If 'disastrous' Brexit happens, how would it affect us?
Published 17/01/2016 | 02:30
Britain's forthcoming EU referendum is causing the pound to weaken - hurting Irish exporters in the process, writes Dan White.
The euro rose to almost 76p at one point this week, its highest level against sterling since February 2015. The UK currency has now lost almost 10pc of its value against the euro since mid-November. This is bad news for indigenous Irish exporters, the tourism sector and producers of goods and services for the domestic market, most of whose main competitors are British.
The Irish economy has benefited from a powerful triple whammy of favourable exchange rates, low interest rates and falling oil prices over the past few years. It is these tailwinds that have propelled the recovery of the Irish economy with the ESRI estimating that the domestic economy, as measured by GNP, grew by 5.2pc in 2015 and forecasting GNP growth of 5.3pc for this year.
"The economy has been very strongly helped by extraneous factors over which we have very little control," says Prof Kieran McQuinn, one of the authors of the ESRI's Quarterly Economic Commentary.
For indigenous companies, by far the most important of the factors boosting growth has been the favourable exchange rate, particularly the recent weakness of the euro against sterling. At one stage last July the euro briefly fell to less than £0.70. This meant that Irish exports were hyper-competitive in the key UK market while the cost of visiting Ireland fell for UK tourists.
Despite the fall in international dairy commodity prices, 2015 was a bumper year for most of the Irish food and drink sector with exports growing by 3pc to €10.8bn, according to recently-published Bord Bia figures. In 2015, the recent trend of diversifying away from the British market was reversed with the proportion of Irish food and drink exports going to the UK increasing from 39pc to 41pc. In cash terms that translates into a €350m jump to over €4.4bn in the value of Irish exports going to our nearest neighbour.
Tourism has also been a major beneficiary of the weaker euro. The latest figures from the CSO show that the number of overseas visitors to Ireland jumped by 14pc to over eight million in the first 11 months of 2015. Once again it was the British market that was to the fore with the number of UK visitors climbing to almost 3.3 million, over 40pc of the total.
Now there are clear signs that the favourable euro/sterling exchange rate, from which we have benefited so much, may be beginning to move against us. While the recent fall in the value of sterling against the euro is well within the pain threshold of most Irish companies selling into the UK market, that could change if sterling fell further against the euro.
And many of the ingredients for a further significant fall in the value of sterling are already in place with the economic news coming out of the UK being mediocre at best. The most recent figures show that the British government borrowed £66.9bn during the eight months to the end of November. This makes it virtually impossible for Chancellor George Osborne to meet his £68.9bn borrowing target for the year to the end of March 2016.
Other recent UK economic indicators have been equally lacklustre. Manufacturing output was 0.4pc lower in November 2015 than in the previous month and 1.2pc lower than the November 2014 output while the value of retail sales rose by just 0.9pc in the three months to the end of December.
Britain's current account deficit, the difference between the value of the goods and services which it buys from and sells to the rest of the world, is also perilously high at over 6pc of GDP.
This combination of weak underlying economic performance and a very high current account deficit would, under certain circumstances, be more than sufficient to trigger a good old-fashioned sterling crisis which would see the value of the pound fall dramatically.
However, it is not these factors which are the main cause of the current weakness of sterling but uncertainty surrounding Britain's future membership of the European Union, as our nearest neighbour gears up for a referendum on whether or not it should leave the EU later this year. As the date of the referendum, which could take place as early as June, draws closer, currency traders are becoming increasingly concerned that British voters will opt to leave the EU and that 'Brexit' will become a reality.
So just how real it the likelihood of Brexit? Speaking in Dublin last week, Willem Buiter, chief economist of Citigroup and a former member of the Bank of England's Monetary Policy Committee, said that there was a "serious risk" of Brexit - up to 35pc - and if this did happen, it would "be a disaster for Britain".
While most other economists don't put the chances of Brexit quite as high as Dr Buiter, with opinion polls showing that voters are split almost 50:50 on continued British membership of the EU and Prime Minister David Cameron having been forced to concede the right of cabinet ministers to campaign for a 'no' vote, it is clear that any referendum will be a close-run thing.
The 'yes' side in the referendum did have one good piece of good news last week with outgoing Mayor of London Boris Johnson apparently ruling out the possibility of his leading the 'no' campaign in the referendum.
Fergal O'Brien, director of policy with employers' group IBEC, feels that once the uncertainty surrounding Britain's EU membership is resolved, the sterling exchange rate will move in Ireland's favour once again.
"In 2016 we are going to see currency volatility but we are not going to see a crisis for Irish exporters. The expectation of a referendum in the summer of 2016 has focused the market's mind. However, we still think that over the course of the full year there will be a favourable average exchange rate", he says.
Mr O'Brien expects that sterling will strengthen against the euro in the second half of 2016 after a 'yes' vote in the UK referendum.
If sterling continues to weaken, both the food and tourism sectors will quickly feel the impact.
"Every 1pc weakening of sterling potentially costs Irish food and drink exporters €44m. The UK is a core market for us and will continue to be so", says Padraig Brennan, director of markets at Bord Bia.
Tourism will also find itself in the frontline. Last week Failte Ireland chairman, the straight-talking former Ryanair number two Michael Cawley, warned of the danger of "gouging" visitors". "Our underlying cost creep here is at an unacceptable level", he said. "We can't depend on strong currencies to bail us out if we are becoming uncompetitive locally, and that seems to be what's happening here."
The fact that the imminent prospect of a referendum has forced currency traders to take the prospect of Brexit seriously doesn't necessarily mean that British withdrawal from the EU is the most likely outcome - far more likely is that British voters will do what they did in the previous EU referendum in 1975 and unenthusiastically vote 'yes'.
Unfortunately that's not an outcome we in this country can afford to take for granted. There remains the significant possibility that, probably more by accident than design, Britain's manoeuvers itself into a situation where it finds itself outside the EU. If that happens then all bets are off and sterling could experience further sharp falls against the euro.
A November 2015 ESRI report on the possible consequences of Brexit for this country estimated that British withdrawal from the EU could cut trade between the UK and Ireland by up to 20pc. On the plus side, by making the UK a less attractive location for foreign direct investment, it could boost Ireland's attractiveness.
Bord Bia's Padraig Brennan points out that, while the UK is a very important market for Irish exports, Ireland is also a very important market for the UK. In the circumstances there would have to be some sort of a trade agreement between the two countries in the event of Brexit.
"I hope it doesn't come to that", he says. Given the likely implications of Brexit for the euro/sterling exchange rate and Anglo/Irish trade flows, most people in this country would probably agree with him.
Sunday Indo Business