Sluggish Banking Sector Burdens U.K. Economic Forecast for 2016
The U.K. economic forecast for 2016 should be examined with the facts that the U.K. economy is the fifth-largest economy in the world and the second-largest in Europe at the forefront. If the region votes the wrong way in an upcoming referendum, the U.K. could be plunged into a recession.
The British government is very serious and adamant on demanding European Union (EU) reforms, threatening to run a referendum that could result in the U.K. leaving the EU altogether by 2016. The current prime minister, Conservative David Cameron, has sent a list of the country’s demands to the EU centered along four main conditions, aiming to ensure a greater degree of autonomy for individual member states and reiterating its independence in monetary and migration affairs.
Nevertheless, the U.K. economy is taking a gamble by pushing for an exit from the European Union, referred to as the “Brexit,” dampening the U.K. economic outlook for 2016 and beyond.
Financial Crisis Could Rock U.K. Economic Outlook in 2016
The United Kingdom’s financial sector, which is one of the largest in the world, has not yet recovered from the financial crisis of 2008–09. Overall, government measures to recapitalize the banking system have exceeded £110 billion (US$167 billion), which has added to the burden of public debt in the United Kingdom in no small way.
No British banking group has been spared from having to engage in complex restructuring, refocusing on the domestic market and cutting back on the international scene in a complete reversal of the pre-crisis decade. This has affected the U.K.’s growth rate and prompted a reluctance about trading in the global financial markets.
The weight of the financial system in the U.K. has raised questions about the health of its banking systems, which is one of the essential indicators of economic strength, especially in those regions in which the banking system is the main channel for financing the economy.
Financial System Could Hamper U.K. Economic Growth in 2016
The 2008–09 financial crisis has shown that banks’ difficulties can erode the strength of an economic system. One well-known example may be the case of Germany’s Deutsche Bank and its tremendous derivative exposure. Estimated to be 24-times Germany’s gross domestic product (GDP), the central bank’s exposure is a substantial risk to the global financial system. However, this is not the only source of banking fragility in Europe. While the United Kingdom’s banking risk may be less-known, that does not make it any less risky.
The U.K. is among the few European countries where economic recovery has been significant. The European Commission expects the U.K.’s growth rate for the 2014–16 period to average 2.4% a year, doubling the growth achieved by Germany and more than three times that of the eurozone’s. (Source: “CBI warns ‘gloomier’ global outlook will hit UK growth,” DorsetECHO, November 8, 2015.) The banking system, however, is still reeling from the effects of the international crisis of 2008–09.
The damage done then forced British authorities to nationalize two medium-sized banking groups, Northern Rock and Bradford & Bingley, which had total assets of approximately $200 billion and $100 billion, respectively, as well as the Royal Bank of Scotland (RBS). As mentioned earlier, government measures to recapitalize the banking system exceeded £110 billion (about US$167 billion), a commitment that has contributed greatly to the increased weight of debt in the U.K., increasing from 44% of GDP in 2007 to 89% at the end of 2014.
HSBC (the Hong Kong & Shanghai Banking Corporation) was able to sustain the financial crisis of 2008–09, thanks to its commercial banking strength and the geographical diversification of its activities.
In contrast, Barclays was rather heavily affected in the crisis, also because of its exposure to the U.S. market. Barclays rejected public support, but it recapitalized, thanks to significant support from the Qatar Investment Authority (QIA) and, to a lesser extent, from three major Asian investors.
The soundness of the banking system in the U.K. is a much more sensitive topic than elsewhere. The ratio of bank assets to GDP rose from around 100% in 1975 to the current 450% (one of the highest values in the EU), with the prospect of a further rise in the future. The five major banking groups in the EU have a market capitalization of between €69.0 million and €160.0 million (US$74.5 million and US$172.8 million) and balance sheets with total assets ranging from €1.1 trillion to €1.7 trillion (US$1.2 trillion to US$1.8 trillion). (Source: “The World’s largest banks and banking groups by market cap (as of April 30, 2014),” BanksDaily.com, last accessed November 12, 2015.)
The government has initiated a process of disengagement from the two groups, which it nationalized after the crisis. In the case of the RBS, it is just a first, tentative step (just £1.4 billion, or US$2.1 billion) because the condition of the group is unable to make the placement at a price per share to allow full recovery of the aid granted (£46.0 billion, or US$70.0 billion), despite political electoral promises to the contrary.
