Stock Market

UK unlikely to exit EU but see pound selloff if it does: Experts

Jan Dehn, Co-head research, Ashmore Investment

World over, traders and investors are awaiting a key economic event with the some trepidation.

On June 23, a vote by UK citizens will decide whether Britain stays in the European Union or not. In the event, there is indeed a “Brexit”, or Britain exit, will the European Union itself get looser and collapse; or will the euro tumble?

The pandemonium surrounding Brexit is not new. Back in 1975, Britain had held its first referendum in which 66 percent of the British voted to stay in the European community.

If Britain decides to vote for Brexit, the UK won’t be able to enjoy free mobility of labour as migrants from any EU country will have to pay taxes in Britain. Other EU nations will not be entitled to unemployment benefits, child allowances and other benefits that Britain offers.

Out of the total EU budget, about one-third of the money has to be spent in Britain. In 2015, Britain contributed £17.8 billion, out of this £4.9 billion was spent by the EU in Britain.

So why do some British want to leave the EU? Will more nations follow suit? Will the pound selloff?

To find out, CNBC-TV18’s Latha Venkatesh spoke to Jane Foley of Rabobank International, Jan Dehn of Ashmore Group, and Jeff Chowdhry of LGM Investments.

Below is the verbatim transcript of Jane Foley, Jan Dehn and Jeff Chowdhry’s interview with Latha Venkatesh and Sonia Shenoy on CNBC-TV18.

Q: Let me start with you, the story is that Britain entered the European Union (EU) way back in 1971 and referendum approved this in 1973. Why the sudden distaste for the EU after what so many years of almost 50 years?

Foley: Well of course, if we go back to right at the start of the history of the EU, in fact, if we go back to the late 1960s, the UK was not a founding member. Back then, there was lot of scepticism about joining the system, it was only later on in the 1960s as European growth seemed to be doing so well that Britain really wanted to join and at that point.

Britain was initially vetoed by France and later joined and there was in the 1970s there was another referendum two-thirds of the UK people wanted to join, but it’s fair to say that the mentality of the UK population is isolation. There has always been some scepticism about Europe that perhaps one of the reasons why the UK did not join the Euro — we have of course still got the Sterling currency — so there has always been some scepticism. Function of the fact that the UK is of course an island.

This isn’t necessarily a sudden move and what is also worth pointing out is that there is right now a lot of nationalistic tendencies in various European countries and quite possibly, the most lasting legacy of this vote in the UK, the referendum on June 23 will be its impact on Europe. If there is a Brexit — which opinion polls aren’t pointing to — but if there is, then it could create a widening of the cracks within the cohesion of the wider EU nations.

Q: Are you saying that this is just a nationalist or an isolationist culture — a streak in the Brits or is it that merging into the common market has not been to Britain’s economic advantage?

Foley: I think they are woven into one thing and certainly in the minds of many voters. If we consider the European economy broadly, particularly since the crisis when we see now years of pretty slow wage growth; we see in some of the European countries and in some pockets of the communities perhaps young people we see some level of dispossession, we see asset price inflation leaving some people feeling dispossessed; income inequality of course widening as well. So, there are certain economic factors which are making many voters feel disgruntled.

This is one reason why there is this blame perhaps posted on the EU. This is one reason why there is nationalist tendency in Europe too and even in the US of course we see voters now more polarised in a way from the centres. So a kind of lot of disgruntled voters that is perhaps one reason and of course in Europe, we have immigration crisis. I think you could argue that immigrants are again a scapegoat and another reason why some people feel that they would be better off outside the EU.

Q: What is your sense about why are the Brits asking to leave now? Why are there fresh doubts about whether the Union is worth staying in or not?

Dehn: Well, one of the parts of the backdrop is that there has been quite a lot of noise coming out of Europe over the last few years to do with the European debt crisis and so on. However, I am afraid that the main driver for the whole motivation for this referendum has actually very little to do with rest of Europe. It has a lot to do with the domestic politics in the UK.

The Conservative party is deeply divided over the question of Europe and by offering a referendum in the second term, David Cameron was essentially able to neutralise the Europe issues for his entire first term in office. That was instrumental to him in obtaining a second term in office.

However, as soon as that second term was then achieved, the referendum issue had to be delivered on and now we see of course these deep divisions resurfacing within the conservative party. So, in effect, this referendum and the associated risks to the UK economy has everything to do with domestic party politics within the Conservative party. It is a big price for the UK economy to pay for peace within the ruling party.

Q: Would you concur that this is largely domestic politics? Britain doesn’t feel that the immigrant problem is too serious or that it is paying too much and getting too less. There is no economic motivation to this vote?

Chowdhry: I partly agree with that, I think some of it is to do with domestic politics as mentioned. I think there is also a fact that since 1973 a lot has changed. One of the things that has changed clearly is that European Economic Community as sort of a miracle of Europe hasn’t really been a miracle. I think a lot of UK investors, UK politicians have become a bit disenchanted with Europe.

Then also you had the whole Middle Eastern crisis and the tragedy of the refugees pouring into Europe which is really accentuated the immigration issue. So, there has been sort of a number of factors, but domestic UK politics is certainly one of those factors.

Q: What’s your sense, what will be the impact if indeed Britain were to vote to leave the EU?

Foley: If you listen perhaps to some — there are one or two members of the Federal Open Market Committee (FOMC) and again some voices which have had been heard round about this G7 summit currently — then you do hear some commentators suggesting that this could be an event, which could send shockwaves through the global economy. If you consider a scenario perhaps whereby the UK were to vote to exit the EU, then you consider that that action were to create greater cracks in the cohesion of the EU itself. 

