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Economic Update

2016/06/24

The Day after – A Major Hangover

The Day after – A Major Hangover

The result of the British Referendum has left most of us in shock. A total of 33,551,983 people voted and 51.9% of them voted in favour of Britain exiting the 28-member European Union (EU). Nevertheless, according to the Guardian, the UK Prime Minister David Cameron is not "legally obliged to invoke the Lisbon treaty to start an EU exit."1 While it will take some time for us to digest the impact of these unchartered waters, some of the possible impacts are as follows.

Immediate market responses

It is clear that the result has caught much of the market participants by surprise. The sterling had risen to 1.5018 as recently as 5:51 am today in Hong Kong, before reaching a 31-year low of 1.3229 as of 12:27 pm. The Hang Seng Index plunged by over 1000 points at one point, while we have also seen the futures of Dow Jones Index pointing to a major correction as of 3 pm. Such volatilities of the global asset markets are comparable to, if not more severe than, the situation on 15 September 2008 when Lehman Brothers filed for bankruptcy. This erratic situation will likely continue for the near term, until the markets have a better feel of the future directions.

Reactions from governments and central banks

The world is looking for clearer signals from the UK and other major governments. Despite his earlier indication to stay in the position regardless of the result, Cameron has announced to step down by October after British people voted to leave the EU.

Then the next question is related to whether he will ignore the result of the referendum and bring the question of leave/stay to the MPs. With a majority of the MPs indicating that they were in the Remain camp, it is possible that the UK could choose to stay as part of the EU regardless of the referendum outcome.

If the British government eventually decides to leave, capital outflows from the economy could be drastic, and the financial services industries from traditional banking services to fintech will be hurt.2 It will also lead to further complications to stability within the UK. In the Scottish independence referendum on 18 September 2014, Scotland decided to stay in the UK; in today’s referendum, Scotland has voted to remain in the EU (62% to 38%) and all 32 council areas backing such intention. Such uncertainty cannot be neglected.

On the international front, we have yet to hear comments from global leaders about the situation, but this is expected to be covered widely over the next few hours.

Central banks would need to orchestrate efforts in order to stabilise the volatility in the foreign exchange market. While major central banks like the European Central Bank, the Fed, the PBoC and the Bank of Japan previously said that there would be stabilising actions, the scale and timing remain unknown.

As a result of Britain’s decision to leave the EU, confidence in the legitimacy of the establishment of the EU is damaged. According to Eurostat, Britain represented 16% of GDP in the EU in 2014, and its exit suggests that the strength of the union will be damaged. In addition, other countries in the EU may call for their own referendums. According to the Telegraph, the Five Star Movement, which won 19 out of 20 mayoral elections on 19 June, declared that it would demand a referendum on the euro in Italy.3 Also, in France, Marine Le Pen, leader of Front National, declared that France should have its own referendum on the EU as well. Indeed, after Brexit, terms like Depar-tugal, Ita-leave, Bye-gium, Fin-ish and Czech-out have been surfacing lately, hinting the likelihood of major fallouts of the EU.

Implications to Hong Kong

Although our exposure to the UK is marginal in terms of economic fundamentals (1.5% of Hong Kong's merchandise exports), with our high exposure of international markets, the equity market should continue to see volatility in the near term. Moreover, the aftermath as a result of the referendum – like the potential fallouts of the EU, accounting for some 9% of Hong Kong’s export – could lead to much unaccounted downside risk.

On the positive note, as a result of the referendum, we may not be seeing a rate hike in the next couple of months. Fed Chairman Janet Yellen previously suggested that "A UK vote to exit the EU could have significant economic repercussions"4 , which leads to our belief that the likelihood of a rate-hike in the US in July has become slimmer, despite the sound economic trends suggested by recent economic data.

Questions for consideration

As we were approaching the referendum before the vote, business leaders had shown their inclination toward stability over volatility. Now that the results are here, the key question is how businesses can react and move forward. While instability is expected in the near term and risks have been addressed, would there be potential opportunities coming out of Brexit? The questions below are worth considering:

a) According to the SWIFT, the euro and sterling represented some 30.5% and 5.4% of international settlement as of the end of 2014.5 With the overwhelming uncertainties, what are the implications to the use of the RMB going forward?

b) If the RMB can play a larger role in cross-border settlement, how can Hong Kong leverage on our position as the leading offshore RMB centre?

c) If the UK decides to leave the EU eventually, a lot of re-negotiations on new arrangements will be needed with its trading and investment partners, both in Europe and globally. Would it lead to relocation of headquarters or regional offices from London and other UK cities to, perhaps, Hong Kong?


1The Guardian (23 June 2016) Is the EU referendum legally binding?
2Politico (22 June 2016) London may not be fintech capital if UK opts for Brexit — CEOs
3The Telegraph (23 June 2016) The Brexit contagion: How France, Italy and the Netherlands now want their referendum too
4Yellen, J. L. (21 June 2016) Semiannual Monetary Policy Report to the Congress
5Swift (December 2015) Worldwide Currency Usage and Trends.

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