How would a Brexit affect SMEs?

Falling sterling would be a plus for exporters, but expect some serious volatility, says Jeremy Cook.

by Jeremy Cook
Last Updated: 24 Jun 2016

Dawn is breaking across Westminster and the apple cart has been well and truly upset - the UK electorate have voted to leave the EU. David Cameron has resigned, with George Osborne expected to do the same later in the day. As Nigel Farage is on his 19th pint of bitter, the thoughts of small business owners in the newly-independent UK shift to how they will thrive in an unfamiliar trading landscape.

As that same dawn breaks over the City and Canary Wharf, traders will come out swinging in a bid to take the pound lower. Fears over the twin deficits – current account and budget – alongside concerns over a possible recession, interest rate cuts or increased quantitative easing from the Bank of England, as well as a likely Cameron resignation, would all be sticks to beat up sterling – an outcome that would have significant ramifications for UK SMEs with international ambitions.

Once the dust settles we would expect sterling to be 15-20% lower than current levels against the US dollar with a similar decline in the short term against the euro entirely possible.

Whilst these are big swings, it is not all doom and gloom, particularly for exporters. As scary as the falls in sterling may be, a 20% cut in export prices is going to see export demand pick up no matter what the industry. So for UK businesses currently facing difficulties in exporting their goods and services owing to a lack of price competitiveness thanks to an overvalued pound, a sharp devaluation could be the panacea to some of their woes. As a result, some UK businesses could see new markets opening up that were previously considered not viable to export to.  

An important caveat is that this is based on the belief that transactional tariffs are not imposed as part of any new post-Brexit model – a 20% devaluation and a 20% tariff leaves exporters with no help at all.

Should sterling fall as mentioned above, we would expect to see a significant demand for forward contracts or other hedging products that would allow an exporter to lock in those multi-year beneficial rates for up to 3 years. Some companies will have just been a business plan on a napkin the last time rates were so low, meaning astute SMEs will be eager to lock in these favourable gains for as long as they can.

However, for every action there is a reaction with currency and trade in some cases being a zero-sum game. For all the advantages that the UK’s exporters would gain, importers would be losing as trade becomes more uncertain and products more expensive.

Also at a macro level, a weaker pound is naturally a catalyst for a divergent investment atmosphere. The UK is the main beneficiary of EU Foreign Direct Investment i.e. investment made by a company or entity based in the EU, into a company or entity based in the UK. Some believe that to be in danger in the event of a Brexit, although there is the likelihood that the UK economy is attractive enough to keep its status as a top investment destination. Foreign businesses do crave stability, as all businesses do, but longer term flows and a beneficial regulatory environment may be enough to surpass this in the future – UK SMEs seeking foreign investment who wake up on June 24th to a Brexit, will certainly hope this is the case.

A weak pound naturally makes investing into cheaper UK property or factories that much more attractive too. If the aforementioned Brexit scenario were to materialise, prepare to hear a lot more about parts of London and other business hubs, such as Manchester, becoming increasingly holed out by rich foreign investors looking to capitalise on cheaper property. This would be a clear hindrance to UK businesses looking to expand domestically, as commercial property might become increasingly snaffled up by those from overseas. 

It is also worth mentioning that whilst the EU referendum will likely have the greatest influence on sterling this year, there are other events that will shape our currency too. From a rise in US interest rates and the possibility of Donald Trump reaching the White House, through to a further rise in global oil prices, UK businesses won’t see the back of sterling volatility for some time yet. 

Back to the EU referendum, I think it is fair to say that the trading landscape of the UK’s internationally focused companies would be thrown into a new and rather uncertain dynamic by a vote for a Brexit. Trade deals may be signed quickly but the viciousness of the moves in currency markets will make conditions tough. There is only one way to find out.

Jeremy Cook is chief economist at World First.


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