Economy
Hard Brexit would be particularly painful for Hungary
‘Hard Brexit’ is likely to have a negative impact on long-term growth
The ongoing stalemate in the discussions between Britain and the European Union about the exact stance of British-EU relations after March 29 next year have increased the concerns regarding the so-called ‘hard Brexit’. In the understanding of Erste Bank analysts, this term implies that the UK would no longer be part of the single market or the customs union and would trade with the remaining EU countries on WTO terms.In practice, it would mean an increase of tariffs and non-tariff costs as well as changes to migration policies.
According to the latest developments, chances of a no-deal Brexit have increased due to the Northern Ireland-Ireland border impasse. Without a deal, UK-EU27 trade relations would be back to WTO terms by 29 March 2019 instead of end-2020, i.e. the end of a grace period. If there’s a deal hammered out between the two parties by the end of this year, however, there is a chance that the integration will go from EU membership to an FTA (Free Trade Agreement). This scenario assumes that the UK leaves the single market and the customs union, but the UK and the EU agree on a broad free trade agreement.
There is a broad consensus that a ‘hard Brexit’ is likely to have a negative impact on long-term growth. Erste cites an IMF study published in the summer that estimates the output loss for the EU of up to 0.5% in the case of a ‘hard Brexit’ scenario, with a negative impact varying across countries. For example, the long-term impact on the Czech Republic could reach a decline in output at around 1%, for Hungary a bit less (cc. 0.7ppt), while for Poland roughly half of the Czech value (0.3ppt).
In the world of complex trade linkages, not only direct relations, but also the position in the global value chain matters. As far as the trade of goods is concerned, export to CEE has been constantly growing across time, yet exports to the UK from CEE amounts to roughly 5% of total exports, far less than with Germany - the main trading partner. Trade of services accounts for an even smaller share of CEE GDP than trade of goods. Chen et al. (2018) estimates that national exposure to Brexit understood as the domestic value added of exports varies from around 2% for the Czech Republic (2.14%) and Hungary (1.71%), through 1.31% for Poland and Slovakia, to around 0.5% for Romania (0.56%) and Slovenia (0.42%). These numbers represent an upper bound of the Brexit impact on GDP growth in the case of all UK trade linkages falling to zero, which seems unrealistic.
In our view, a slowdown of the Eurozone would hurt the CEE growth to a greater extent than Brexit itself. Further risks to economic growth lie in the deterioration of market sentiment and investment activity in Europe, as strategic investments may be delayed.
Although it is difficult to quantify at this moment, it is reasonable to assume that a lower amount of the EU funds flowing to CEE is likely to provide less ‘easy money’ for investment activity, the analysts added.“However, the smaller pot of EU funds will hardly have any material effect on CEE before 2022, given that CEE countries will be drawing funds from the current programming period ending in 2020 for two years afterwards." In the next programming period, there will be more focus on higher co-financing from national sources and private funds, which might mitigate the impact of less EU money and result in higher ownership and efficiency of projects.
Exposure of UK banks to CEE is rather small, except for Czech Republic
Given that many global banks have large headquarters in the UK that may be forced to downsize or relocate important operations to the continent, analysts at Erste can see some divestments. According to BIS data, UK-based banks do not have large exposure to CEE countries, which may wane in the case of a hard Brexit, except for the Czech Republic. (Hungary, on the other hand, could benefit from the relocation of positions in the financial sector.)The IMF paper presented above also includes cross-border banking positions, and subsequently, the model returns a relatively large negative impact for the Czech Republic for a hard Brexit.
However, Erste’s analysts believe that this approach might yield a conservative estimate, as the large size of foreign claims on the Czech Republic is courtesy of the FX floor regime, as the central bank increased its FX reserves substantially as well. In the case of sudden capital outflow, the CNB would be ready to liquidate some of its excessive FX reserves, which currently stand at about 60% of GDP.
CEE migration to UK has dropped after Brexit and fewer people are likely to leave in years to come
One important aspect of the post-Brexit world concerns migration issues. The biggest number of migrants comes from Poland (amounting roughly to 1mn, according to ONS data), which comprises a third of total Polish migration according to OECD data. A further 2% of the Romanian population lives in the UK, followed by Slovakia (1.5% ) and Hungary (1%). Since the Brexit vote, the inflow of migrants has been dropping, and as of March 2018 more people left than entered the UK from CEE8 (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia).On the other hand, we still saw more people coming from CEE2 (Bulgaria and Romania) in the last couple of years.
After Brexit, we expect fewer migrants to choose the UK as their destination. However, we believe that the majority of those who already work and live in Great Britain are likely to stay in, with only part willing to come back.
“If migrant workers are to return to CEE, they could increase the labour supply. In the current setup, in which many economies cope with labour shortages, this could be seen in a positive light."
Given very tight labour markets at home, they would not be crowding out workers at home. This could compensate for the negative impact stemming from lower remittances from the UK. For countries with a high flow of remittances, the weakening of the British pound could reduce household disposable incomes. However, for the country with the highest share of migrants living in the UK, i.e. Poland, 20% depreciation of the pound would reduce the value of remittances by about 0.2% of GDP.
