The world woke up in disbelief on Friday morning. Headlines such as “Bratastrophe”,“Everything has changed” and “When reality TV show becomes reality” reflected the severity and magnitude of the decision the British public had taken to exit the European Union (EU). The aftermath of Brexit, as it has been termed, is still being fully digested, but little doubt exists about the significant ramifications which will extend far beyond the UK and Europe. The world has entered a new and uncertain phase in its history. With many unanswered questions, not only politically but also economically and legally, financial markets have been sent into a tailspin in the wake of global anxiety and panic. Emerging markets and African economies will not be immune to the fallout, and businesses, policymakers and citizens across Africa are now asking the question: “What does it mean for us?”
To be able to answer that question effectively, the Brexit decision needs to be understood in the context of the global economy. The UK’s decision to leave the Eurozone comes against an already fragile global growth environment, together with high levels of global indebtedness and growing income inequality. In the near term, the hit to global financial markets and heightened risk aversion will result in tighter global financial conditions which, coupled with increased economic uncertainty, will push global growth lower than forecast. Over the longer term, the “leave” decision increases uncertainty over the future of the EU, the Eurozone and globalisation in general. Unfortunately, what happens in UK and Europe also affects countries in Africa which are already battling currency weakness, severe strains on their balance sheets, weaker prospects for foreign investment and ratings downgrades.
The violent reaction of financial markets will continue for the immediate future Contagion will persist and probably intensify, with sentiment towards emerging markets likely to sour as the financial world moves into a “risk off’ mode. Typically, in periods of elevated uncertainty, risk aversion spikes and triggers a flight to safety and investors demand a higher premium for riskier assets. Consequently, safe haven assets such as the US dollar and gold will soar, while emerging markets, with weak fundamentals such as twin deficits and high inflation, fall firmly in the firing line. Capital flight, lower commodity prices, a slowdown in exports, higher debt servicing costs, greater currency volatility and dollar liquidity issues are some of the challenges African economies are likely to experience in the immediate aftermath of the leave vote. Already hard hit by the Chinese slowdown, this is another hefty blow to Africa’s prospects, particularly for its commodity exporters.
Already, the South African rand depreciated by over 5 per cent against the US dollar in a single day’s trading, whilst Nigeria, which last week devalued its currency, partially in a bid to attract portfolio investment, will face difficulties in achieving its objectives due to global risk aversion. Brexit may also affect the country’s plan to tap international capital markets again this year. The Ghanaian cedi too has seen a sharp selloff while Kenya’s central bank governor has already reassured the market that the country has sufficient buffers in its forex reserves to protect against any balance of payments shocks that may emanate in the aftermath of the “leave” vote.
Over the medium to longer term, much will depend on the manner in which the UK decides to leave. Importantly, this will not happen immediately and will have to be negotiated, with a formal exit only likely in 2019. Who is likely to lead the exit, and what its terms will be, is unclear in the wake of Prime Minister David Cameron’s resignation last week.
The key question is whether leaving the EU will be a “big out” or a “small out”. A big out will be messy and disorderly and see a lengthy, legally complex and cumbersome process which will lead to bureaucratic inertia. A small out could potentially be less damaging and see the UK retaining certain “in” elements such as the single market and customs benefits, although this option seems tough, given the hard-line stance the Eurozone leadership has adopted thus far. Neither option is likely to be straightforward, and with no visible plan or idea as to how the process will work on a practical level, speculation will continue to rise, and businesses will adopt a ‘wait and see’ approach. This will translate into ‘real economy’ effects, particularly through trade and investment channels.
The potential for economic weakness in the UK due to declining confidence levels is likely to spill over into growth in Europe and other regions such as Africa. This could lead to declining business confidence and delayed or abandoned investment decisions or even disinvestment. In short, greater uncertainty will filter through to weaker business confidence which in turn leads to investment paralysis and in so doing saps economic vitality. Across the world, private sector investors are likely to hold off major decisions until there is a resolution to the current impasse.
As a result of leaving Europe, Britain will need to renegotiate its trade agreements with all 162 World Trade Organisation member countries. These renegotiated trade arrangements have the potential to significantly raise the costs of doing business and increasing restrictions and barriers to trade. Whilst there may not be significant direct trade relations with Britain for African countries (only around 4 per cent of Sub-Saharan Africa exports are to the UK), the slowdown in the UK will have a an indirect effect by impacting the growth outlook for other key European trading partners – thereby reducing demand for African imports. Nigeria, for example, could be adversely affected by declining export volumes to Spain and the Netherlands, its third and fourth largest export destinations respectively. Furthermore, lower growth in incomes and possible changes to immigration and labour laws may lead to lower remittances from large African diaspora populations abroad which will further depress forex earnings. While gold exporters such as Tanzania, Ghana and South Africa could stand to benefit from an uptick in prices, the net effect given the higher debt service, currency pressures, and potential capital flight remains uncertain.
The question of economic diplomacy is another that will feature prominently in the wake of Brexit, as it is unclear whether this decision will see Britain pivot towards a more insular approach, retreating from globalisation, or a more expansionary approach which broadens its trading partners. On the one hand, with Britain distancing itself from Europe, this could offer a potential opportunity to leverage its traditional relationships with Commonwealth countries and foster favourable bilateral trade deals with African countries. Britain has long been a critic of Europe’s distortionary agricultural subsidies which disadvantage Africa, and some commentators are of the view that African countries could stand to gain from this in the longer term. African countries could also get some respite from looking east for new export markets. However, if Britain becomes more inward focused, African countries are likely to feature low on its list of renegotiated trade agreements while traditional economic super powers and trading partners such as the US, China, Japan, India and Brazil are likely to be higher on the priority list. In addition, with the British economy likely to contract, the level of developmental assistance to development partners in Africa could be affected. Little clarity has been given on any of these issues.
The political spill over has the potential to be huge. With the genie now out of the proverbial bottle, and a push for new referenda in places like Scotland and the Netherlands, the broader European integration project is also under threat. Any subsequent exit votes from other EU members, especially the Netherlands, pose significant risks to the East African Community, in terms of trade flows (for Kenya in particular) and development assistance. For East Africa, which has made major strides towards greater regional integration, this process may be threatened or delayed. To quote one commentator: “it’s like the parents getting divorced whilst watching their child’s wedding.”
Finally, with the wave of anti-establishment and nationalism sweeping across the developed world, the political landscape in many African countries, still wrestling with the aftershock of the Arab Spring, may also undergo significant change.
The British have a saying: “Keep calm and carry on” which may well be the only option African countries have at the moment. With very little control over external affairs, African policymakers need to continue diversifying their economies, implementing structural reforms and presenting compelling growth opportunities for investment, whilst articulating clear and consistent policies. These are essential because the Brexit hangover is likely to be long and painful.
*Ronak Gopaldas is the Head of Country Risk at Rand Merchant Bank