Brexit: The Impact on Sri Lanka

What will the UK – EU divide do to the economy?

Following a fierce and often toxic ‘Brexit’ campaign, the United Kingdom decided on Thursday to become the first full member nation to leave the European Union at a national referendum that was decided on a simple majority. Final results released on Friday stunned both the locals as well as international observers, with the “Leave Campaign” narrowly beating the “Remain Campaign” with 51.9% of the vote to the latter’s 48.1%. The economic and political consequences were almost immediate as the Sterling Pound dropped to a 31 year low and Prime Minister David Cameron announced his intention to resign before October. Beyond the immediate chaos, driven mostly by policy and market uncertainty regarding the future of the EU and the UK economy, the long term impacts of Brexit are likely to have a significant influence on Sri Lanka.

Capital Markets

The most immediate impact on Sri Lanka’s economy is with regard to international capital markets. Given the economy’s heavy debt burden in recent years and the unavailability of concessionary lending, as a low-middle income country, Sri Lanka has depended on international capital markets through the issue of offshore bonds. However, since Brexit, global risk assessments have been negatively affected. Given the volatility associated with capital markets currently, investors generally refrain from investing in frontier and emerging markets such as Sri Lanka and tend to move towards safer assets such as the Dollar and Gold. This trend was almost immediately observable as the price of gold and the value of the dollar appreciated since Brexit was becoming imminent. Therefore, the cost of borrowing for Sri Lanka is likely to rise further and pose a short term challenge to the government.

Source: BBC News

Impact on Trade

Following Brexit, the UK will be exempt from all existing international trade agreements signed between the EU and its partners. Currently, the EU is party to Preferential Trade Agreements (PTAs) with 52 countries and is in negotiations with a further 72 other countries. Therefore, the UK will be required to initiate negotiations or renegotiate bilateral agreements with effectively 124 countries. The international trading arrangements are made even more complicated by the absence of a UK specific schedule of tariffs, commitments on services, and agricultural subsidies at the WTO. While international trading agreements are not required to partake in trade, they will be instrumental in protecting British interests from disputes and arbitrary action by other countries. In this vein, Sri Lanka will also be required to initiate negotiations with the UK in order to establish some form of an economic pact that grants access for Sri Lankan exports to the UK market. In context, 10% of Sri Lanka’s total exports are destined to the UK and any medium to long-term distortions will severely affect the country’s revenue flow.

Source: Financial Times

GSP+

The current government has spent tremendous political capital in engaging with the European Union over the past year or so to regain GSP+ status. The EU was one of the main export destinations for Sri Lankan garments and the withdrawal of GSP+ concessions in 2009 is reported to have amounted to a loss of $782 million in the industry. Currently, the USA and EU account for almost 57% of Sri Lanka’s total exports with close to 28.8% of total exports going to the EU as a whole. Furthermore, the significance of regaining GSP+ is further highlighted by the fact that the EU market accounts for 43% of Sri Lanka’s apparel exports. Therefore, the expected benefits of regaining the GSP+ at the end of this year were considerable. However, these benefits are likely to be diluted drastically as the UK leaves the EU and Sri Lanka loses its access to the UK market through GSP+. Moreover, negative shocks to the EU may also lead to a reduction in consumer spending within the EU, similar to what occurred after the 2008 financial crisis. This will also impact demand for Sri Lankan exports negatively. It is important to note, however, that the UK will officially leave the EU only two years after the government triggers Article 50 of the Treaty of Lisbon. This is expected to be done close to October, although EU leaders have called for Britain to initiate the process as soon as possible in order to avoid prolonged uncertainty. Until the UK formally exits the EU, however, Sri Lankan exports will have access to the UK through existing EU frameworks.

Uncertainty

The current market volatility is likely to ease as the UK provides a clearer picture of how it intends on transitioning out of the EU, and other stakeholders such as the Bank of England and the European Central Bank intervene to stabilise their respective currencies. Therefore the effects of Brexit, especially on Sri Lanka, will be clearer with time. It is, however, obvious that Sri Lanka needs to be vigilant and make appropriate policy adjustments, especially with regard to trade, in order to minimise the negative effects and maximise potential benefits for the country.