Pakistan’s Economy After Brexit

Written By: Dr. Zafar Mehmood

On June 23 this year, in a historic referendum people of United Kingdom voted for a British exit, or Brexit, from the European Union (EU). Majority people voted against remaining in the EU. As soon as the result of the vote was declared, it sent shock waves throughout the world. It created turmoil-like situation, which resulted into immediate loss of $2 trillion across the global stock markets. London stocks were down by 16%, Frankfurt lost 10% and Paris 8%. In response to the panic situation, the central banks’ governors around the globe started pacifying their investors and others by announcing that the central banks will provide needed liquidity to markets for averting volatility so that currencies do not face any major burden. Nevertheless, the pound fell to its lowest value since 1985. It depreciated by 10% against U.S. dollar, while yen appreciated by 13% against pound. These were the immediate reactions. However, few expect a full scale financial crisis like that of 2008 great recession when the financial giant Lehman Brothers collapsed.


There remains a fear that these crises may have long term adverse economic implications not only for the UK but also for the rest of the world economy. Keeping this in view, the new Prime Minister of England, Theresa May is trying to create a future for the UK out of the EU zone. She is initiating concrete actions to retain UK’s access to EU’s single market, satisfying the wishes of anti-immigration and anti-globalization voters. For this, she is creating a right balance between a control on immigration and at least partial free trade access to the EU single market zone. To avert future surprises, UK does not want to start withdrawal talks anytime soon, though the EU leaders wish this to happen quickly. EU leaders are taking hardline to exit so that anyone leaving the EU in the future will have to pay a price. Nonetheless, delay and uncertainty have already injured the UK economy.
As the UK is starting exit negotiations with the EU, it wants to assure that its economic future would be linked to the EU single market. But the UK government does understand that other countries of Europe (Iceland, Norway and Switzerland) who have not joined the EU but are given free trade access to EU area, regularly contribute to the EU budget and allow free movement of EU workers. Thus, the UK will have to accept these conditions before having free trade access to the EU single market.


For Pakistan, any major development taking place in its key markets, such as the UK and the EU, certainly have important repercussions for its domestic economy. Let’s assess how Pakistan’s markets reacted to the Brexit news and how its economy will perform in the future to developments in the UK and the EU?


With referendum results on Brexit, Pakistan’s stock market lost over 1,400 points, with textile and auto sectors bearing the major brunt. As Pakistan Stock Exchange (PSX) is now well connected with the global markets, it took a hard hit after the Brexit decision. The benchmark index was down by 2.2% from a day earlier. After losing over 1,400 points in the early trading, the KSE-100 Index recovered some of the losses but the day’s loss was 848 points.


Publicly traded textile companies at the stock market were badly affected. The EU and the UK are major destinations of Pakistani textile products. Investors foresee export-oriented textiles companies listed on PSX will be facing problems in the future, as a cheaper pound will make Pakistani exports uncompetitive in the UK market.


With the news of Brexit, yen appreciated significantly. It appreciated by about 3% against Pakistani rupee in a single day’s trading. A stronger yen inflicts the earnings of auto companies based in Pakistan, because it results into rise in cost of parts imported from Japan. But as soon as the effect of yen appreciation will get neutralized so will the cost of Japanese parts.


In the short term, fears would remain that foreign investors might pull out some of their investments from Pakistani bourses. According to the National Clearing Company of Pakistan Limited, foreign institutional investors were net sellers of Rs. 506.1 million during the trading session on June 24. If government and the central bank keep on ensuring sufficient foreign and domestic liquidity flows to the market, it will stay panic free and fears will disappear shortly.


The price of gold increased by 3% in the local market, although in international market it increased by 5.3%. With volatility remaining in the FOREX market, gold prices are likely to rise as assets holders will come out of foreign currencies and will substitute it with gold.


