Report - Lebanon s Economic Performance in the First Half of 2016

Transcription

1 First HALF

2

3 HALF Report - Lebanon s Economic Performance in the First Half of 2016 I. General Introduction 2 II. Output and Demand 3 III. Fiscal Policy and Indebtedness 5 IV. Monetary Policy and Prices 7 V. Financial Markets 11 VI. External Sector 13 VII. Economic Prospects 14 Study - The Possible Implications of the Brexit Referendum I. Introduction 15 II. A New Shock for the Global Economy 16 III. The Implications 17 a. The immediate effects of the referendum 17 b. The economic impacts on the United Kingdom 17 c. The global economic effects 19 IV. The Risks Facing European Banks 19 V. Conclusion 20

4 Lebanon s Macroeconomic Performance during the First Half of 2016 I. General Introduction The Lebanese economy has continued its sluggish performance in the first half of 2016 as the domestic political conflict and regional turmoil, particularly along its border with Syria, are still affecting the Lebanese economy negatively. Political paralysis as symbolized by the presidential vacancy since May 2014 persists, while the influx of Syrian refugees decelerated significantly after the Lebanese government imposed entry restrictions. The real sector continued its downturn trend as its major indicators declined in the first half of 2016 relative to their level in the same period of The hotel occupancy rate dropped by 3%, and revenues per available rooms contracted by 22.1%. Also, cleared checks decreased by 1.7% in the first half of 2016, from USD 34.4 billion in the first half of 2015 to USD 33.8 billion, thus reflecting a weaker aggregate demand (spending) in the economy. The fiscal conditions remain highly unfavorable in light of continued fiscal deficits and growing public indebtedness. The public deficit grew by 9.3% in the first four months of 2016; while the aggregate public debt grew by 5.63% in first half of 2016 to reach USD billion at end-june of The Monetary Authorities maintained their monetary stabilization and economic stimulus policies in the first half of Inflation in the first half of 2016 was lower due to sluggish economic activity and falling external prices (especially the oil prices). The financial sector continued its decelerating growth as the banking sector has continued its growth in the first half of 2016, though inferior to in the same period of 2015 growth due to weaker economic growth. Also the capital market has experienced a weaker activity in the first half of 2016 relative to that of the same period of The external sector has also weakened during the first half of 2016 with higher imports (7%) and lower exports (-11.1%), as well as surging capital inflows (5.59%), which led to a lower deficit of USD 1.77 billion in the balance of payment. The International Monetary Fund (IMF) is estimating the real economic growth in Lebanon to stand at 1% in first half of 2016, down from a previous forecast of 2.5% due to the growing uncertainty that seriously affects the Lebanese economy. 2

5 II. Output and Demand 1- Coincident Indicator The Central Bank s Average Coincident Indicator, which mirrors the trend of domestic economy, recorded points for the first half of 2016, rising by 1.6% relative to the same period of the previous year. The growth of this indicator was nearly 0.9% in the same period of 2015 and The first half of 2016 growth in the Central Bank s Average Coincident Indicator reflects a non-uniform performance in key economic sectors. But, in general, the first half of 2016 confirms the sluggishness in overall growth and performance of real economic sectors. Exports declined by 11.1% in first half of 2016, while imports increased by 7%; whereas the value of real-estate property sales surged by 14%, and construction permits increased by 7.5%. However, the hotel occupancy rate decreased by 3%, and the cleared checks decreased by 1.7% in first half of 2016, falling from USD 34.4 billion in the first half of 2015 to USD 33.8 billion, thus reflecting a weaker aggregate demand (spending) in the economy Coincident Indicator Index increased by 14% to USD 4.1 billion in first half of 2016, as compared to USD 3.6 billion in the same period of Property taxes, thus, increased by 6.4% in first half of 2016 to reach USD million as compared to USD million in the same period of ,000 34,000 33,000 32,000 31,000 30,000 29,000 28,000 27,000 26,000 - Number of Real-Estate Sales Transactions - 31,943 34,109 28,724 29,988 Construction permits, which reflect future supply in the real estate sector, surged by 7.5% in first half of 2016 to reach 6.41 million square meters, as reported by the Order of Engineers of Beirut and Tripoli. 8,00 7,00 6,00 5,00 4,00 3,00 2,00 1,00 0,00 - Construction Permits (Square meters, million) Jun/2015 Jun/ Trade and Services 2- Real Estate and Construction The performance of this major sector of Lebanon s economy witnessed a relative recovery in first half of 2016, where the number of real-estate property sales transactions increased by 4.4% to 29,988 transactions in first half of 2016, as compared to 28,724 transactions in the same period of The value of these transactions The performance of this sector was relatively better in first half of 2016 when compared to the same period of The total number of tourists increased by 7.7% in the first half of 2016 to reach 723,105 tourists, as compared to 671,398 tourists in the same period of As for their spending, as reflected by the VAT claims at the Global Blue Lebanon, it declined by 18% in the first half of 2016 as compared to its level in the same period of

