Elevated no deal Brexit risk threatens CEE

Elevated no deal Brexit risk threatens CEE
By Clare Nuttall in Glasgow January 16, 2019

It was the worst defeat for any government in modern British history: MPs in the House of Commons voted by 432 to 202 against Theresa May’s Brexit deal just 10 weeks before the UK is due to leave the union. The result — while largely expected — leaves the future both for the UK and for the remaining 27 members of the EU, not least those in Central and Southeast Europe, highly uncertain. 

As far as UK politics are concerned, May is likely to win the no-confidence vote on January 16, and is talking about trying to reach a cross-party consensus though there are few signs that bringing together the deeply divided British political class will be possible. Optimists may look to the hint from the EU’s chief negotiator Michel Barnier, who said post-vote that should the British side be willing to compromise on some of May’s “red lines” — drawn on issues such as freedom of movement and the jurisdiction of the European Court of Justice — then the EU would respond favourably. Yet such a step is hard to envisage given the opposition it would meet from hardline Brexiteers in London.

EU leaders have already stressed that it is up to the UK to decide what course it takes. “First of all, the UK government has to clarify its position. We need to know what comes next in the UK,” said Romania’s President Klaus Iohannis. “The procedures that may ultimately lead to the approval of this agreement have not been exhausted, and this would be the best solution. On the other hand, the European Union, made up of the 27 states, is also prepared for other alternatives. Many people have wondered whether a renegotiation of this Agreement is possible or whether there are different positions within the EU27. And I can tell you very clearly: EU27, so we who remain in the EU, are united. There are no divergent approaches.”

MEPs from neighbouring Bulgaria have also commented on the situation, saying that the ball is in the UK’s court, but also expressing concern over “potential chaos” facing EU businesses. 

“The set of possible ends to the Brexit drama seems to have become smaller last night. Whereas before there were three elements: {“deal“, “no deal“, “no Brexit“} only the options starting in “no” seem to be left now,” Commerzbank analysts wrote on January 16. “Of course “no deal” (i.e. a disorderly UK exit from the EU) is the less likely of these two possibilities.” This was reflected in the value of the pound, which appreciated after the vote. 

The consensus among analysts is that the British government will apply to postpone Brexit given the March 29, 2019 deadline is now imminent. “The government must now present a plan B by the end of the week. We expect it to apply to the EU for a postponement of the exit date (until the summer months). Given the almost unpredictable economic impact, the EU is likely to agree,” wrote Raiffeisn analysts after the vote.

“It now looks as if the Brexit date will be postponed … but I wonder what good that will do,” concurred the note from Commerzbank. “The British side has — to use FX market parlance — no positive theta, unless Brussels caves in. I consider it to be quite courageous to bet on that. There will not be much of an extension anyway. The European elections limit that — it would not work for British parliamentarians from the previous election period to remain in the European parliament for too long. And it cannot be imagined that the UK will take part in European elections again.”

With the current disarray in the UK, the outcome of the vote makes the prospect of a no deal Brexit — the worst case scenario for fellow EU members in terms of trade and the wider economy — that bit more likely, even if no Brexit at all is also now looking like a stronger possibility. 

Even an orderly Brexit would, as ING analysts wrote in late 2018, “have profound implications for Central European countries”. ING’s report projects that while all of the EU would be affected, “Brexit will especially resonate with Central Europe. Here European supply chains will be questioned and to a lesser extent the free movement of people and its impact on remittances from the UK. Brexit will also draw attention to the 2021-27 EU budget round, where the loss of the UK’s contribution will be painful.” 

Severe disruptions to trade are expected, especially in the agriculture, automotive, textiles and retail sectors that dominate the CEE region’s trade with the UK. “After the Netherlands, it is the Czech Republic, Poland and Hungary with the largest relative exposures to UK demand. While these exposures are still relatively small in GDP terms, they do centre on a few key industries such as the auto sector, agriculture and textiles, as well as services,” ING’s research finds. 

A report by the European Committee of the Regions delves deeper into which industries, regions and cities are likely to be worst hit by the UK’s withdrawal from the EU. Its exposure index is based on trade flows in six key economic sectors: Transport Vehicles, Machinery, Electronics, Textile and Furniture, Vegetables, Foodstuff and Wood, Chemical and Plastics. 

Romania’s Vest development region in the western corner of the country that has emerged as a hub for the automotive industry is one of the four regions likely to be severely affected in the transport vehicles sector. Vest along with Západné Slovensko region in Slovakia and Střední Morava region in the Czech Republic would be severely affected in the electronics sector too. The Czech Republic’s machinery sector is also singled out. Brexit could reduce Czech GDP by up to CZK55bn (€2.1bn), or by 1.1%, according to the analysis by the bank Ceska Sportelna released in November. Brexit could also lead to layoffs of up to 40,000 employees in Czechia and have a significant impact on automotive, electronics and machinery industries.

Elsewhere in the EU, Bulgaria’s Severozapaden region is one of the four most exposed in the textiles and furniture sector. And in the Vegetables, Foodstuff and Wood category, Latvia together with Ireland is the most exposed smaller country. 

“In general, the situation varies across EU regions,” says the report, but adds that, “There is no clearly identified ‘winner’.” 

Meanwhile, a November 2018 report from the European Bank for Reconstruction and Development (EBRD) forecasts that a no-deal Brexit would hit the Southeast European economies hardest among the EBRD regions. “Cumulatively, the economic impact of a no-deal Brexit is projected to be largest for economies of south-eastern Europe, mainly through disruption to trade linkages encompassing the UK and other advanced economies in Europe, the impact on the EU accession reform momentum and a reduction in the EU structural and cohesion funds,” said the EBRD’s latest Regional Economic Prospects report.

