Amid secular stagnation, Europe’s challenges have increased dramatically in the past few years, while new risks – particularly Brexit – have potential to trigger negative chain reactions, says Dan Steinbock.
Since the European sovereign debt crisis in 2010, Brussels has avoided hard political choices. After weeks of travels in multiple European economies, I believe that’s no longer a viable option.
The next milestone is the UK’s EU referendum on June 23.
Asia’s Brexit Exposure
Whether you are a tourist taking photos of the Buckingham Palace, an eloquent politician on Downing Street, or a financial wizard in Canary Wharf, you can’t help but hear recurrent debates about the EU referendum: To Brexit or not, that’s the question.
According to current polls, the battle with the “Remain” and “Leave” camps is too tight to call; a statistical tie. Over three years ago, Prime Minister David Cameron pledged that, if the Conservative party should win a parliamentary majority in the 2015 general election, his government would negotiate more favourable terms for British membership of the EU, before holding a referendum.
According to most projections, the Brexit could cause substantial loss of household wealth over time, falling exports, rising prices and possible recession. But what would Brexit mean to Asia?
In light of exposure to UK via spillover channels, Britain’s old colonies remain most exposed. Among Asian economies, Hong Kong has the relatively greatest trade, investment and financial linkages with the UK. To a lesser degree, the same goes for Bangladesh, Singapore and Australia.
The linkages with the UK are relatively lower for East Asia (Japan, South Korea), New Zealand, much of ASEAN (Malaysia, Thailand), and emerging ASEAN economies (Indonesia, Philippines).
In contrast, China, somewhat like India, is less exposed to the Brexit. As Beijing has only begun critical financial reforms, it is not as vulnerable to British portfolio flows or bank claims. Moreover, China’s largest trade partners are the US, Japan and South Korea, not the UK.
Nevertheless, since China is reliant on Hong Kong as its financial intermediary, the mainland is exposed to the Brexit, particularly via financial linkages. Moreover, the past years have witnessed increasing economic cooperation between China and the UK, as evidenced by London’s decision to participate in the Asian Infrastructure Investment Bank (AIIB) and support for the renminbi as an international currency reserve, multibillion bilateral deals, and so on. A Brexit could endanger some of these achievements.
Toward Greater Uncertainty, Volatility and Risk
If the UK’s “remain” camp wins the EU referendum, Europe may shift closer to a truly integrated union over time. In that case, a relief rally would drive the markets. The UK pound would appreciate against Asian currencies. Emerging Asia’s stocks and bonds would benefit, while reduced uncertainty would support commodities.
If the Brexiters triumph, it could spark a chain reaction of further EU fragmentation. The UK would face prolonged stagnation. Markets would be in turmoil. The UK pound would depreciate against yuan and major Asian currencies. Emerging market equities and bonds would be shaken and uncertainty would harm commodities.
In practice, the referendum outcome could prove conditional in two ways. Despite the “Remain” camp’s win, Europe might suffer a series of crises. Conversely, despite the “Leave” camp’s win, Europe could prove resilient but further integration would be slower in a rigid, protectionist EU in which Germany would dictate policies. In both cases, the net outcome would reduce the benefits of export-led growth in Asia. Import growth is not typical to ailing regions.
Moreover, the UK’s democracy deficiency is likely to add to the post-referendum uncertainty. While polls reflect a tight race between the “Leave” and “Remain” camps (45%-40%), most parliament members seem to be for the “Remain” rather than the “Leave” vote (about 70%-20%). As a result, some political observers anticipate the referendum to result in a protracted, 2-year bargaining period.
Such a net effect would fuel Euroskepticism that’s on the rise across Europe, particularly in Greece, France, the UK and Spain. It could also undermine EU’s favourability in those economies that still support the EU, including Germany, the Netherlands, Sweden and Italy.
Across countries and parties, most Europeans agree that a British exit would harm the 28-member EU. Moreover, a protracted period of more economic uncertainty, market volatility and political risk is precisely what the UK, Europe, Asia and the world economy least afford today.
Europe’s “Summer of Discontent”
Along with the migrant crisis and security concerns, the demise of the Schengen and new geopolitical threats (e.g., Russia sanctions, Middle East turmoil), the Brexit risk is not Europe’s only challenge. The continent struggles with liquidity issues and systemic banking risks; inadequate fiscal adjustment that has led to stringent austerity and mass unemployment; deteriorating competitiveness and innovation; and rising debt burdens, which remain at threat levels in Greece and Portugal and excessively high in Italy and France.
Today, the Eurozone is amid a fragile cyclical rebound. While the region may achieve 1.5 percent growth in 2016, it will decelerate close to 1 percent by early 2020s.
In Paris, labour reform demonstrations against Hollande’s socialist government will continue through the 2016 soccer games. In London, Prime Minister Cameron’s government is preparing for a divisive EU referendum. In Italy, Matteo Renzi’s administration seeks to reform an economy that suffers from corruption and grey market. Under Angela Merkel, Germany remains powerful even if its best days may be over. Greece is preparing for the next bailout drama. In the Nordics, the generous postwar welfare systems are coming to an end. The Swiss seem to sustain their growth, after the eclipse of their bank havens.
Economically, Europe relies on the European Central Bank’s (ECB) zero-bound interest rate policy (ZIRP) and continued quantitative easing (QE), even though their effect is diminishing and monetary addiction cannot cure fiscal challenges. Politically, “integration without common institutions” is now shakier than in years. Militarily, Brussels has nurtured assertive policies toward Russia and in the Middle East that threaten to undermine Europe’s economic prospects.
Since bailouts are not a viable option in Europe’s core economies, progress requires structural reforms, which are extremely challenging to execute without political turmoil. If Europe boils over, the implications will not be just regional. Nor will Asia remain immune.
A slightly shorter version of this commentary was published by South China Morning Post on June 20, 2016.
About the Author
Dr. Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see http://www.differencegroup.net/