6 740, , , , , , , , , , ,864 - Number of Tourists - 650, , ,105 This improved tourism activity was mirrored by the growing number of passengers via Beirut Rafic Hariri International Airport (HIA) reaching 3,272,580 passengers in the first half of 2016, up by 5.1% from the same period of Departing passengers increased by 3.1% and arriving passengers by 7.3%. 3,300,000 3,200,000 3,100,000 3,000,000 2,900,000 2,800,000 2,700,000 2,974,330 - Passengers at HIA - 2,921,831 3,113,777 3,272,580 Another indicator of the tourism sector is the slight deceleration in the occupancy rate of hotels in Beirut to 54% in the first half of 2016, down from 57% in the same period of A good indicator of the performance of trade is the increase in Beirut Port s revenue by 1.92% in the first half of 2016 to reach USD million. Also the total number of containers grew by 3.67% in first half of 2016 reaching 578,074 containers. Moreover, the quantity of goods increased by 12.93% to 4.4 million tons in first half of In addition, the number of ships increased by 23.47% in first half of 2016 to reach 1,052 ships. 1,200 1, , Demand - Number of Ships at Beirut Port - 1,001 The private demand in Lebanon is still supported by consumption spending of the Lebanese citizens, Syrians and Iraqis. Also, it is stimulated by the Syrian investments. As the Syrian turmoil endures, Syrians in Lebanon are gradually shifting their economic role from being mainly consumers reliant on handouts to becoming income earners in the informal sector. This includes establishing micro and small businesses that sell goods (including those produced in Syria) at lower prices targeting the Syrian community. This is causing competition to Lebanese businesses, and hence they are negatively affected , ,00 100,00 95,00 90,00 85,00 80, % Hotels Activity Indicators % % % % 58.00% 56.00% 54.00% 52.00% 50.00% 48.00% Public investment and consumption on the other hand, were more tempered in the first half of 2016 as the Ministry of Finance has provided more scrutiny on outlays. The total value of cleared checks, mirroring aggregate spending, declined by 1.7% in the first half of 2016 to reach USD 33.8 billion, as compared to USD 34.4 billion in the same period of the previous year. 75, % Revenues per Room (USD) Hotel Occupancy 4

7 - Evolution of Clearing Activity (USD, billion) H H H Total Amount In FX In LBP Real Sector Indicators H H Variation Construction permits (SQM, million) % Number of real-estate sales transactions 29,988 28, % Value of real-estate transactions (USD, billion) % Number of tourists 723, , % Number of passengers at HIA 3,272,580 3,113, % Cleared checks (USD, billion) % Hotel occupancy rate (%) % Number of ships at Beirut Port 1, % III. Fiscal Policy and Indebtedness The fiscal conditions remain highly unfavorable in light of continued fiscal deficits and growing public indebtedness and the crowding-out effect of private investment initiated and fueled by public borrowing. 1. Fiscal Deficit The fiscal figures for the first four months of 2016 reveal that the public deficit, which mirrors internal deficit in the economy, grew by 9.3% on annual basis, against a surge of 22.56% during the same period of Despite the observed economic slowdown in the domestic economy, public revenues increased by 5.3% in the first four months of 2016 as compared to the same period of On the other hand, the government increased its public spending by 7% in the same period of 2016 as compared to that of As a result of these conditions on revenues-spending front, the fiscal deficit rose by 9.3% during the period under consideration. Consequently, the fiscal deficit-tospending ratio climbed up to 32.93% as the end of 2015, as compared to 32.25% for the same period of (1.00) (2.00) Public Finance Indicators (USD, billion) (1.12) (0.89) (1.49) M M M2015 4M 2016 (1.64) Government Revenues Government Expenditures Fiscal Deficit 5

8 As for the primary balance, which excludes debt service, it recorded a deficit of nearly USD 151 million in the first four months of 2016, against USD 96 million in the same period of The debt service grew by 6.01% between the two periods, reaching USD 1,482 million as the end of Within aggregate public revenues, the budget revenues increased by 5.8% on annual basis, despite to a drop of 12.66% in non-tax revenues, against a surge of 47.3% in treasury revenues and a surge of 4.67% in tax revenues which in turns is caused by an increase of 3.8 % in VAT income; while customs duties and other tax income increased by 2.39%. As for the aggregate public spending, the budget expenditure increased by 7%, due to a 7.35% surge in general expenditures and 6.37% increase in debt service (6.95% in interest payments on domestic debt and 5.36% in interest payments on foreign debt). On the other hand, treasury expenditures increased by 8.58% during the same period. 2. Public Indebtedness As a result of these fiscal conditions, the aggregate public debt grew by 5.63% in first half of 2016 to reach USD billion at the first half of Domestic debt jumped by 3.68% to reach USD billion; while external debt increased by 8.72% to reach USD billion Gross Public Debt (USD, billion) This high debt-to-gdp ratio is caused by the fact that the cost of financing significantly exceeds its income growth rate. These longstanding structural bottlenecks in public finances of the country remain and continue to impair progress towards the development of the country. Public Finance Indicators H H Variation Public revenues (USD, billion) (first 4 months) % Public expenditures (USD, billion) (first 4 months) % Fiscal deficit (USD, billion) (first 4 months) % Deficit /Expenditures (%) (first 4 months) % Gross public indebtedness (USD, billion) % Net public debt (USD, billion) % Primary surplus (USD, million) (first 4 months) % Sources: Ministry of Finance and Central Bank of Lebanon 6

