The IMF sees Brexit’s ‘substantial impact’ while the world’s economy holds its breath

A European Sting Photo taken outside the House of Commons on 20 June 2016. Hundreds of people have showed their sorrow and paid tribute to the tragic loss of Jo Cox’s life. This photo was taken by the European Sting during the newspaper’s London coverage of the EU referendum (The European Sting, 20/06/2016)

The International Monetary Fund last Friday published what will most likely remain its most detailed analysis on a “Brexit” scenario, calling the impact of Britain’s departure from the European Union “negative and substantial”. With only two days to go until the referendum, it is clear more than ever that the economic field now is where the toughest match is being played to convince voters. However, the real impact of such a history-changing move might be only quantified in the years to come.

IMF study

After having promised for a long time its official estimates on a possible Brexit, the IMF last Friday used its annual report on the British economy to weigh the impact of the June 23 vote. Despite still keeping an often claimed “neutral” position on the matter, the IMF leaves no doubt: an exit from the EU would see no economic advantage for British economy, and would only drag the country into uncertainty as a first effect.

A decision by UK voters to exit the EU would subsequently kick off negotiations between the UK and the rest of the EU over the terms of its withdrawal and over the details of its future relationship with the Union. “The UK would likewise need to renegotiate trade relationships with the 60 non-EU economies where trade is currently governed by EU agreements”, the official IMF statement claimed.

This negotiations, according to the IMF, could drag on for years, leading to a period of heightened uncertainty and risk aversion, which in turn would discourage consumption and investment and roil financial markets. “In the long run, most formal assessments agree that the UK would be worse off economically if it were to leave the EU”, IMF officers explained, “as higher trade and financial barriers would lead to lower output and incomes”.

Impact quantified

The IMF explored the potential impact of uncertainty on UK growth during the post-Brexit transition in two different scenarios, referred to as the “limited scenario” and the “adverse scenario”. In the limited scenario, in which uncertainty is relatively moderate and the UK is assumed to negotiate a status similar to what exists between Norway and the EU, output falls by 1.4 percent by 2019 (compared to the baseline case in which the UK remains in the EU). In the adverse scenario of long negotiations and a default to the trade rules of the World Trade Organization, Britain would fall into recession in 2017 and its GDP would plunge by 5.6 percent by 2019, again compared to the baseline case in which the UK remains in the EU.

So in both cases, the IMF findings show that a Brexit would seriously hit British living standards and would anyway have negative impact on macro-economic indicators and employment. “The longer this uncertainty persists, and the less advantageous the outcome of trade negotiations for the UK, the larger are these short- and medium-run costs”, the IMF underscored in its statement. The adverse scenario presented by the IMF of course is not considering the possibility that Britain would secure a trade deal quickly, and that the level of investments and consumer spending would only be limited for a short period – something already experienced during the recent global economic crisis. This is indeed something that a few analysts believe it could happen, as reported by the Economist.

IMF Chief’s words

In a speech in Vienna, IMF Chief Christine Lagarde underlined the importance of a victory of the “remain” vote towards economic benefits. “We have already been on record that the economic risks of leaving are firmly to the downside”, Lagarde said. “There is a clear case as to how the UK has benefited and will continue to benefit from its membership in the European Union”.

“Being part of the EU has greatly aided the transformation of the U.K. into a dynamic and vibrant economy”, Madame Lagarde added. “The U.K. has benefited from the many contributions of talented and hard-working migrants from all over the world, including the EU, while providing record-high levels of employment for all its residents”, she declared.

Brexit backers’ point

There’s also those who believe a Brexit would not throw Britain into recession though. Responding to the latest IMF remarks, Matthew Elliott, chief executive of Vote Leave declared that Mr. Lagarde openly decided to forego any mention to possible positive results a Brexit would give. “The IMF has chosen to ignore the positive benefits of leaving the EU and instead focused only on the supposed negatives”, the Guardian quoted Mr. Elliott as saying. “If we vote leave, we can create 300,000 jobs by doing trade deals with fast growing economies across the globe. We can stop sending the £350m we pay Brussels every week. That is why it is safer to vote leave.”

A group of eight well known economists have released a report under the banner of “Economists for Brexit”, explaining how they think leaving the EU would be even good for the UK economy. They predict that, in 2020, the UK economy would grow 3.4% if the UK left the EU, while it would grow only 2.5% if the UK remained, as reported by the BBC. The basis of their assumptions is that after leaving the EU, the UK would trade under World Trade Organisation rules and immediately drop all tariffs on imports from everywhere in the world to reduce the prices of products for people in Britain, the BBC explained in a report at the end of April.

Effects on the Stock exchange

However, negative effects on production and consumer spending are not the only risks that a Britain outside of the EU would have to face. The impacts on Stock Markets, with effects on currencies and possible shockwaves through the global economy, are reported to be consistent. The Bank of England made it clear just one day before the report by the IMF was published: the risk for the pound sterling are real. According to the latest studies by the BOE, indeed, a vote to leave the EU in the referendum would push the pound “sharply lower”.

“In the weeks since the ‘May Report’, an increasing range of financial asset prices has become more sensitive to market perceptions of the likely outcome of the forthcoming EU referendum”, the BOE explained last Thursday in its latest Monetary Policy Summary. “On the evidence of the recent behaviour of the foreign exchange market, it appears increasingly likely that, were the UK to vote to leave the EU, sterling’s exchange rate would fall further, perhaps sharply”, the BOE statement said.

Pound Sterling to fall “sharply”

According to Economist Intelligence Unit, which is part of the Economist Group, the situation would be even worse: the pound would fall 14-15% against the US dollar in the course of this year, and the UK would even risk losing its status as a global financial centre. The pound has already weakened during this tough run to the vote: last Thursday, Sterling fell throughout the afternoon, down around 1.3% against the dollar to $1.4016, but gained ground in late trading to $1.4152. The decision by the BOE to keep interest rates at their record low of 0.5%, with also claims of a Brexit as “the biggest immediate risk to UK financial markets”, say how much BOE officials are worried.

Headaches in America

The Bank of England is not the only one to be suffering from unrest. American businesses are indeed currently weighing possible impacts of a Brexit, and the feelings around those studies are not idyllic. In a recent analysis, the Washington Post calls the possible effects of the UK leaving the 28-country bloc as a threat “to more than a trillion dollars in investment and trade with the United States”. The United States represent indeed the largest single investor in Britain, and the stars-and-stripes press, including the prestigious Washington-based paper, is already counting down risks. Most of US firms indeed believe that a Brexit would jeopardize their access to those markets, as Britain is currently seen as the main gateway to the EU. The Washington Post supposes many US firms would potentially consider relocating their European operations elsewhere.

Facing the unpredictable

All in all, the truth is that no one knows what a leave vote would bring, and nor can anyone measure it. The shockwaves that such a life-changing moment would generate, given the unique nature of it, are truly unpredictable. The world has learnt during the global financial crisis that began in 2008 that is barely impossible to analyse the effects of such enormous potential economic revolutions. While challenged by the BBC on whether there would be a problem with the predictions by the IMF and a possible lack of credibility, IMF Chief Lagarde said that some of them may be right while some other may be wrong. “But when all of them except one particular institution… are heading in the same direction, I think it’s compelling”.

Emanuel Adam, head of policy and trade for BritishAmerican Business, while interviewed by the Washington Post last week said: “Nobody knows at this point how the world would look like with the UK out of the EU”.

“This alone creates an uncertainty that businesses don’t wish to see”, he added, and rather hit a bull’s eye like that.