Sunday, 26 June 2016

Brexit and the Arab World

Limited economic consequences from Brexit on the Arab World.

Against the odds, rational arguments and cost-benefit analysis, the good people of the United Kingdom voted to leave the European Union in a referendum on 23 June. The news sent shockwaves throughout the world and a long period of institutional uncertainty is likely to follow. The UK economy is expected to be hit hard by the decision, with growth being flat or negative. The uncertainty could spill over to neighbouring European countries, and forecasters around the world are revising down growth projections as a result.

How does an event of such seismic proportion impact the economies of the Arab world? The short answer is: not much for now.

For the long answer, we need to consider three channels.

1. The trade channel. If Brexit leads to slower growth in the UK or a recession, then the demand for imports in the UK will fall, hurting the UK’s trade partners in the Arab world. But the impact of this channel is limited because the UK is not a large export destination for any country in the region.

Take Qatar for instance. It is the UK’s largest trade partner in the Arab world, but the value of its exports to the UK is still small relative to the size of the economy at only 1.6% of Qatari GDP. Even if UK imports drop by 12% this year (one of the most pessimistic estimates), the impact on the Qatari economy will be small at only 0.2% of GDP.

2. The financial channel. Brexit has spooked financial markets, causing investors to hold safe assets such US or German bonds and shun riskier assets like stocks or emerging market bonds. This was evident in the stock-market meltdown on Friday 24 June, following the announcement of the referendum results.

How does this affect the Arab world? Many countries in the region, especially oil exporters, are looking to borrow from global markets to finance their deficits following the decline in oil prices. Analysts expect 2016 to register record borrowing from the Middle East on global financial markets. But the appetite from global markets to absorb this might diminish as a result of Brexit. Consequently, Arab countries might find it more challenging to finance their deficits with external debt.

But even the impact from this channel is mitigated by three factors. First, some countries in the region, such as Oman, Qatar and the UAE, have already secured funding from global markets, and have little need or requirement for further borrowing. Second, some countries, especially Algeria and those in the Gulf, have significant foreign reserves which they could use to finance themselves if global conditions tighten. Third, other countries are on a programme with the International Monetary Fund (most recently Iraq, Jordan and Tunisia) and can secure their funding requirements through the IMF.

3. The investment channel. Some Arab countries have investments in global firms and real estate through their sovereign wealth funds. And return from these investments could be hit by Brexit.

But again, the impact from this channel is likely to be limited as sovereign wealth funds have long investment horizons and are less sensitive to short-term movements in the value of their assets. Indeed, even the global financial crisis of 2008 did not seem to cause lasting damage to the region’s sovereign wealth funds.

So the bottom line is that the economies of the Arab world are relatively immune from Brexit, provided that Brexit remains localised and does not trigger an outright global crisis. In the meantime, the region is far more exposed to oil prices, attempts to diversify many of its economies and security issues, which pose more immediate and serious problems than Brexit.