 2017.
Transmission to Asia
The importance of the UK as an individual export market for Asian companies has declined significantly over the past 20 years. Fast-growing Asian markets, notably China, have themselves become increasingly important export markets for many Asian nations.
Owing to the declining importance of the UK as a significant export market, Asia-Pacific nations are not significantly exposed directly to the effect of any sharp slowdown in UK imports in 2017.
However, the wider effect of the forecast EU slowdown is much more significant. The 28-member grouping remains an important export market for many Asian economies. Asia-Pacific economies are expected to be impacted by the UK decision to leave the EU through the transmission effects on Asian exports of weaker EU growth.
A second transmission channel will be through volatility in financial markets, such as near-term weakness for the British pound and euro, owing to the political and economic shocks from the UK Brexit vote.
A number of UK commercial real estate funds have suspended trading due to a surge in redemption requests following the Brexit vote, creating liquidity pressures for the funds.
The weaker growth outlook for the UK and Eurozone in H2 2016 and for 2017 has pushed European bond yields lower. Eurozone government bonds with a face value of €4.3 trillion and an estimated €500 billion of corporate bonds now have negative yields.
The total amount of global government bonds with negative yields is estimated to have risen from US$11 trillion prior to the Brexit vote to US$13 trillion by end July 2016. Of this total, Japanese Government Bonds (JGBs) account for around US$8 trillion. The total value of JGBs with negative yields has risen substantially in June and July. Still, the US dollar and Japanese yen are expected to be preferred safe-haven currencies versus the pound and euro.
A third transmission channel will be lower European investment flows into Asia-Pacific countries. Weaker economic growth in the UK and EU and weaker corporate earnings as well as a more uncertain business climate will reduce corporate business confidence and constrain European corporate business investment plans globally.
Weaker UK and EU GDP growth in the near term is expected to result in the further postponement of any additional US Fed rate hikes until at least 2017, and is expected to result in further easing of monetary policy by the Bank of England.
The impact of Brexit on Australian exports is low, modest for China, significant for India and a negative shock for Japan
Meanwhile, the Bank of Japan has also announced further limited monetary policy easing measures in order to mitigate the effect of further yen appreciation, by lifting its annual purchases of exchange-traded funds from 3.3 trillion yen to 6 trillion yen per year.
Overall, the Asia-Pacific GDP growth forecast for 2016 is expected to remain unchanged. However the APAC GDP growth forecast for 2017 has been cut from 4.7% to 4.5% following the results of the Brexit referendum, mainly through the impact on Asia-Pacific exports.
Asia-Pacific exposure to the EU
The importance of the EU as an export market does vary significantly among the Asia-Pacific countries, with the total EU market share of Australian merchandise exports being very low, at around 5%, while for China the EU market is much more significant, accounting for around 15.6% of total EU merchandise exports.
- The impact effects of Brexit are estimated to be quite low for Australia. The Australian GDP forecast for 2017 is unchanged.
- For China, the impact is more significant, but still modest. Chinese GDP growth forecast for 2017 has been lowered from 6.4% to 6.2% as a result of Brexit.
- For India, the EU is a very important export market, accounting for around 16.2% of total Indian merchandise exports. As a result, Indian GDP growth forecast for 2017 has been lowered from 7.6% to 7.4% due to the impact of Brexit.
- For Japan, the effect of Brexit and the EU growth slowdown is a significant negative shock. Japan is hurt both because of the importance of the EU as an export market, which accounts for 10.6% of total Japanese merchandise exports, as well as the appreciation of the yen against most currencies, including the euro and pound, as it seen as a safe haven currency by global investors. Due to the estimated impact of Brexit on the UK and Eurozone, the Japanese GDP growth forecast for 2017 has been lowered from 0.9% to 0.7%.
- While Malaysian exports to the UK account for only a very small share of total Malaysian exports, the EU-28 group of nations accounted for 10% of Malaysian merchandise exports in 2015, making the EU Malaysia’s third-largest export market. Therefore, any substantial slowdown in EU GDP growth will have a significant impact on Malaysian exports. Due to the importance of exports in overall GDP, Malaysia is also more vulnerable to the transmission shocks through the trade channel than many other APAC nations. Consequently, the Malaysian GDP growth forecast for 2017 has been lowered from 4.4% to 4.0% due to the estimated impact of Brexit-related external shocks.
Since the EU does not yet have free trade agreements with many APAC countries, the UK will have greater flexibility to negotiate bilateral FTAs with those nations that may have faced cumbersome negotiations with the EU
- The direct effect on the Philippines' export sector from the UK economic slowdown is expected to be limited, since the UK is not one of the Philippines' major export markets. However, the lower growth forecast for the EU will hurt Philippine exports to Europe, which totaled €8.6 billion (US$9.5 billion) in 2015. The EU-28 bloc accounted for 12.2% of Philippines' total merchandise exports. Overall the estimated impact of Brexit transmission shocks on the Philippines is expected to be modest, with the GDP forecast for the Philippines in 2017 edged down from 5.9% to 5.8%.