9 IV. Monetary Policy and Prices The Monetary Authorities have maintained their monetary stabilization and economic stimulus policies in first half of Inflation in first half of 2016 was lower due to sluggish economic activity and falling external prices (especially oil prices). 1. Inflation Amid sluggish economic activity and falling oil prices, Lebanon s inflation rate remained at its lowest levels in a decade. The CPI inflation rate averaged -2.6% in the first half of 2016, compared to -2.1% in the same period of The declining inflation rate in the first half of 2016 reflects a continued negative output gap and favorable external prices (mostly declining global energy and food prices, and an appreciating effective exchange rate given the country s peg to the US dollar) % 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% 8.80% - Consumer Price Index % -2.10% -2.60% The slowdown in inflation has translated into tepid growth in money supply (M4), which registered a 3.47% increase or nearly USD 3,616 million in first half of 2016 against an increase of USD 2,880 million in the same period of Money Supply (M4) (USD, billion) - 2. Monetary Stabilization Policy The exchange rate stability (USD 1 = LBP 1,507.5), coupled by a growing output gap, and low levels of inflation, prompted the Central Bank of Lebanon to continue its expansionary monetary policy in the domestic economy. The dollarization rate recorded nearly 65.3% in first half of 2016, largely unchanged from Central Bank s Foreign Assets The Central Bank s balance sheet continued to maintain high levels, at USD 99.1 billion in the first half of 2016 as compared to USD 90.9 billion in the same period of Its foreign assets decreased by 2.2% to reach USD 36.3 billion in the first half of 2016, lower by USD 800 million as compared to the same period of Whereas, its gold reserves surged by 12.3% to reach USD billion in the first half of 2016 as compared to USD 9.84 billion in the same period of Central Bank s Indicators - (USD, billion) Balance Sheet FX Reserves Gold Reserves

10 Monetary Situation Indicators H H Variation USD/LBP exchange rate 1, , % The Central Bank of Lebanon s assets in FX (USD, billion) % The Central Bank of Lebanon s gold reserves (USD, billion) % Money supply (M4) (USD, billion) % Inflation rate (%) % Sources: Central Bank of Lebanon and Association of Banks in Lebanon 4. Beirut Traders Association Retail Index BEIRUT TRADERS ASSOCIATION RETAIL INDEX 2 nd Quarter The consumption tempo continued to decline during the second quarter of 2016, despite the holy month of Ramadan and Eid-al-Fitr a period that usually witnesses a relatively stronger pattern of consumption, especially in the food and basic necessities sectors. The geopolitical situation in the region (and especially in Syria), as well as the resulting political and social situation in Lebanon, have both generated a combination of negative factors that have affected the economy as a whole, and the commercial sector in particular. The commercial markets have thus witnessed further decline in their turnovers, at a time when most traders mainly the small and medium sized ones, continued to face the heavy burden of increased expenditure not only vis-à-vis their employees, their bankers and their suppliers, but also vis-à-vis the numerous public agencies and official institutions. Hence, this undermining situation continued to prevail while no serious solution to the internal problems and difficulties could yet be reached - be it at a level of the regularization of institutional issues (on top of which the election of a president of the republic), as well at the economic and social levels, in addition to the highly harmful drop in the number of tourists and visitors - especially from the gulf, and their important effect on local consumption and investments, thus their direct impact on our overall national economy. As a result, the overall consolidated activity of all retail commercial sectors has declined nominally by -5.61% during the second quarter of 2016 in comparison with the second quarter of This trend appears to have remained also negative even after applying the CPI for this concerned period as the real decline reached -4.68%. And if we exclude the fuel sector, it appears that the nominal decline of consolidated turnovers increases to % and the real decline to -5.41%. These figures are worrisome, especially that the BTA- Retail Index had registered in the previous quarter its first drop below the level of 50 since the launch of this index. It is worth noting that the CPI, that measures the inflation, continued its downward trend, although at a slower pace, as it registered for the seventh consecutive quarter a decline of % between the second quarter of 2015 and the second quarter of 2016, despite an increase in the CPI of Clothing that reached % for the same period. This is a clear indication, once again, that the purchase power of Lebanese households the prime consumers in the Lebanese markets currently, is in constant shrinking, and that their purchasing priorities are focused today on basic living commodities despite the decline in prices in most retail commercial sectors and in spite of the huge sacrifices endured by traders in the form of special offers, price reductions and payment facilities.

