Sunday 23 October 2016

Post-Brexit sterling collapse will hit our economy a body blow, with tourism and car sales set to feel the pain

The collapse in sterling after the UK referendum will hit indigenous companies hardest and slow the economic growth the Government was banking on to fund its spending plans, says Dan White

Published 10/07/2016 | 02:30

The euro climbed above 86p sterling last week, its highest level since October 2013. Good news for anyone contemplating a holiday in Britain or a cross-border shopping trip - but bad news for just about everyone else. Photo: PA
The euro climbed above 86p sterling last week, its highest level since October 2013. Good news for anyone contemplating a holiday in Britain or a cross-border shopping trip - but bad news for just about everyone else. Photo: PA

The euro climbed above 86p sterling last week, its highest level since October 2013. Good news for anyone contemplating a holiday in Britain or a cross-border shopping trip - but bad news for just about everyone else.

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Why does the British vote to leave the EU matter so much to this country? Since we first joined what was then the EEC more than four decades ago we have successfully diversified our overseas trade away from the UK.

Way back in 1973, over 90pc of our foreign trade was with the UK. By 2015 only 14pc of our goods exports went to the UK while 20pc of our services exports went to the UK in 2014, the last year for which figures are available.

A higher proportion of our goods imports, 26pc, come from the UK, but only 10pc of our services imports come from across the water.

Unfortunately, the Central Statistics Office (CSO) figures seriously understate our real dependence on the UK market. A bit like an athlete on steroids, the official trade statistics have been artificially boosted by the multinationals giving a misleading impression of our real level of performance.

Look at indigenous exports and it quickly becomes apparent we are still very dependent on the British market. Last year, 41pc of our food and drink exports, about €4.4bn worth, went to the UK. Food and drink is the largest indigenous sector of the economy with more than 230,000 people employed.

Indigenous exports, most of which go to the UK, are far more valuable to the economy than is immediately apparent.

Figures compiled by the Department of Jobs, Enterprise and Innovation show that foreign-owned, IDA-supported firms had total sales of €141bn in 2014 and that €134bn of these sales, 95pc of the total, were exported.

To compare, Enterprise Ireland-supported indigenous firms had total sales of €33bn of which €16.6bn, just over 50pc, were exported.

On the face of it these figures would seem to indicate that the multinationals were worth four times more to the Irish economy than the indigenous companies. Look again. While the multinationals spent €20.4bn (just 15pc of their sales) on Irish inputs, the indigenous companies spent €20.7bn - or 63pc of sales.

What this means is that every euro of indigenous exports, which go disproportionately to the UK, is worth over four euro of multinational exports.

The official trade statistics also tend to understate the dependence of Irish services providers on the British market.

The CSO's first quarter Quarterly National Household Survey estimated employment in accommodation and food service activities at 142,000, 7pc of total employment. However, Failte Ireland puts the number of tourism-related jobs significantly higher at 205,000 or 10pc of all jobs in the economy.

In 2015 a record 8.6 million overseas visitors came to Ireland. Of these 3.5 million or almost 41pc came from Britain.

A British visitor planning a trip to Ireland could have expected to receive more than €1.40 for every pound last November. This week he or she would have received just €1.17.

What impact will this dramatic fall in the value of sterling against the euro have on tourist numbers? The most recent CSO figures show a further 16pc increase in the number of overseas visitors to Ireland to almost 1.8 million in the first quarter of 2016.

That might be as good as it gets.

One possible pointer to where the sector might be headed is the one-third fall in the share price of Dalata, the country's largest hotel operator, since the start of the year. Irish Continental Group, the largest ferry operator on the Irish Sea, has also been clobbered, with its share price having fallen by over 20pc since the referendum result.

Clearly investors are betting that Brexit signals harder times for Irish tourism.

The food and drink sector is also circling the wagons. It consists of a small number of large companies and a plethora of smaller ones. While the share prices of large, well-diversified food companies such as Kerry and Glanbia have held up relatively well, the smaller players face a much more uncertain future.