In the case of Lloyds Banking Group (LBG), however, the U.K. government’s disengagement has reached an advanced phase. Having taken more than 43% of assets, Westminster now holds less than 20%. As recently announced, by March 2016, the government could be fully out of LBG.
The downsizing of the international presence is one of the fundamentals of these restructuring processes. Since 2008, RBS has abandoned 25 of the 38 countries where it was present. Now, the revenues from outside the U.K. are just 20% of the total. LBG has reduced its international presence from 30 to six countries, while Barclays, after retiring from the United Arab Emirates, has proceeded to the almost complete sale of its retail business in Europe.
The new banking profiles of these once-mighty international groups constitute part of the risks of the U.K. economy, which has become more inward-looking. In terms of financial impact, the banks are charged with having sold unnecessary insurance policies (Payment Protection Insurance, or PPI) from 1990 to 2010 to current account holders for a total of around £44.0 billion (US$67.0 billion).
In 2011, the British Financial Services Authority (FSA), which is the body that oversees the U.K. financial market, demanded that British institutions fully reimburse customers for these policies where inappropriate. This decision has already resulted in £17.0 billion (US$26.0 billion) in repayments, excluding legal costs.
Weakness in the construction and manufacturing sectors, meanwhile, has weighed down the U.K. economy. The overall U.K. growth rate was an annualized two percent in the third quarter, compared to a 2.8% increase in the previous quarter, according to Scotiabank, all in the context of a weak eurozone. (Source: “Global Forecast 2016,” Scotiabank, November 2, 2015.)
Having said all of that, the biggest risk affecting the U.K. economy in 2016–2017 is the prospect of a Brexit.
A Brexit would certainly cause problems for the whole eurozone, given that London is Europe’s financial capital. But the U.K. economy itself faces catastrophic consequences.
Prime Minister David Cameron, with some hubris, intimated that the U.K. is strong without being in Europe, urging the EU has to change to become more competitive. (Source: “Full text: David Cameron’s Chatham House speech on Europe,” The Spectator, November 2015.)
These words, while a warning to the EU, ignore the losses that the U.K. economy would have to confront if the British people vote in favor of a Brexit in the promised 2016 referendum. This will be one of the most highly watched decision processes of the next year worldwide. Its outcome is crucial for future economic strategies at the national (U.K.), regional (European), and global levels.
Brexit: This Should Terrify Investors Everywhere
Prime Minister David Cameron is threatening Paris, Berlin, Rome, and 24 other European capitals with a referendum over his country’s membership in the European Union (EU). Americans may feel shielded from European events, but Britain’s departure from the EU could cause a tsunami that will promptly reach American shores and Wall Street at the speed of Internet communications.
The governor of the Central Bank of England, Mark Carney, explained the possible fiscal consequences of a Brexit, or as it has been called, “the Bookend file.” The Guardian newspaper disclosed that selected officials of the Bank of England are secretly working on “the Bookend file,” thoroughly evaluating the potential financial implications if British voters choose to divorce the EU. (Source: “Secret Bank of England taskforce investigates financial fallout of Brexit,” The Guardian, May 16, 2015.) Carney warned Scottish voters about the dire financial consequences if they chose to leave the United Kingdom.
However, the latest polls have shown a greater willingness of the British people to leave the European Union compared to some time ago, but should England really should leave the EU? Carney doesn’t think so. David Cameron is trying to reform relations with the European Union. In fact, the prime minister wants his country to have a relationship similar to what Switzerland has with the EU. In some circles, this formula is known as “having your cake and eating it too.”
This Could Spark a Eurozone Recession
The EU is unlikely to acquiesce to such favorable terms and if the British vote for a Brexit, the effects on the U.K. could be far more devastating than its effects on the surviving EU countries. A study by Germany’s Bertelsmann Stiftung in collaboration with the IFO Institute in Munich suggests a Brexit could cost British taxpayers about $313 billion, while GDP could drop 14% over a period of 12 years. (Source: “Brexit would cause more damage to European Integration than a Grexit,” International Finance Magazine, July–September, 2015.)