11 CPI (as per CAS official results) Q4 14 / Q % Q1 15 / Q % Q2 15 / Q % Q3 15 /Q % Q4 15 / Q % Q1 16 / Q % Q2 16 / Q % Q4 14 / Q % Q1 15 / Q % Q2 15 / Q % Q3 15 / Q % Q4 15 / Q % Q1 16 / Q % Q2 16 / Q % It is noted that this continued fall in the CPI is accompanied by an increasing drop in the level of activity of retail markets, with a nominal fall in consolidated turnover figures equivalent to 7.14 % for the first quarter of 2016 as compared to the first quarter of 2015 (excluding the increase in the volume of liquid fuels). The application of the CPI ratio for this period gives a real drop of 3.82 %. Yearly Variation between 2 nd Quarter 15 and 2 nd Quarter 16 Q Q Nominal Year to Year Variation (incl. Liquid Fuels) Nominal Year to Year Variation (excl. Liquid Fuels) CPI between Jun 15 and Jun 16 (as per % the official CAS figures) Real Year to Year Variation (incl. Liquid Fuels) % Real Year to Year Variation (excl. Liquid Fuels) % In the details, it appears once again that most retail commercial sectors have experienced lower turnover figures for the second quarter of this year in comparison with their levels during the same quarter of last year. Those sectors that did not experience similar decreases have reported either equal levels or very slight increases. The main sectors where a decrease in real turnover was experienced in comparison with the second quarter of last year (i.e. after applying the CPI relative to every specific sectors) are: Shoes and Leather Products ( %) Cellular Phones ( %) Car Dealers ( %) Pharmaceuticals ( %) Home Accessories ( %) Malls ( %) Medical Equipment ( %) Toys ( %) Watches and Jewelry ( %) Clothing ( %) Bakeries & Pastries ( %) Perfumes and Cosmetics ( %) Sports Equipment ( %) At the same time, some sectors have posted better results, such as: Building Equipment ( %) Restaurants and Snacks ( %) Liquor & Spirits ( %) Books & Stationery & Office Supplies ( %) 9

12 Supermarkets and Food Shops ( %) Household Electrical Equipment ( %) Tobacco ( %) The above variations indicate that: Bakeries & Pastries have experienced a drop in sales, while Supermarkets & Food Shops appear to have maintained a stable level of activity. Malls have witnessed a slowdown, also felt at the level of the Clothing sector, the Home Accessories sector, the Toys markets, and the Watches & Jewelry sector. And as some specialized reports have already reported, the building equipment sector and the Restaurants sector have both experienced an improvement in their levels of activities. On the other hand, and after a first look at the results of the second quarter of this year in comparison to the first quarter figures, we may say that these results have experienced a slight improvement, whereby the nominal consolidated increase posts %. Yet the real figures show once again a decline although symbolic, of -0.44%. Accordingly, results displayed for the period between Q1 16 and Q2 16, a sharp drop in the real turnover of Cellular Phones ( %), Sports Equipment ( %), Clothing ( %), Books & Stationery ( %), Watches & Jewelry ( %), as well as Malls ( %); while other sectors have posted better real results, such as Household Electrical Equipment ( % because of extreme offers and discounts), Liquor and Spirits ( %), and also Supermarkets and Food Shops ( % - because of the holy month of Ramadan) as well as Restaurants & Snacks ( %) As a result, with our base index 100 fixed at the fourth quarter of 2011, and with a quarterly inflation rate of % for the second quarter of 2016, as per the official CAS report, the BTA- Retail Index is (with all sectors included) at for the second quarter of the year BTA - Retail Index for Q (Base 100 : Q4-2011) Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Nominal Index - w/out inflation Real Index - w/ inflation CPI In conclusion, it is clear that the BTA- Retail Index has continued to fall and that, for the second consecutive quarter, it remained below the level of 50%. Yet, and in spite of all what such results do bear in terms of pressures and difficulties on all the commercial community, and more so in the context of the whole spectrum of the retail trade sectors, and although the tendency might be depressive and worrisome, spirits are still high and an overall willingness for resistance and persistence still prevails, with the expectation that the emergence of any positive signs will immediately reflect in the markets, and a healthy activity would regain its momentum and vitality. 10