With Pakistani rupee becoming stronger viz-a-viz euro and pound, exports will lose competitive strength as they will become expensive for the EU and the UK consumers, causing export demand to decline. At the same time, an economic slowdown and hence a fall in incomes in the EU and the UK will also cause a decline in demand for Pakistani exports. As our major exports to the region are textiles, clothing and leather, producers of these goods will face a slowdown in their export earnings. Our exporters are concerned about developments in the UK and they look forward to the government as to how it handles its affairs after the official break away of the UK from the EU.


As long as the UK was part of the EU’s customs union, it used to practice common external tariffs as were used by other EU members. However, once UK quits the EU, it may adopt different tariff levels for the rest of the world. A new tariff structure in the UK will affect Pakistani exports depending on whether it becomes more favourable for the rest of the world or more stringent than before.


The EU awarded the Generalized System of Preferences Plus (GSP+) status to Pakistan in December 2013 for the next 10 years. It has helped the country to add over $1 billion per annum of exports. The government of Pakistan should re-negotiate at some appropriate time to get the same tariff concessions if not better from deals with the UK and the EU.


Pakistan’s exports to the UK may increase if some trade diversion from the EU takes place. This will provide an opportunity to our exporters to benefit from it. Concomitantly, as UK exporters will start looking for opportunity to export out of the EU zone, it may increase our imports from the UK. There will also be an opportunity for Pakistan to conclude its long pending Trade and Investment Framework Agreement (TIFA) with the UK, which was rather more difficult to negotiate with EU’s 27 countries.


As UK’s financial market settles and prepares itself for the non-EU regime, it is quite possible that UK investors explore foreign markets such as Pakistan for their overseas investment. At that time, depending on the strength of our capital market and incentive regime, the UK investors may opt to invest in Pakistan.


Before the referendum, a major issue was migration from the EU countries to the UK. With Brexit, the UK may not offer quota-based employment to potential EU migrants. Consequently, UK may open up its borders for workers coming from other countries either on permanent or temporary basis. This may provide an opportunity to Pakistani workers to migrate to the UK.


At the same time, fears are being expressed that Brexit has created racial intolerance that would unleash hostility among the working classes who expect immigrants to threaten British economy as well as security. This feeling is being expressed by British nationals of other origins including Pakistan. Anti-immigrant sentiments may force Pakistanis residing temporarily in the UK to leave. A domino effect may also occur if other EU countries pursue the UK policy of protecting and closing its borders for migrants. This will halt entry of our workers to European countries. Our government should remain vigilant of any development that may take place in this regard.


With fall in incomes, it is likely that remittances from the UK (our 3rd major source of remittances) will decline. But, if some British nationals of Pakistani origin return home due to a rise in prejudice then one time remittances might go up sharply.


An extended fall in pound may reduce our debt liability denominated in pound sterling. Moreover, after Brexit, the UK may not stick to the EU rules and regulations concerning Overseas Development Assistance (ODA). As a deliberate move, it may divert its ODA towards Commonwealth countries, including Pakistan, to gain diplomatic and political support and strength.


In sum, Brexit has raised a whole new set of risks for global economies. Looking forward, thus, there is a considerable amount of ambiguity that will cloud the global economic horizon for some time to come. A prolonged uncertainty can damage the UK economy as well as those who are connected with it. Our policymakers should carefully watch developments in the UK and the EU single market zone and take appropriate measures to benefit from upcoming opportunities and avert negative repercussions.

 

The writer is a Professor of Economics School of Social Sciences and Humanities, National University of Sciences and Technology, Islamabad. He can be reached at

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As UK’s financial market settles and prepares itself for the non-EU regime, it is quite possible that UK investors explore foreign markets such as Pakistan for their overseas investment. At that time, depending on the strength of our capital market and incentive regime, the UK investors may opt to invest in Pakistan.

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Pakistan’s exports to the UK may increase if some trade diversion from the EU takes place. This will provide an opportunity to our exporters to benefit from it. Concomitantly, as UK exporters will start looking for opportunity to export out of the EU zone, it may increase our imports from the UK. There will also be an opportunity for Pakistan to conclude its long pending Trade and Investment Framework Agreement (TIFA) with the UK, which was rather more difficult to negotiate with EU’s 27 countries.

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