On 23 June, the United Kingdom voted to leave the European Union in a non-binding advisory referendum, which resulted in the resignation of UK Prime Minister David Cameron and is likely to trigger fresh elections later this year or in 2017. Despite pressure from some European Union countries, it is unlikely that exit negotiations will begin until a new UK government is firmly in place. There is a possibility that the next UK government will not trigger exit negotiations at all, based on a legal technicality or if it calls a second referendum.
Regardless of the probability of an eventual UK exit from the European Union, the referendum result has caused market turmoil across the world, as investors worry that the result of the UK vote could drive fresh momentum to anti-establishment movements in other European countries.
Global stocks lost $2 trillion in value on 24 June and sterling fell to 31-year low. UK companies and banks were some of the worst affected, with $55 billion wiped off banking stocks. The price of commodities also fell, with the price of oil dropping 3.9% to $50 per barrel. However, the price of gold gained 4.7% as a reflection of investors’ perception of gold as a safe haven.
In Africa, currencies, stocks, and bonds also tumbled as a result of the UK referendum vote. The South African rand fell by 8% against the US dollar, before recovering to trade at 3.6% weaker, while falling to a record low against the Japanese yen. Investors are worried that African countries will have less access to international capital markets, which would halt large infrastructure and other projects. There is also a concern that the UK will now disengage from Africa, as its economy inevitably slows, and foreign aid flows are cut. While the UK has a firm commitment to spend 0.7% of its gross national income on development aid, an eventual recession in the UK would decline gross national income in absolute terms and thus diminish development aid to Africa.
Moreover, any trade deals that the UK has in place with African countries are essentially trade agreements with the European Union, which has exclusive jurisdiction over its members’ trade deals. Any exit from the European Union could terminate the UK’s access to the European Union’s single market, forcing the country to negotiate new trade accords with African countries, which is likely to be a cumbersome and lengthy process.
It is however likely that the UK would leave many existing trade agreements in place and thus mitigate risk of trade disruption.
Impact on South Africa
The South African economy is now more likely to fall back into recession and extreme currency volatility indicates that a downgrade of its credit rating to non-investment grade in December is now almost inevitable. Bi-lateral security cooperation and aid programmes face less disruption.
The South African economy is the most exposed to the global economy and in particular its currency is the most volatile among its emerging market peers. South Africa is reliant on foreign capital to finance its wide current account deficit. Additional fears of euro-scepticism in other European Union countries have also stoked fears that South Africa’s trade with the European Union is under threat.
South African exports to the European Union reached over $14.2 billion in 2015. However, the impact on the South African economy would be short-lived and relatively manageable. In a worst case scenario, where the UK economy were to shrink by 5% and UK imports were to drop by 10%, South Africa’s economic growth would fall by only 0.1% according to research by North West University.
While a 0.1% loss in GDP growth is relatively small, the country’s economic growth rate has already slumped, recording a 1.2% contraction in the first quarter of 2016, as mining and farming output shrank. The UK exit vote thus indicates that a recession will be increasingly likely for the South African economy in 2016.
The impact on the currency would be more significant and have longer term implications on the country’s debt rating. The Rand has already lost 21% against the US dollar so far in 2016. On 24 June, the South African Rand was the worst performing currency after the UK pound, before paring some of its previous losses. This is due to South Africa’s close financial ties to the UK and the fact that many large South African companies have a dual listing on the London and Johannesburg stock exchanges.
According to research by Unicredit, UK banks’ claims on South African companies account for 178% of South Africa’s foreign currency. South Africa’s already volatile currency and a probable recession further would increase the prospect of a downgrade of the country’s credit rating to non-investment grade by December. The longer term implications would lead to weak growth, higher inflation and interest rates, as well as extensive capital flight.