13 V. Financial Markets The banking sector has continued its growth in first half of 2016, though inferior to in the same period of 2015 growth due to weaker economic growth. Also the capital market has experienced a weaker activity in first half of 2016 relative to that of in the same period of Banking Sector The Lebanese banking sector s activity mirrored by the consolidated assets that grew by 5.7% at end- June 2016 to reach USD billion, as compared to USD billion in the same period of However, this activity was inferior to that of in the same period of 2015 where the growth in assets was 6.2%. This reflects the effects of sluggish economic activity on banks operations. The slower banking growth was mirrored in the growth of both credits and deposits. Deposits of banks grew by 4% or USD 5.95 billion at end-june 2016 to reach USD billion as compared to USD billion in the same period of Total lending of banks, on the other hand, increased by 6.8% or USD 3.45 billion at end- June The deposit dollarization ratio stood at 64.9% at end-june 2016 as compared to 75.2% in the same period of Banking Assets and Deposits - (USD, billion) Total Assets Total Deposits The banking sector is adequately capitalized, with the capital adequacy ratio standing currently at 13.2% at end-june 2016, which is double what is required by Basel III standards. This indicator gives banks high resilience against any potential capital pressures. The banking sector maintains good profitability, despite difficult regional and domestic conditions. Banks capital base increased by 10.53% to reach USD 16.8 billion at end-june 2016, as compared to USD 15.2 billion in the same period of Banking Sector Indicators H H Variation Total assets (USD, billion) % Total deposits (USD, billion) % Total loans (USD, billion) % Ratio of Private sector s loans to Deposits (%) % Banks capital base (USD, billion) % Sources: Central Bank of Lebanon and Association of Banks in Lebanon 11

14 2. Capital Market The activity of the Beirut Stock Exchange (BSE) was inferior in the first half of 2016 relative to in the same period of 2015, as the figures released by the BSE indicate that the total trading volume decreased by 1.2% to reach 44.3 million shares in the first half of 2016, as compared to 44.8 million shares in the same period of While aggregate turnover surged by 12.3% to reach USD million in the first half of 2016, as compared to USD million in the same period of % Stock Market Activity % % 3.60% % 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Market capitalization deceased by 4.5% to reach USD billion in the first half of 2016, as compared to USD billion in the same period of 2015, of which 82.9% was in banking stocks, 14% in real estate stocks, and 3.1% in industrial stocks. The market liquidity ratio increased by 0.6% to reach 3.6% in the first half of 2016, as compared to 3% in the same period of The average daily traded volume for the period declined by 2% to 365,787 shares as compared to an average daily volume of 373,252 shares in the same period of The average daily traded value for the period increased by 11.4% to reach USD 3.3 million in the first half of 2016 as compared to an average daily value of USD 2.96 million in the same period of Market Capitalization (USD, billion) Market Liquidity Beirut Stock Exchange Indicators H H Variation Market capitalization (USD, billion) % Total trading volume (Shares, million) % Aggregate turnover (USD, million) % Average daily value (USD, million) % Sources: BSE and Central Bank of Lebanon 12

15 VI. External Sector 1. Foreign Trade According to the figures issued by the Higher Customs Council, imports increased by 7% to reach USD 9.4 billion in the first half of 2016, as compared to USD 8.8 billion in the first half of Whereas exports decreased by 11.1% to reach USD 1.4 billion in the first half of 2016, as compared to USD 1.57 billion in the same period of 2015, leading to an increase of 10.8% in trade deficit to reach USD 8 billion in the first half of 2016, as compared to USD 7.23 billion in the same period of In this sense, net exports have decreased in the first half of 2016 and the same period of 2015, mirroring a weaker aggregate demand and a weaker GDP growth in this period. - External Sector Indicators (USD, billion) - 2. Capital Inflows Capital inflows increased by 5.59% to reach USD 6.23 billion in the first half of 2016, as compared to USD 5.9 billion in the same period of 2015, which indicates higher inflows from its previous level as a result of higher capital inflows from the Syrian refugees incoming to Lebanon Financial Inflows (USD, billion) (8.73) H (8.42) H (7.23) H (8.00) H Balance of Payments Based on the figures issued by the Central Bank of Lebanon, Lebanon s balance of payments posted a significant deficit of USD 1.77 billion in the first half of 2016, as compared to a deficit of USD 1.32 billion in the same period of This cumulative deficit over the first half of 2016 was caused by a deficit of USD million in the Central Bank of Lebanon s net foreign assets and a deficit of USD 1.41 billion in those of banks and financial institutions. Such a large deficit in the balance of payments is caused by the unfavorable political conditions in Lebanon, and the political and security tension in the region. Imports Exports Trade Deficit - Balance of Payments (USD, million) - The main sources of imports are China with10.8% of total imports, followed by Italy and the United States of America (7.6% each) and Germany (6%). While the main sources of exports are South Africa with 15.9% of total exports, followed by the Kingdom of Saudi Arabia (10.6%), UAE (9.1%), and Syria (6.2%). - (200.00) (400.00) (600.00) (800.00) (1,000.00) (1,200.00) (1,400.00) (1,600.00) (1,800.00) (382.10) (1,021.00) (1,320.00) (1,770.00) 13