- The EU is the second largest market for Vietnam, accounting for 18.5% of Vietnamese merchandise exports in 2015. Consequently the estimated impact of Brexit and slower EU GDP growth in 2017 is estimated to trim Vietnamese GDP growth from 6.5% to 6.3% in 2017.
- Although the EU accounts for around 10% of Indonesian exports, the overall importance of the export sector in the overall Indonesian economy is still relatively low, with domestic consumption and investment still dominating the structure of the economy. As a result, the GDP forecast for 2017 remains unchanged.
APAC FTAs with the UK
As a member of the EU, the UK has benefited from being a member of the EU Single Market as well as being part of EU free-trade agreements (FTAs) with non-EU countries.
The immediate effect of the UK Referendum is that the UK is expected to enter into a two-year period of negotiations with the EU about the terms of its exit. Therefore, the existing arrangements regarding the FTA within the EU will need to be negotiated through a new bilateral FTA between the UK and the EU.
After its EU exit deal is agreed upon, the UK will also no longer be under the umbrella of EU FTAs with non-EU countries. Therefore, the UK will need to negotiate new FTAs with individual APAC countries.
Given strong UK trade and economic and political ties with many APAC nations, this process of establishing new bilateral FTAs that mirror the EU FTAs could be relatively smooth with countries that already have an EU FTA in place, such as Singapore, South Korea, and Vietnam.
The South Korean government has already indicated that it will seek a new bilateral FTA with the UK as a trade policy priority. Incoming UK PM Theresa May and Australian PM Malcolm Turnbull have already signaled that a UK-Australia FTA would likely be a high priority for both nations.
Since the EU does not yet have FTAs with many APAC countries, this also offers the UK greater flexibility to negotiate bilateral FTAs with those nations that may have faced cumbersome negotiations with the EU.
But the EU-Singapore FTA, which has been agreed by both the EU and Singapore, and is currently being reviewed by the European Court of Justice to assess whether the European Commission has the authority to sign and ratify the FTA, could now face further delays in being implemented as a result of Brexit.
For APAC manufacturing companies with production hubs in the UK, an important uncertainty will be whether UK trade with the EU will remain free of tariffs, or whether any tariffs on trade will be applied
Asian investment in the UK and EU
While the political turmoil and uncertainty in the UK following the Brexit vote is expected to deter foreign investment into the UK by global multinationals in the near term, the slump in the pound and euro may increase the attractiveness of certain European assets for Asian individual and institutional investors, such as residential and commercial real estate.
With a number of UK commercial real estate funds under pressure to sell assets due to surging requests for fund withdrawals post-Brexit, this could create opportunities for Asian investors with long-term investment strategies.
APAC firms operating in the UK will also need to assess the implications of the UK exit on their use of the country as an operations center for accessing the EU market. Negotiations with the EU about exit terms is expected to take up to two years, so there is likely to be protracted uncertainty about the final terms of the UK’s exit from the EU Single Market.
For APAC manufacturing companies with production hubs in the UK, an important uncertainty will be whether UK trade with the EU will remain free of tariffs, or whether any tariffs on trade will be applied.
A key concern for foreign financial services firms operating in the UK will be the future terms and conditions for cross-border financial services provision from the UK to the EU countries. One important issue is whether the UK will be able to continue to operate as a Euro clearing hub for the EU or whether such functions will need to move to within the EU Single Market.
At present, IHS expectations are that the effect from Brexit on global growth will be modest and that the impact on world oil prices will be relatively limited. European oil demand growth is already very weak. The emerging markets, notably China and India, are the main drivers of oil demand.
IHS Energy continues to expect global oil (liquids) demand to be higher than production through the rest of 2016—and for Brent to average US$49 through the end of 2016.
During 2017 and 2018, IHS Energy continues to assume a moderate uptrend in world oil prices, which will continue to support a gradual improvement in oil-related fiscal revenues for Asia-Pacific oil and gas exporting nations such as Indonesia and Malaysia.
Outlook and implications
The Brexit vote has created political turmoil in the UK, and is expected to result in greater political and economic uncertainty during the next two years, as the UK negotiates its exit terms with the EU. The IHS GDP growth forecast for the UK has therefore been cut sharply for 2017, with Eurozone GDP growth also expected to be lower in 2017.
The overall impact of softer EU growth is expected to trim the overall Asia-Pacific GDP growth rate for 2017. However, the effect on GDP growth in individual Asia-Pacific countries is expected to vary, reflecting factors such as the share of the nation’s total exports that go to the EU, exchange rate effects, and the importance of the EU as a source of foreign direct investment into a particular country.
With many APAC nations having already experienced declining exports since mid-2015 owing to China’s economic slowdown and transmission effects to the East Asian supply chain, the effect of Brexit will further dampen the GDP and export growth outlook for many APAC nations. Still, the overall impact of Brexit on the APAC region is expected to be moderate.
About the Author
Rajiv Biswas is the Asia-Pacific Chief Economist for IHS Markit, which provides information and analysis to support the decision-making process of businesses and governments. He is the author of Asian Megatrends, published by Palgrave Macmillan in 2016.