How Will a No Deal Brexit Impact Central and Eastern Europe? (4 min read)
At Macro Hive, we’ve recently tried to show the broader impacts of Brexit on Europe. In this piece, we have asked the team at CEEMarketWatch to extend this work to Central and Eastern Europe.
The direct impact should be minimal. The UK accounts for a relatively small share of trade (around 6.4% over the past 5 years, with a tendency to decline), and the finance ministry doesn’t expect public finances to be affected. There are concerns about second round effects coming from the euro area, particularly Germany, which trades much more with the UK than Poland does. There may be even some positive effects, as the Central Bank (the NBP) projects that about 15% of Polish emigrants to the UK might return, invigorating the local labour market which currently experiences significant labour shortages. However, there is no hard evidence to support that expectation, as according to a recent survey only 10% of Poles living in the UK consider leaving the country after Brexit.
Overall, the government doesn't appear to be worried, which we believe is a sign of complacency. In case there is a recession or minimal growth in the euro area, it will inevitably affect Poland, though its economy has proven more resilient than CEE peers during the latest euro area recession (Poland was the only EU economy not to enter a recession). We do expect a negative impact on economic activity, but it is difficult to predict the scope at this point. Even if the economy starts slowing down, the NBP is already in a dovish stance and is ready to keep going in that direction if needed. As far as the exchange rate is concerned, it will probably suffer a general reduction of investment in emerging markets, which usually happens when economic activity slows down in developed economies. However, fundamentals do not suggest a sharp depreciation, so it will be mostly external sentiment that affects it.
The government is very concerned about a disorderly Brexit and the finance ministry expects a negative impact on GDP growth within 0.6-0.9pps, with a negative impact on the fiscal balance at about 0.1% of GDP. However, the finance ministry tends to be somewhat pessimistic, as the Central Bank puts a possible negative impact on activity growth from Brexit at about 0.6pps. The UK is not a major trade partner, as its share is about 5%, with a tendency to decline (4.6% in 2018).
As with Poland, concerns are mostly focused on second round effects and a possible slowdown in euro area growth, which will directly hit the Czech economy. There isn't an expectation for a mass return of Czech expatriates, as the Czech government is already working on ways on keeping Czech citizens' rights intact. It has granted British citizens rights equivalent to EU citizens until the end of 2021, which is one of the most generous schemes granted by EU members, though the Czech labour market could use people returning home since its labour shortages are acute and labour costs have been rising fast. We don't expect a lot of people returning, however, since Czech living standards are generally on the higher end among CEE peers and yet there haven't been many people coming back in recent years despite strong wage growth.
The exchange rate will very probably suffer from a negative market sentiment, even if fundamentals do not suggest depreciation. The Central Bank has been dealing with this for some time, as the exchange rate has failed to appreciate as fast as its forecast suggests. There is an issue of excessive CZK liquidity in the moment, a result from the one-sided FX commitment, which kept the EUR/CZK exchange rate at 27 or weaker until April 2017. Given that there are few CZK-denominated assets available because it is a small market, the potential for sustained CZK appreciation is not big even in normal times, let alone in case of a disorderly Brexit. The Central Bank is ready to intervene, though, and it has held on monetary tightening this year, even though inflation is currently at the upper end of the tolerance band. In general, we don't expect a recession resulting from a disorderly Brexit, but economic activity will probably slow down close to 2%, maybe even slightly below.
The National Bank of Hungary (NBH) has published a paper estimating the impact of Brexit under three different scenarios, one of them corresponding to a hard Brexit. This scenario practically estimates a reduction of GDP growth of an average of 0.5pps per year or a cumulative negative impact of 2.7% over a period of five years. The estimate is based on the expected direct effects from Brexit, which include terms of trade, uncertainty, FDI, EU funds, and remittances. The government does not appear overly concerned with Brexit, although it did show a proactive approach in talks with the UK about Hungarians working in the UK. PM Orban recently appointed a special government commissioner to deal with the consequences of a hard Brexit. He also spoke of two new economic stimuli programmes for 2020 and, though he did not mention details at all, we think they might be partly related to the increased likelihood of a hard Brexit.
A hard Brexit will have probably have a depreciating impact on the forint due to the usual increase in risk aversion and the deteriorating growth outlook. This might present some dilemma to the NBH when shaping monetary policy since the forint is already relatively weak and further weakening could risk the inflation outlook. We rather bet on a looser monetary policy though as the NBH is likely to see a stronger disinflationary risk stemming from the reduced growth.
The finance ministry has estimated that a No Deal Brexit could reduce GDP growth by 0.7-1.4% in the long run with the impact to be most notable in the first two years. The Central Bank has estimated that a hard Brexit could cause a cumulative drop of GDP of 0.7-1.1% until 2023, mainly through foreign trade that might see a downtick. It says that the uncertainty over future arrangement of economic ties between the UK and EU poses one of the most significant risks for economic growth. A model of Oxford Economics indicated that a No Deal Brexit would result in the level of Slovakia's GDP being 0.6% below the baseline forecast at the end of 2020, with only four other EU countries to be hit harder.
The impact of a hard Brexit on Romania's economy will be insignificant. Romania's exports to the UK market amounted to EUR 2.5bn., representing 5.4% of Romania’s total exports to EU member states in 2017. Romania had a positive trade balance with the UK in 2017.
A bigger problem will arise for those Romanians living in the UK. They are about 0.4mn. people and represent the second largest non-British nationality after Poles (some 10,000 are doctors and nurses working in the UK healthcare, according to local media). In case of a hard Brexit, foreign workers might have to leave the UK. Remittances from abroad will probably be affected if those workers return home, although that might also have positive influence on Romania's labour market which lacks skilled employees mainly due to emigration.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)
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