16 External Sector Indicators H H Variation Trade deficit (USD, billion) % Exports (USD, billion) % Imports (USD, billion) % Capital inflows (USD, billion) % Balance of payments (USD, billion) % Sources: Higher Customs Council and Central Bank of Lebanon VII. Economic Prospects The IMF in its latest report, showed that Lebanon s real GDP growth rate is projected in 2016 to reach 1%, unchanged from the 2015 growth rate level, and as compared to average forecasted growth rates of 2.9% in the MENA region, 3.5% in the oil-importing countries, 3.1% in the Levant economies, 4.1% in the developing countries, and 3.2% in the global economy. The projected real growth rate of Lebanon in 2016 is resulted from the domestic political instability and the regional turmoil in Syria, which continue to affect negatively the Lebanese economy. This level of growth rate would make Lebanon the second lowest country among 18 MENA countries directly after Yemen (0.7%), and the 11 th slowest growing economy worldwide. The Fund also indicated in its report that the average inflation rate in Lebanon is forecasted to be around -0.7% in 2016 as compared to an average inflation rate of 5.5% in the MENA region, 5.8% in the oil importing countries, and 8.2% for the Levant countries. 14

17 Study - The Possible Implications of the Brexit Referendum I. Introduction After 43 years of membership, the shocking result of the British voters came out on June 23, 2016 in favor of the United Kingdom (UK) exit from the European Union (EU) which is composed of 28 states. This historic decision was driven by many challenges witnessed by the European Union including the UK since the initiation of the global financial crisis in 2008 that triggered the Euro zone crisis, in addition to the refugee crisis and the European confusion in how to deal with such issue, which has caused a political debate in the UK, and led to the hasty decision of holding a referendum concerning the UK membership in the EU. This decision had tremendous effects on the global economy, despite all the precautions taken by the global Table 1: Financial Market Indicators (Changes since 23 June 2016) central banks to manage the worst, given the size of the implications and turbulences caused and driven by this referendum, besides the negative repercussions that are expected to emerge in the coming years. The vote to exit the EU was a surprise to the financial markets as they were very volatile in the days following the referendum. There were very sharp falls in bond yields and equity prices (particularly bank share prices) and large movements in foreign exchange markets (particularly a depreciation of the British pound). Despite this, market functioning was generally orderly, and asset prices have largely stabilized and in a number of cases retraced their initial falls. Exchange 10-year govt Share prices - Share prices - Interbank Bank CDS rate bond yield broad market banks spread premia (%) (%) (%) (%) (%) (%) UK Europe Japan USA Australia Source: Bloomberg Global equity prices fell sharply following the Brexit referendum, although the initial falls have been in many cases wholly retraced. UK equity prices fell by less than those in many European countries as the depreciation of the UK pound was seen as supporting the earnings of internationally focused companies. The share prices of euro area banks and UK banks with a predominantly domestic focus have fallen by 15% 30%. At the same time, yields on riskier types of debt issued by these banks and the price of credit default insurance have increased, but by less than during the pronounced market volatility in early Index Share Price indices (1 January 2016 = 100) - Broad market Banks US Australia Europe UK Japan J F M A M J J J F M A M J J Index

18 II- A New Shock for the Global Economy There were many immediate direct consequences to the UK European Union membership referendum on the global stock markets, which had lost at the day of announcing the results in June 24, 2016 more than USD 2 trillion of their value. This decline would affirm the fragility of the global economic situation awaits any spark to enter into a deep recession. It is true that the market overreacted on the direct and short term, but their interaction indicates the gravity and seriousness of the problem globally in the long term. In the United Kingdom in particular, the economic implications were directly initiated, where its currency, the pound, witnessed historical losses, and lost another credit of its excellent rating, which would force it to cut spending and raise taxes; while it is expected to transfer at least one fifth of the British companies activities abroad. It is expected that the European economies would be re-evaluated and possibly downgrading the forecasted growth for the current and upcoming years. This issue is not limited to Europe alone, but it also includes various global economies. One of the main reasons for this concern is that the economic growth in most global economies have declined due to the ailing recovery of the global economy that did not yet recover from the severe 2008 crisis, besides the current instability and uncertain situation that resulted from the successive following crises that were less effective than the UK European Union membership referendum. It is expected that the prices of raw materials continue to fall, and the global trade would be generally affected by the slight contraction, in addition to the temporary currency market disorder, and the prospects of rising inflation and unemployment rates. One of the most negative effects in the recent period after the referendum occurrence is the high decline in the yield on British sovereign debt, which created many concerns from the start of an explosion in the global bond market, which is already witnessing a turmoil that is threatening its collapse. It is feared that the worst is yet to come, whether in the United Kingdom or at the global economy. The immediate effects, disregarding their size, are still controlled, in terms of global equity and currency markets volatility. The longterm effects, may be severe, because it awaits the default or shrinkage of the British economy along with declining FDI inflows to Britain, which was considered as one of the most important global financial investment destinations, besides the implications of reducing the UK credit rating by the international rating agencies and losing its privileges that it used to enjoy in the rewarding trade agreements within the European Union framework. Many concerns have been imposed concerning the implications following the UK European Union membership referendum on the European area, the United States, and other countries. The deteriorating bilateral trade between EU countries might lead to significant effects on the economies of these countries and in the whole euro zone. These incidents would be followed by consequent renewed financial volatilities similar to what have occurred after the 2008 financial crisis. This British decision could lead to further complications at the United States, which is currently undergoing a slowdown in the employment pace driven by weak business investments and sluggish economic growth rates. There is no doubt that the US exports would be affected negatively given the dollar appreciation against the UK pound and the euro, besides the consequences resulted from higher investor s conservatism and reducing expenditures given lower consumers spending. It is also feared that this referendum will encourage other parties in the EU to follow the same path as the United Kingdom, which could threaten the existence of European unity. The United Kingdom itself might face another referendum for Scotland s separation from the Kingdom. 16

