By Dr. Hippolyte Fofack
The voices of Britons who strongly believe that the United Kingdom will be better off outside the European Union prevailed on June 23, in a historic referendum on UK membership in the European Union. Warnings of the dire economic and financial consequences of a divorce were not enough to deter the growing wave of Eurosceptics and “Brexiters”. Britain’s next leader will have the historic task of activating Article 50 of the Lisbon Treaty to disentangle the UK from the European Union.
The economic and financial implications of Brexit for the UK were felt immediately. The British pound crashed to its lowest level against the US dollar in more than 30 years. Most banks lost a third of their value before stabilizing. More significant than the short-term volatility and turmoil in the market, however, is the downgrading of the UK’s sovereign credit rating by both Fitch and S&P. Over the years, Britain has run a high current account deficit and increased its reliance on external financing, often in the form of foreign direct investment. The downgrading of its sovereign credit rating and increased uncertainty post-Brexit could undermine its ability to attract foreign direct investment and in the process put even more pressure on the pound. Citing this concern, credit rating agencies pointed to the marked deterioration of external financing conditions and to the increased downside risks to growth, both for the UK and within the EU, as major risks to the global economic outlook.
The implications of Brexit have also been analyzed from the political and geopolitical standpoint. One emerging concern is the survival of the UK itself, especially as Scotland—which voted overwhelmingly against Brexit—weighs the advantages of staying in the UK against the disadvantages of losing the financial and economic benefits associated with EU membership. The implications of Brexit on transatlantic relations are also of great concern. After Brexit, the United States will likely lose a direct link, and in essence its trusted and unofficial ambassador, to the EU. Whether on global security or free trade issues, the UK was always fully aligned with the US and made sure that the EU’s foreign and trade policies were US-friendly.
The mainstream media has tended to frame the referendum as a confrontation between nationalists and internationalists, yet its assessments of the potential implications of Brexit have been geographically limited, essentially focusing on the epicentre of the crisis: Britain, and then Europe and America, full stop! The Financial Times editorial on the day of the referendum is illustrative: “The Financial Times remains resolute in its belief that leaving the EU would be a grievous act of self-harm that would damage not only the UK but Europe and the West.”
Yet if there is one lesson we have learned from the ongoing process of globalization and increased interdependency of economies, it is that the policies undertaken by large economies have strong repercussions for developing countries—sometimes even stronger than their domestic repercussions. Recall that in the decades following African independence, when Britain and France were the main trading partners of Africa, it was often said “when Europe sneezes Africa catches cold.”
Brexit’s Impact on African Economies
Britain is no longer Africa’s main trading partner, but the economic and financial implications of Brexit are highly likely to affect growth in African economies and indeed other regions of the world. Africa will feel the effects through several channels, including heightened downside risks to global growth and global demand; trade; development aid advocacy; and access to financing.
Despite the steady decline in its economic stature since the Second World War, and particularly over the last two decades with the rise of China, the UK remains one of the world’s largest economies and is the second largest of the EU economies (after Germany). Hence, any drastic economic contraction in the post-Brexit UK could increase the downside risks to global growth, with direct implications for growth performance in Africa, exactly when growth in that region has been decelerating. Recent growth forecasts, made before Brexit, predict that Africa will grow at an average rate of 3 percent in 2016, down from 5.1 percent achieved in 2014, owing largely to slumping commodity prices following global demand shocks, growth deceleration in emerging market economies, and lackluster growth performance within the EU where many countries are still suffering from the lingering effect of fiscal and sovereign debt crises. The downside risks associated with Brexit could further lower that growth, especially with the consensus forecast suggesting that UK growth—projected to be the fastest within the EU—in 2017 will be slashed from 2.1 percent when surveyed before Brexit to just about 0.3 percent after. Nigeria and South Africa, the two largest African economies and leading recipients of UK foreign direct investment, are already facing significant challenges, and South Africa’s growth is at its lowest in several decades. Brexit could further undermine prospects for recovery in these countries at the most inopportune time. Empirical analysis by researchers from South Africa’s North-West University has found that Brexit could shave off South Africa’s economic growth by about 0.1 percent.
Expected Rise in Trade Deficits
Trade is an important channel through which Brexit could be harmful to Africa. The UK’s trade with Africa is skewed, with more than 80 percent concentrated in five countries. South Africa and Nigeria, its top two trading partners in the region, account for more than 52 percent of UK’s total trade with Africa, probably making these countries the most vulnerable to downside risks associated with Brexit.
