Brexit will severely harm the British economy
Britain, in a historic referendum on June 23, voted to leave the European Union (EU).
Reams of newsprint will now be dedicated to analysing the outcome of Brexit in the coming days and possibly years to come.
The news was met with a sense of fear and uncertainty by markets the world over and that, I think, stems from an inadequate understanding of the factors to be taken into consideration to make a proper assessment of Brexit.
It is, however, certain that in the immediate to medium term, there will be a net negative impact on markets.
The British high street is where the most visible impact is going to be felt, first and almost immediately. With the pound under fire, the import of food, apparels, electrical products, leather products, and so on will become expensive. Food inflation will become a certainty, as UK imports 60 per cent of the food it consumes.
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In the IT and software services sector, if a large part of the demand originates in the UK itself and requires end-use deployment there, Brexit would have a neutral effect. Growth, however, will suffer as business sentiment worsens and no fresh IT investments are made.
If, on the other hand, most of the demand in IT and software services is from the European mainland, staff would need to be relocated or dehired. Offices would need to shift to the European mainland to be closer to the clients. And headquarters would have to be shifted to lower cost regions of the EU.
UK's IT market is about 60 per cent of that of the EU (based on Indian software exports figures).
The prognosis, in the short term, therefore does not look too good for IT companies. And it is not just the weakened pound. If the UK has steady and good quality labour supply, the risks will be mitigated somewhat. But not much.
Moreover, British steel, manufacturing (auto, aerospace) and pharma sectors which look to the EU as their main market (steel accounts for 52 per cent of EU imports) for their produce will be affected. Their own cost structures will also change on account of the fall in the pound, and costs of inputs going up.
The most of UK's GDP (80 per cent) comprise services. Within that, a large share is that of financial services.
The UK is the largest exporter of financial services to EU, with London (over 500 banks) contributing the bulk of it. London contributes 22 per cent of UK's GDP. So the financial services sector in the UK is going to take the biggest hit. It will put an end to London ever being seen as an alternative financial capital of the world to New York or Tokyo.
Furthermore, the UK's tourism sector is sixth largest in the world. It will take a major hit. Seventy per cent of tourist traffic is from Europe. Mainly to London. This generates significant employment at the low-end and boosts local communities. With passport control back again following Brexit, it will serve as a deterrent for employment and for tourists.
There are other sectors in the UK which will also be effected like education and healthcare, designing and creative services.
The creative services ecosystem which Britain had been trying to build up over the last decade will be severely dented. Disruptive Fintech companies in the UK look at the European mainland as its major market and a testbed. Now the UK will no longer be required to implement or follow any EU payments legislation, which could clearly impact the payments environment. So one set of regulations won't fit all. And scale and economics, two factors, which act as incentives for innovation and building sustainable businesses will now drop off.
So the UK is headed for a period of degrowth, deceleration in investment and consumption, a run down of inventory, re-pricing of financial assets, property market decline and therefore, a period of recession. It will put it on a road to a become a middling country - a shadow of its former self.
It has already dropped one place in the global GDP rankings, from fifth to sixth, and that is a sign of things to come.
Further, with job losses (relocation, right-sizing) and the throttling of the steady supply of cheap unskilled and semi-skilled labour from eastern and southern Europe to do jobs that that no Briton has wanted to do since the 1970s, (when Africans and Asians provided the first surge of labour force), wages can only be expected to go up. And overall, all things considered, the UK is now also set for a period of inflation.
So Britain has to work out what are its new competitive advantages and strengths, and figure out its relationship with its major partners.
India has to be at the front and centre of these plans. Both these countries have to quickly sit down and start setting the broad contours of what the reset and new special relationship will mean by quickly working to introduce special free trade-type rights in order to attract enhanced investment, capital, tourists and trade.
Then depending on how the UK (with or without Scotland) manages its own rights and obligations with the EU post Brexit, these will prove to be beneficial for Indian companies and investors in continuing to use the UK as a launching pad to Europe.