19 III- The Implications A - The immediate effects of the referendum Upon the announcement of the UK referendum from the European Union, the GB pound dropped to its lowest level since 1985, to record the biggest drop in its history, whereas the euro was also downward influenced before recovering some of its losses in the following days. It was a strong blow to the global financial markets, as the commodity markets volatility was greatly intensified, and the oil prices were highly influenced, losing more than 5% of its value. The global economy has entered into a disequilibrium state since the UK referendum occurred suddenly and against most expectations. The EU reaction was prudent as they invited the United Kingdom to quickly activate its withdrawal mechanism from the European Union as mentioned in the Lisbon Treaty to avoid any unfavorable uncertainty, and to protect the EU unity. In contrast, the Brexit supporters declared their willingness to negotiate on the future relations between the United Kingdom and the European Union before the official exit. Under these contradictions, there is an uncertainty surrounding the future relationship between the two parties amid an intensified political conflict in the United Kingdom at an unprecedented level. B The economic impacts on the United Kingdom There is no doubt that the disadvantages of this decision outweigh its benefits, as there is a huge doubt that Britain might lose its stature as a global trade partner. It is expected that the FDIs incoming the United Kingdom will decline by at least 5% in The British Finance ministry has estimated in its report the tax revenue to decline by around GBP 36 billion, and the GDP would decline by 6.6% of GDP given the retreat in the financial position of the United Kingdom as the most important financial market in the European continent for the benefit of other European capitals, most notably Frankfurt and Luxembourg. Another major concern relates to the possibility that the British economy might enter into recession lasting for more than a decade. Also, some banks and major financial institutions had made the decision in case of a referendum in favor of the exit, to transfer some of its work tranches outside the UK to one of the EU states. It is also expected that the investment cost in the energy sector will rise, since a shortage in the supply of electric power is expected in the United Kingdom after its referendum decision, which will deteriorate the investors> confidence in this sector. Upon voting for the UK exit from the European Union, the United Kingdom lost its excellent classification, since «Standard & Poor s» agency removed two degrees from its grade to become classified as AA with a negative outlook, which means the possibility that the agency further reduce the UK rating. The agency stated that it is the first time that it lowers an excellent rating country by two notches at once. In the financial sector, the financial institutions will lose the privilege to sell their financial services to twenty-eight states in the Union. The trade sector will also be affected, where there is a current surplus of the EU s trade with the United Kingdom of 100 billion Euros, while Britain recorded a surplus of 20 billion Euros in its service exports, due to its financial sector. Whereas, Switzerland, which does not benefit from the provision of financial services to the EU countries, recorded a trade deficit in this sector. The exit may also affect the competition level, since any British company that wants to acquire another company in the Union needs to obtain the acquisition approval from both the British and the European Union s authorities, which means additional legal costs amid the risk of receiving contradicting decisions from both parties. In the energy sector, the Brexit may lead to increasing the investment cost in this sector and delaying its new projects in light of a projected shortage in the electric power supply in the Country. Thus the investor might hesitate to invest in the energy sector, besides the warnings provided to Shell and BP regarding their exit from the United Kingdom. 17

