Active Stocks
Thu Mar 28 2024 15:59:33
  1. Tata Steel share price
  2. 155.90 2.00%
  1. ICICI Bank share price
  2. 1,095.75 1.08%
  1. HDFC Bank share price
  2. 1,448.20 0.52%
  1. ITC share price
  2. 428.55 0.13%
  1. Power Grid Corporation Of India share price
  2. 277.05 2.21%
Business News/ Opinion / Why EU exit would punish Britain
BackBack

Why EU exit would punish Britain

As JP Morgan CEO Jamie Dimon told shareholders in his annual letter, the best-case scenario for Britain leaving the EU is 'years of uncertainty'

Photo: APPremium
Photo: AP

One of the biggest unanswered questions of Britain’s looming referendum is how much capital might flee the nation if it decides to go it alone.

As it stands, foreign investors do better in Britain than British investors abroad, and that investment has been a big driver in the UK economy. It also helps explain why there’s concern about the nation’s growing deficit in its current account.

Britain’s economy is one of Europe’s strongest in terms of growth. But in 2015, the country’s current account deficit hit a record. After widening for four consecutive years, the deficit reached £32.7 billion ($46.47 billion) in the fourth quarter—that’s 7% of GDP, the highest of any developed nation. It suggests two things: The nation remains a highly attractive place for foreign investors, and it’s living beyond its means.

Capital flows to areas where investors can earn a higher return, and Britain’s economy has performed well relative to its largest trading partner, Europe. But the worsening of the current account deficit has come largely from a decline in net income from British investments abroad. That means income paid out to foreigners on their investments in Britain outstrips the amount the nation takes in on its investments in other places.

The UK has for a long time imported more goods than it exports, while running a surplus in services, thanks to its large financial sector. But that still means Britons are again consuming more than they are producing. Whatever belt-tightening happened after the financial crisis seems to be gone. British household consumption has been expanding, with big increases in consumer credit; while savings are at historic lows and investment in tradable goods has declined.

One of the ways Britons are financing all the spending is with investments from abroad. The UK economy relies heavily on booming sales of high-end London property to foreign buyers. Housing prices have now reached levels that are starting to look like a bubble. Any shock—and an exit from the European Union would qualify—is likely to reduce foreign inflows to the housing market.

All of this leaves Britain dependent on “the kindness of strangers", as Bank of England governor Mark Carney put it earlier this year.

Foreign investors can be fickle, especially when the boat gets rocked. In the 1997 Asian crisis, the economies of countries that suffered the most had the largest current account deficit. In the more recent financial crisis, European countries with the largest current account deficits were the hardest hit, even without a major shift in their trade balances.

One reassuring note about Britain’s deficit: most of the money flowing into the country, or about 81% of net UK capital flows in 2014, is more stable, long-term foreign direct investment. But confidence can easily turn and even currency fluctuation may not be enough to restore a sense of order. Britain’s current account deficit is too large to be whittled away through exchange rates. Sterling depreciated 25% on a trade-weighted basis in 2008, but the trade response to that was modest. Unless Britain invests in new export capacity, a decline in the currency is little help.

Stable investment is the long-term answer. Even beyond the EU vote, protecting the British economy from shocks will mean that chancellor of the exchequer George Osborne needs to worry more about the current account deficit and less about the budget deficit that’s consumed his attention the past five years. The single-minded focus means investment in human capital and infrastructure has been insufficient.

In the meantime, it’s hard to see Europe riding to Britain’s rescue. As JP Morgan CEO Jamie Dimon told shareholders in his annual letter on Wednesday, the best-case scenario for Britain leaving the EU is “years of uncertainty". There are, of course, even worse things than uncertainty. BLOOMBERG

Therese Raphael is a Bloomberg View editor in London.

Comments are welcome at otherviews@livemint.com

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 08 Apr 2016, 12:40 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App