Africa has suffered from recurrent balance of payments crises, stemming from structural trade deficits and excessive dependence on natural resources and primary commodities. In recent years, the UK has emerged as Africa’s trade-balancing nation within the EU, consistently importing more goods from Africa than it exports to Africa. Africa’s resulting trade surplus with the UK has enabled the region to reduce its relatively large trade deficits with France and Germany—its two largest trading partners in the EU (see Figure 1). In a context of deterioration in the terms of trade of commodities and rising demand of manufactured goods by the growing African middle class, these countries have drawn on sustained demand of large import items such as electrical machinery and apparatus, motor vehicles, aircraft and associated equipment to uphold their trade surplus with Africa.
At a time when most African countries are confronting serious macroeconomic management challenges such as shrinking foreign reserves and rising fiscal and external deficits in a context of slumping commodity prices, the expected increase in trade deficits as a result of the slowdown in the UK could widen the financing gap in an extremely difficult global environment of increasingly less accommodative financing conditions. Brexit could make it harder or more costly for African countries to access liquidity to close financing gaps in support of growth and structural transformation of their economies. Yields on dollar bonds across Africa rose sharply after the Brexit referendum, and the spread could widen even more with increased downside risks. This increase in risk aversion is occurring in a challenging global environment where African Eurobond issuance has become increasingly more expensive and softening. Governments that used global investors’ hunger for yield to tap international capital markets have already been facing higher borrowing costs for hard-currency bond issuance, leading most of them to delay future plans to tap the international bond market.
Development Assistance May Slow
Another area where Brexit could be costly for Africa is development aid advocacy, especially within the EU. A little over 40 years ago, advanced economies committed to raise their level of overseas development assistance to at least 0.7 percent of gross national income (GNI). Although that commitment was reiterated in 2005 during the G8 Summit hosted by the UK at Gleneagles, the overwhelming majority of countries have not honoured it. In an unprecedented move, in 2015 the UK Parliament passed into law its commitment to spend 0.7 percent of GNI on aid every year, making the UK the first G8 country to meet this target. The passage of this law gave Britain the moral authority and credibility within the EU and even globally to lead the push towards increased and sustained financing for implementation of the Sustainable Development Goals. After leaving the EU, Britain may have less clout to push this noble agenda.
However, as in life in general, risks are associated with opportunities. While the short-term implications of Brexit for Africa’s economic development seem significant, the long-term implications are less obvious. The overall net effect on Africa could be even positive in the long run: as more African countries opt to diversify their sources of financing and trade partners, the likely improvements in the terms of trade might more than offset the expected losses of aid.
By entering as a single entity the trade negotiations leading to the Economic Partnership Agreement (EPA) with African countries, the EU has enjoyed a position of strength, in contrast to African countries, which have often entered these negotiations divided, and hence on the losing side of the trade bargain. Although Brexit will not solve the major challenge facing African countries in the global trade arena—their deficit of coordination, and the perennial collective action problem—losing the second largest EU economy could undermine the bargaining power of the EU bloc in future trade deals.
Greater African Regional Integration May Improve Renegotiated Trade Deals
Ironically, Brexit coincided with the African Union’s launch of an All-Africa Passport on June 13. Although such a move may be viewed as just a baby step in a world where large trading blocs are negotiating treaties to shape trans-Pacific and transatlantic trade agreements, it should not be discounted: every step is important in the life of a growing baby. If, as is hoped, increased labour mobility throughout Africa becomes entrenched and deepens economic and political integration, the result will be to improve African policy coordination and strengthen the decision-making power of continental institutions in global trade negotiations—and thereby enhance Africa’s integration into the global economy as an effective trade partner and player. In the post-Brexit world, renegotiation of trade deals previously agreed in line with EU directives will provide the first opportunity to test the commitment of African leaders to improved policy coordination at the continental level under the All-Africa Passport.
For the UK, the challenge is now to ensure that the quest for greater sovereignty is not achieved at the expense of the economic and financial benefits accruing from globalization and trade. Interestingly, the post-Brexit blueprint for galvanizing the UK economy, articulated by Chancellor of the Exchequer George Osborne after the referendum, is largely predicated on increased foreign direct investment from China. The foundation of that blueprint suggests that Britain may be “nationalist” on immigration policy and “internationalist” on economics and finance. Such globalization à la carte might heighten the global competition for limited financial resources, with traditionally advanced economies competing against developing economies for the same pool of funds. One would hope that the UK’s new aspirations and development strategy will not divert Chinese foreign direct investment away from African countries, whose combined financing gap for trade and infrastructure is estimated at more than US$200 billion annually.
To sum up, in addition to short-term implications for economic growth and trade, Brexit could also raise a number of challenges for African countries in the medium and long term, not least in accessing long-term financing for infrastructure development in support of the growth and structural transformation of African economies.
Dr. Hippolyte Fofack is the Chief Economist of the African Export-Import Bank.