Yes, by exiting the union, the United Kingdom would save on the expenses it pays for the right to EU participation, which goes to the EU’s budget. These expenses amount to about 0.5% of the U.K.’s GDP. However, saving that petty sum does little to compensate the GDP losses that will be caused by the Brexit. If the U.K. leaves the union, EU countries could decide to regulate trade more stringently with the United Kingdom. Such a move could affect various sectors of the U.K. economy and its economic outlook for 2016.
The financial sector would lose five percent and could grow heavy when many financial institutions based in London decided to move their offices to other eurozone financial capitals, such as Frankfurt, Dublin, or Milan. Yet the chemical industry is the one that would suffer higher losses of an estimated 11%. Other sectors, such as the automotive, mechanical, and engineering sectors, would suffer heavily because they are too rooted in European economies.
The effects on the EU economy would be less severe, but Germany would feel it most. The most affected sectors would be the automotive sector (with losses estimated at around two percent), the electronics industry, the steel industry, and the food industry.
In short, the Brexit is a game that will have no winners.
It is no coincidence that the British financial community is feeling pressure to vote down the Brexit referendum and that Washington views it with concern. Now that the eurozone and economies across Europe are beginning to see the first signs of economic recovery, a Brexit seems like an especially pointless populist exercise.
Brexit Is Worse Than a Grexit
Cameron’s government has given the EU an ultimatum, including four ways to reform its governance and a year’s time to endorse the proposed changes. Failure to comply will set the trigger for an EU membership vote in 2016, opening the path to a Brexit.
The first threat of a potential Brexit is the weakening of the EU, as the British referendum acts as a wedge promoting destabilization. The EU’s failure to comply with the U.K.’s ultimatum will trigger the Brexit, pushing the U.K. and the EU to consider what we get by trying to divide 1 by 0. The answer is “E,” or undefined, because with the folkloristic exception of Greenland, there has not been any case of an exit from the EU. In the past two years, there has been talk of the Brexit and even more talk of a Grexit in relation to the euro crisis prompted by Greek sovereign debt and German rigor. Yet Greece still uses the euro and despite the victory of the euro-skeptical Syriza party, which recently won yet another election, there is no talk in Athens of Greece leaving Europe.
As the skeptics would imply, surely Greece has had all to gain and nothing to lose from its EU membership, but even Britain should consider the advantages membership brings.
Indeed, Cameron is playing the Brexit card to hedge his party’s chances in the forthcoming 2016 election for the House of Commons. Polls have shown that those in favor of remaining in the union have a slight edge, which means the electorate could be fractured. Moreover, the loudest message in favor of the Brexit has come from Nigel Farage’s europhobic UKIP, some Thatcher-era remnants (Nigel Lawson), and financiers embittered with Brussels.
Those opposing a Brexit include three former premiers, John Major, Tony Blair, and Gordon Brown. These premiers argue that it is essential that the euroskeptics be defeated, but explaining the benefits of membership in the EU has always been a daunting task, especially to the British. The residents of the United Kingdom have been rendered almost defenseless before the numbers and statistics expertly modulated to persuade them to reject the EU, a sentiment that the fiercely anti-European Rupert Murdoch propagates through his vast media outlets.
How the Brexit Referendum Will Unfold
Quite clearly, the travails of the euro will do EU supporters no favors nor will the controversy on the cost of immigration to British taxpayers, accented by images of migrants trying to board boats for Dover from Calais. However, what is less clear beyond the British Isles’ shores is that a Brexit is merely one of the tools that the ruling Conservative party is using to avoid fracture.
Prime Minister Cameron is essentially pushing his country-and Europe, for that matter-to face a major existential debate and referendum for the sole purpose of keeping the Conservative party, rather than the United Kingdom, united. Cameron has not fully explained how humoring the whims of euroskeptics will benefit the U.K. economy or fill the pockets of people like Murdoch or his readers with even more British pounds.
November is the month when the British delegation will be active in Brussels, getting their message and Brexit warnings across to the European Council. European sources have observed that Westminster has been slow to formulate concrete demands, delaying the negotiations. For now, Cameron has spoken mostly of reforms concerning the issue of social benefits to immigrants, urging these be cut. (Source: Herman, Y., “Cameron set for high-stakes game of bluff with Brussels,” Reuters, October 20, 2015.)
The British leader also wants to reserve the right to exempt themselves from greater EU integration, even as Cameron demands, paradoxically, that concessions on economic competitiveness and greater protection for countries do not belong to the euro area.