Currency hedging is a big issue. While the larger food and drink companies have hedged their sterling receivables forward, allowing them to delay the impact of the sterling collapse, most of the smaller companies don't have access to hedging.

Bord Bia estimates that at least 60pc of the smaller companies have not hedged their sterling receivables.

Unlike the larger players, diversifying away from the UK market is not a realistic option for most of these smaller food and drink companies.

"The UK is the best-paying market for things like beef. It has the widest range and is the nearest to us. Their tastes are similar to our own. It is a great market. Two-thirds of companies want to stay in that market," says a Bord Bia spokesperson.

With the UK having to import 40pc of its requirements, it isn't going to suddenly pull down the shutters on Irish food, regardless of the outcome of the Brexit negotiations with the EU.

For Irish exporters to the UK, living with currency volatility comes with the territory. Ever since the link with sterling was broken in 1979, the value of the punt and more recently the euro has fluctuated against the British currency. As the Bord Bia spokesperson points out, the value of sterling against the euro is now back to where it was in 2013.

While such volatility in the euro/sterling exchange rate is not unprecedented, what is unusual is the speed with which the exchange rate has moved - from 70p as recently as last November to 86p last week. That's a 23pc jump in just over seven months.

And it could get worse. Employers' body IBEC predicted in its quarterly economic outlook last March that the euro could rise in value to 85p in the run-up to the UK referendum. They also said that if British voters voted to leave, the euro could rise to parity against sterling within two years.

Given that the first part of the prediction was bang on the money, how worried should we be that the second part will prove to be accurate also?

Ger Brady, IBEC senior economist, believes that the euro could climb to 90p over the next few weeks. "The feedback from our members is that 85p is tough but bearable. Once you get to 90p things are in a bad way," he says.

So how do Irish exporters respond to the collapse in the value of sterling?

With the euro set to rise even further against sterling, Mr Brady fears that many of them will opt to switch production to Northern Ireland or Britain. In order to head off this danger he recommends that the Irish Government addresses the taxation of capital gains, share options and personal income, where the rates are much higher than those levied in the UK.

With UK Chancellor of the Exchequer George Osborne, who had previously planned to cut the UK corporate tax rate to 17pc by 2020, having now said that he will bring it down to a maximum of 15pc - as near as makes no difference to our 12.5pc rate. Ireland's increasingly uncompetitive personal and capital gains tax rates look set to become a much bigger issue.

So just how much damage could Brexit and the resulting collapse in the value of sterling do to the Irish economy?

Last November, the ESRI predicted that Brexit could reduce bilateral trade flows between Ireland the UK by up to 20pc.

This reduction in trade with the UK would fall disproportionately on indigenous sectors such as food and drink which purchase the highest percentage of Irish inputs. The numbers are potentially enormous.

A 20pc reduction would knock €3bn off the value of our exports of goods to the UK and a further €4bn off services exports. A €7bn reduction in exports would very quickly make itself felt throughout the economy.

One sector that will feel the impact of the Brexit vote very quickly is the motor trade, with cheaper sterling opening the floodgates to cheap second-hand imports from the UK.

With sales of new cars up 25pc to 93,000 in the first five months of the year, it was shaping up to be the best year on the country's forecourts since 2007 when 181,000 new cars were sold.

New car sales collapsed after 2008. This meant that, as the economy began to recover there was a severe shortage of good Irish-registered second-hand cars.

Under normal circumstances much of this demand would have been satisfied by second-hand imports from the UK. However, the strength of sterling from mid-2014 choked off this source. This meant that many buyers, who would have normally bought a second-hand car had no choice but to buy new instead.

But for how much longer? With sterling now down to €1.17 and falling, a two or three-year old UK second-hand import suddenly makes sense. Any downturn in new car sales would feed through into lower VAT and VRT revenues almost immediately.

Mr Brady is still predicting 4pc economic growth this year but warns that: "The bands of uncertainty in future years are now much wider."

With sterling in freefall following the referendum result, we in this country can only batten down the hatches and hope that the UK negotiates an EU exit that does us the least possible harm.

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