This goes beyond EU member states from the region; the EBRD warns that a no-deal Brexit “might also weaken perceived prospects of EU accession for candidate and potential candidate countries. A slower reform momentum would then weigh on growth”. Until recently, the UK had been an advocate of EU enlargement eastwards. 

Budget constraints

Then there is the impact of Brexit — whether managed or not — on the EU budget. As one of the largest net contributors to the EU budget, the UK’s departure will inevitably be felt, especially by major recipients of structural funding. 

“On the money side, the UK had been funding around 6% of the EU’s budget. This contribution will disappear for the 2021-27 round,” ING analysts wrote. “However, the indirect impact of the UK’s departure may be larger. The EU average GDP per capita level will drop after Brexit, propelling the likes of the Czech Republic and Poland above key financial thresholds. EU funding for CE4 economies could drop by anywhere between 12% and 24% in real terms.”

Meanwhile the EBRD forecast that, “Unless other member states increased their contributions to the EU, Brexit would lead to a 10 to 15 per cent decline in structural and accession funds available to countries in central and south-eastern Europe, amounting to a reduction of up to 0.4 percentage points of GDP in EU-supported investment.”

A proposal issued by the European Commission in May 2018 indicates that Poland and other Central European members of the European Union will have to deal with severe cuts in the EU’s cohesion funding in the next EU budget. While it will be up to EU leaders to decide on the budget, the proposal reflected both the financial realities post-Brexit and a shift in the EU’s spending priorities. While previously cohesion funding had been allocated primarily on the basis of GDP per capita figures, the Commission now proposes to reduce the weight of that criterion to fit criteria like youth unemployment, climate, education level, and the reception and integration of migrants.

Going east

The future of the estimated 3.5mn EU citizens who settled in the UK over the past decade remains uncertain, and it is hard to predict what Britain crashing out of the EU would mean for their lives. This is especially a concern the more recent arrivals from newer EU entrants Romania — the source of around 400,000 immigrants — and Bulgaria. 

In terms of their home countries, this in turn creates uncertainty about the future of remittance payments from workers abroad, as many maintain close ties with relatives back home. 

On the other hand, a Brexit that fails to secure EU migrants’  future in the UK — and thousands have already left amid a toxic combination of uncertainty and anti-immigrant sentiment — could be a blessing in disguise for countries in the CEE region as migrants return home. Countries across the region face tightening labour markets amid the ongoing economic boom and (in several cases) declining combinations. 

Back in 2016, real estate firm Colliers International forecast that citizens of CEE would “boomerang” home after the UK’s exit from the EU, thus hiking GDP across the region and provide a corresponding boost for local real estate markets. Together with the uncertainty surrounding their status in the UK, the weakening pound, Colliers anticipated, would "prompt a wave of workers in Western Europe to return to CEE-6 countries". To some extent this has already been seen in the run up to the Brexit deadline, with British businesses especially in the agricultural sector, reporting worker shortages. 

On the other side of the coin, the governments of the Czech Republic and Poland are reportedly preparing emergency legislation to allow British citizens in the two countries to stay in case of a no deal Brexit. 

Not only people but some companies too could start moving eastwards, as UK companies seek to keep a foothold on the continent. “While larger businesses focus on Frankfurt, Paris, and Amsterdam, smaller financial firms are turning to CEE,” said a comment from public policy research institute the Center for European Policy Analysis (CEPA) on January 9. 

It identifies emerging fintech hub Lithuania as being particularly successful in attracting British companies by making it easier to obtain a banking license. According to CEPA, eight UK fintechs now have hubs in Lithuania — among them is fast growing London-based Revolut that received its European banking licence from the Bank of Lithuania in December. 

Aside from Lithuania, CEPA singles out Poland as “becoming more competitive because of its low operating costs” as well as Estonia “for its impressive talent pool in engineering and IT”. 

And in the Czech Republic, Japanese car producer Toyota, for example, is reportedly considering taking over the Toyota Peugeot Citroën Automobile (TPCA) plant in Kolin to boost its production capacities in the EU after Brexit. Brexit may complicate the company’s exports of cars produced in the UK exported to Europe, analysts told the Czech News Agency (CNA) in November.

No Frexits, Nexits or Czexits

On the other hand, the domino effect once projected — with a string of Frexits, Nexits and Czexits and so on following Brexit and leading to an eventual breakup of the EU — has not materialised, to a large extent probably due to the tortuous and as yet incomplete process of the UK’s exit from the union. 

“At the political level, Brexit has not fuelled resentment towards the UK in CEE capitals or stimulated pro-leave movements. Governing parties in Poland and Hungary and Euroskeptics throughout the region may criticize alleged meddling in their sovereignty by officials in Brussels, but they are not prepared to follow London through the exit door,” wrote CEPA’s Janusz Bugajski on January 9. “[O]pinion polls indicate that support for the Union has actually increased during the last year partly because of the political chaos in Britain,” it adds. 

The illiberal governments of Poland and Hungary, for example, have both been on collision courses with the EU, especially over the judicial reforms in Poland and migration in Hungary. However, when it came down to it Poland eventually backtracked on a key element of the reform of the judiciary that had the European Commission sue Warsaw in the EU’s top court. Meanwhile, Hungarian Prime Minister Viktor Orban is seeking to change the bloc from within through his anti-migration alliance with Italy’s Interior Minister Matteo Salvini in the upcoming European parliament elections, rather than envisaging a future for Hungary from outside the bloc. 

Further south, both Romania and Bulgaria are keen for deeper integration with the EU, hoping their presidencies of the European Council in the first half of 2018 and 2019 respectively will position them, despite being among the most recent entrants, closer to the core of the EU.