So that perhaps there could be another referendum in the next couple of years from another country within the system, will certainly at that point you would be looking at something which could create significant shockwaves throughout world growth.

Q: What’s your sense in terms of an impact on financial markets? Are we going to see the European Union get looser if indeed the British were to vote leave?

Chowdhry: The simple answer to that question is no one really knows. If you look at the arguments both for the leave campaign and the remain campaign, both of them are bringing forward arguments about what would happened under both scenarios. The leave campaign is basically saying that UK will be far better without Europe and we can continue to trade as normal whether we are in Europe or without Europe.

The remain campaign on the other hand is saying is this is going to cause uncertainty, the pound would weaken and it’s likely to lead to some other problems, that’s the argument. But the very same and lot of politicians and outside advise is being brought in to kind to support each other’s case. The simple answer is nobody really knows what the effect is going to be of Brexit and that’s why it makes it quite tricky at this point in time for voters in the UK.

Q: Suppose you were trader, what will you do, would you prepare for an eventual tumbling of the Euro itself, because we all know there in confederations if one member exits, there is always a fear that more will exit. The way it has been shown show to speak, will the Euro take a hard knock on June 23 if that were to happen?

Dehn: It will probably experience some volatility, but I actually don’t think it’s going to take that huge a knock. There are other factors that are going to play in. The pound is more vulnerable if there is a vote in favour of leaving the EU. The EU after all is the world’s largest economy and Britain has been sort of a difficult member in that relationship. We are likely to see a strengthening of ties between the core members of the EU in the event of a Brexit. I am not too worried about the Euro I am more worried about the Pound.

Q: Well in that case, as a longer term investor in emerging markets (EM) like India, this is just a passing trouble for you just a niggling worry, this is more a traders’ problem, not really an investor problem at all especially for investing in EM?

Chowdhry: Absolutely, even though the UK is an island and some people in this country still like to think that, we are one of the big superpowers in the world, the reality is we are not. Yes, it’s important for the UK and it’s obviously quite important for Europe as well, but longer term the investment story in EMs is still about India and China and it’s still about the big markets like the US and Japan. So yes it is causing a lot of headlines and news here, but in terms of a long term investment story is not really that relevant to be honest.

Q: What sense you are getting of the European Union? Is it looking like lately as a whole slowing, it got more problems of immigration and constant threat of default by one member or the other. Is the European Union is something that you cannot swallow and you cannot spit out and you are just stuck with it?

Dehn: Europe has got a lot of problems but sometimes the problems are little bit exaggerated. The Europe is benefited quite a lot from the whole era of quantitative easing because the consensus ways to express the trades in Europe have been to weaken the euro and buy government bonds and that has made European exports more competitive resulting a very large current account surpluses and of course it has reduced the refinancing cost for the private sectors. So that default rates, for example, for European corporates are dramatically lower than those in the United States.

So actually the underlying economic fundamentals in Europe are not quite as bad as consensus would seem to imply. Remember that Europe has had weaker growth rates in the United States but if you control for population growth differences, actually Europe and United States have not done differently from one another, so there is a lot of bad sentiment about Europe but in reality the European economy has done okay.

The real vulnerability in Europe is of course that the member states have not surrendered sufficient power to the European Union’s institutions. So you have an economic or political entity that has all the trappings of government but has none of its power and that gives rise to a lot of frustration.

Q: The idea I am getting is that this whole issue is just a small political problem; problem more with Britain and not really a problem that the European Union has created. This is just Britain’s tantrums, you would think?

Chowdhry: That is just part of that. I think if Brexit does happen, there is going to be a lot of negotiation between Europe and the UK and that is a given. If the remain campaign wins, there is going to be less negotiations and probably less volatility. 

But the other thing that is very unusual about this is this is completely along party lines, so you got really unusual situation by the leader of the Conservative Party once it stay and they have got the ex-Mayor of London, Boris Johnson who wants to leave. So it is a bit like the BJP and Congress; politicians next to each other disagreeing over completely fundamental issue.

Q: Will it be a leave vote or remain vote?

Foley: We look at the opinion polls that have been coming out particularly over the last couple of weeks. Generally, they are leaning towards giving the remain vote a wider margin, in fact we have seen a perception that there couldn’t be less political uncertainty on the vote reflected in financial assets particularly sterling.

We have seen sterling perhaps already exhibit some of that relief rally over the last couple of weeks from this perception that the UK after all will vote remain. Of course, in the general election in the UK, in fact in the Scottish referendum the opinion polls got the results wrong.

So it is important to be little bit sceptical about these results but as long as the opinion polls are showing a widening majority in favour of the remain vote, I suppose the implication is, is that it is more likely that the UK would keep within the system and that is partly because many people are frightened of what a Brexit could unleash.

Q: Will it be leave or will it be remain?

Chowdhry: The opinion poll suggests that it will remain and ultimately the British public is probably a bit too scared to exit. So on balance the likelihood is it will be remain.

Q: What is your guess?

Dehn: I think it will ultimately vote to stay in European Union and they are getting scared of the potential negative economic consequences of leaving but the vote will be closer than what the opinion poll suggests.

Q: What happens on June 23 itself if indeed there is upset vote and Britain leaves?

Foley: I certainly think they will. As I said more recently we have seen a bit of a relief rally come early on anticipation that this will be a remain vote and that would mean that if it is a leave, it would be even a bigger shock. So from that point of view we will be looking for maybe a 15 percent fall in the outlook for sterling against dollar.

We also see that the euro fall against the dollar by perhaps a smaller margin and because of huge amount of uncertainty that it would unleash in terms of how the UK then starts to renegotiate its trading position with the rest of the world and these uncertainties could prolong for a number of years. I think we would see a continued level of heightened volatility in UK asset market for some time.