According to Bloomberg, the UK is South Africa’s fourth largest export destination, mostly dominated by metals and agricultural goods. The bulk of these exports have duty-free access to the European Union under the terms of the Trade Development Co-operation Agreement. The trade terms with the UK will now need renegotiation and revision, which could take up to two years, and significantly impact investment in key industries such as mining and agriculture.
Moreover, South Africa is a member of the Southern African Customs Union, which is dominated by asymmetric trade with South Africa. Other SACU members, Botswana, Namibia, Lesotho, and Swaziland, will similarly be affected by the trade renegotiations with the UK.
Impact on Nigeria
The effective implementation of a new foreign exchange mechanism and liberalisation of the fuel sector will face fresh hurdles as the UK withdraws from the European Union. Nigeria will also struggle to attract interest in new debt sales aimed at financing its expansive budget.
The main impact of a Brexit on Nigeria would be further deterioration of the country’s already struggling economy, which has been caused by the fall in global oil prices and a steep drop in local crude production due to an insurgency in the Niger Delta. There is extensive trade and security cooperation between the UK and Nigeria that would be likely to face several years of disruption as the UK departs from the European Union.
Nigeria is the UK’s second-largest export market in Africa. Bilateral trade between the two countries is currently worth $8.3 billion and projected to reach $25 billion by 2020. The UK is also Nigeria’s largest source of foreign investment, with assets worth over $1.4 billion. Moreover, UK-Nigerian remittances account for $21 billion a year. The UK is also one of the largest development assistance donors to Nigeria, although Nigeria is not as aid-dependent as most continental counterparts.
As a result, new portfolio inflows will slow, which will hamper the implementation of the country’s new foreign exchange mechanism.
On 20 June, the central bank introduced a more flexible foreign currency policy, removing a de facto peg of around 197 naira to the US dollar. The naira’s 16-month peg to the dollar had overvalued the Nigerian currency, resulted in an economic contraction, and harmed investments.
Impact on Kenya
Kenyan markets were relatively stable following the Brexit vote, although any disruption in European Union trade negotiations would negatively impact the cut flowers export market. It is likely that the UK would prioritise trade negotiations with Kenya, which could even benefit Kenya and other EAC members.
Kenyan officials were quick to respond to the market turmoil followed by the UK’s vote to leave the European Union. Finance Minister Henry Rotich assured investors that Kenya has adequate foreign exchange reserves to absorb any shocks from the crisis. Kenya has $5.6 billion in foreign reserves, which amounts to 5 months of import cover, which is higher than the four months the country usually holds. The central bank also said it would be ready to intervene in money and foreign exchange markets if required. Such assurances steadied the impact on the Kenyan shilling, but some banking stocks still suffered losses.
However, there is a risk of capital flight from Kenya as risk averse investors seek safe havens. This would weaken the Shilling and increase import costs. Kenya’s import bill has steadily increased by more than 10% over the past five years. Another key concern would be that ongoing negotiations of a trade agreement between the European Union and the East African Community would be delayed as the European Union copes with the UK’s departure.
The Kenya Flowers Association expects any such delays would cost the Kenya flower industry $38 million per month. Horticulture is a primary export market for Kenya and over one third of the European Union’s cut flower imports, mostly to The Netherlands and the UK, are derived from Kenya. However, it is likely that the UK would prioritise trade negotiations with Kenya given the two countries’ long-standing bilateral relations. Such negotiations could even benefit Kenya and other EAC countries, as Kenya gains leverage over setting trade terms.
Despite diplomatic disputes, Kenya is likely to remain a preferred beneficiary of British foreign investment in agribusiness tea, tobacco, and in oil and gas, with the UK being instrumental in the development of Kenya’s region-leading financial sector. Much like US investment, British investment is likely to increase in the renewable energy sector, especially financing and technical co-operation for geothermal, solar, and wind projects, which represent lower-risk sectors. Given these interests, and the large presence of British expatriates and tourists, the UK is likely to maintain security co-operation towards mitigating the threat posed by Islamist militant group al-Shabaab, which has British nationals active within its ranks.