20 It is also feared that the aviation sector might be affected by the UK referendum outcome, as the open space policy between the United Kingdom and the European Union is still valid, which means the freedom to work for airlines from both sides. But the situation will be different after the referendum, which could mean higher aviation prices for consumers. The British citizens will lose the advantages of mobility at the lowest prices in the EU, and to buy goods from any country in the EU without customs taxes, in addition to the unified communication network across the EU as a whole. This damage might affect about 1.3 million British individuals who live and work in EU countries, most notably in Spain that hosts 319 thousands British individuals. After the completion of the referendum procedures, the British citizen would be obliged to obtain a license to work in any EU country. There are also about a thousand British citizens who work in the EU institutions, and they are now threatened to lose their jobs as a result of the referendum. Forecasts indicate that the unemployment rate is expected to rise, after reaching its lowest level in a decade at only 5% due to the great success achieved by the United Kingdom to avoid job losses in light of the global financial crisis that has affected many other countries. The National Institute for Economic and Social Research in the United Kingdom has depicted that real wages would shrink between 2.2% and 7% in 2030, as compared to the expectations related to the United Kingdom existence in the EU expectations. On the other hand, the tourism and export companies will benefit from the depreciation of the national currency, which might also represent investment opportunities in the British market. The country will also be released from the disability imposed by the European Union at a rate of 3% of GDP, and the public debt ceiling at 60% of GDP. The labor market will also be more dynamic after removing the laws imposed by the European Union and their burdens. According to many experts, the farmers in the United Kingdom will benefit after the liberation of the payments that were directed to the European budget and in which they can receive support. The UK referendum will also allow the support of any sector of its economy without obtaining the approval of Brussels, but on the other hand it cannot object to any possible support that is offered to its large companies by any of the Union s states. Summary of the UK Benefits and Losses from Its Referendum Benefits Losses Less legislative restrictions Save the UK contributions to the European Union The ability to hold a new trade deals Adopt an immigration policy to attract skilled labors uncertainty Potential new tariffs on Britain s exports to the European Union Losing the access to the EU market A massive damage to the position of London as an international financial center Low investment due to the increased state of 18

21 C - The global economci effects As noted above, the global financial markets were the first victims, where the effects of the referendum were negative and sharp on these markets, since most analysts were not expecting the British exit from the EU. The results would have been even worse without the central banks and international financial institutions interventions. It is expected that these markets would calm after a period of time, but they will undoubtedly operate in a new and different macro-economic environment that involves greater uncertainty. However, Credit Suisse expects sharper declines and losses in the global markets, because what happened represents a new phase of global isolation rather than a trade liberalization phase which prevailed and expanded before the global financial crisis. This perception is remarkable since the risk is not restricted to the European Union, and it would be extended to the global economy if the presidential candidate Mr. Donald Trump won the president post in the United States, as his restricted strategy would have serious implications on ceasing the free trade agreements. There is no doubt that other factors with political and social dimensions pushed many British individuals to vote in favor of the referendum, which are not related to the economic matters. The spread of racist and xenophobic culture played a catalytic role in creating the right mind to vote for the referendum. The unprecedented migration crisis has played a key role in creating this culture. The financial markets will affect many global economic factors and indicators. The sharp and sustained appreciation of the US dollar against the euro will create an additional pressure on the manufacturing sector in the United States, which is still in the process of recovery, and could curb the growth rate in the US economy. There are expectations that the GB pound might depreciate to below USD 1 by the end of 2016, but the UK real estate and stock markets will remain attractive for foreign investors. As in all crises, gold prices rose with the escalating demand on this commodity as a safe investment, and it would continue to rise to reach its highest level in more than two years, amid expectations that central banks would expand their stimulus intervention to support the global economy to reduce the implications of the UK European Union membership referendum. The President of European Central Bank (ECB) expects the euro zone growth to decelerate due to the UK referendum by rates ranging between 0.3% and 0.5% over the next three years, while previous forecasts suggest a growth rate of 1.6% in 2016 and 1.7% in both 2017 and This decline will happen given the slowdown in the United Kingdom, along with the decline in trade with one of the major trading partners of the euro area that is consisted of 19 countries, as well as the high cost of capital funding due to lower stock prices. IV- The Risks Facing European Banks The UK referendum would lead to an existing major problem back to the front, which is related to the difficulties that might face a number of European banks, as some of which cannot be rescued. The deteriorated economic conditions that will result from the British earthquake will increase the current existing crisis. This problem don t include only Greece and Spain, but also Italy, where «Monte Paschi» Bank which is one of the oldest banks in the world, is suffering from a real crisis given its non-performing loans account for 33% of its total loans, which is equivalent to 47 billion Euros. The ECB has asked the bank to write off 8 billion Euros from these doubtful loans by the end of the next year, as a prelude to write off another 6 billion Euros by the end of It should be noted that this bank has suffered since the beginning of 2016 from an ongoing withdrawal of customers deposits, which led to a decline in the bank s shares value by 58% in 19

22 January In July 2016, its share decreased by another 19%, which would be accumulated to a decline of 77%. The problem is not only confined here, but there are other European banks suffer from similar conditions, most notably Credit Suisse and Deutsche Bank, where the value of the latter shares declined since the beginning of 2016 till July about 48%. V- Conclusion Neither Europe nor the world have accommodated the resounding shock of the referendum results, which constitute the biggest setback taking place in the European Union for the supporters of European unity. There is also a big concern that the referendum might lead, after more than four decades, to a rolling snowball initiated by the United Kingdom towards other European Union countries. It is also a big shock for the global economy, whose full dimensions are not yet clear due to the uncertainty that is still surrounding the future. The difficulty lies in that the UK referendum is an unprecedented issue. Therefore, the legal reference is limited by the time frame of very broad context of the Lisbon Treaty. There will be many details that need to be negotiated and approved to remove the ties that link the United Kingdom to the European Union. 20