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Voting for downgrade

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Why UK outside EU would lose triple-A rating

by Moritz Kraemer in Frankfurt

Sat 4 Jun 2016

After a vote to leave the European Union, fulfilling the UK’s external funding needs would be a challenging task. Britain’s annual current account deficit, almost £100bn, is the world’s second largest, after that of the US. At over 5% of GDP, it’s the highest British deficit since records began.

Jitters among foreign creditors if negotiations with the remaining EU get messy would have a self-reinforcing negative financial and economic impact.

Reflecting a probable post-Brexit climate of economic vulnerability and political uncertainty, S&P has decided that, if Britain opts to leave, we would downgrade the UK’s triple-A credit rating. This would reduce the 13-strong group with this top-notch status – currently Australia, Canada, Denmark, Germany, Hong Kong, Liechtenstein, Luxembourg, the Netherlands, Norway, Singapore, Sweden, Switzerland and the UK – to 12 countries.

One way of measuring vulnerability is to analyse an economy’s annual gross external financing needs, defined as maturing long-term debt and the stock of short-term debt of the private and public sectors, including the banks, as a share of current account receipts and official gold and foreign exchange. The UK score is 755%, the highest among all 131 sovereigns rated by S&P Global Ratings. Among the G7 leading advanced economies, the US and France, with the next least favourable rankings, have scores of 318% and 316% respectively.

Compounding uncertainty about post-Brexit developments is the Brexiteers’ disagreement about what should substitute for the status quo. There is simply no Plan B that all those wishing to leave the EU would wish to endorse.

The rifts in the ruling Conservative party, and UK society at large, will linger beyond referendum day. A Brexit vote would not close the controversy or heal old wounds. There would be a bitter debate on what should happen next. Domestic politics could become still more antagonistic should a decision to leave prompt a resurgence of the Scottish independence movement.

A post-referendum British government would have difficulty coming up swiftly with a consensual proposal for a new relationship with the EU. The position on the European side wouldn’t be much better. Concerns about further EU disintegration could lead to a rather tough stance against the UK’s aspirations, whatever they might be.

European policy-makers would be keen to discourage other member states from contemplating an exit. A highly beneficial deal for a departing UK could further invigorate nationalist and eurosceptic parties elsewhere in the EU, so this reinforces other governments’ reluctance to accommodate UK wishes.

Assuming negotiations bring a successful accord, the agreement would need to pass not only the House of Commons, but also the parliaments of each of the 27 remaining member states. Some of those may choose to put the UK treaty to referendums, with uncertain outcomes. Maybe the UK would have to vote in another referendum to give legitimacy to an agreement with content that would have been unknown in 2016.

Uncertainty about Britain’s future status would increase hesitancy among both financial and entrepreneurial investors. For example, according to an S&P survey, more than nine out of 10 UK infrastructure investors believe Brexit would negatively impact their investment decisions.

More polarised domestic and European political circumstances after a Brexit vote would pose risks for effective, transparent and predictable policy-making. This would raise questions about economic growth and the balance of payments – all detrimental to sovereign creditworthiness.

Moritz Kraemer is Global Chief Rating Officer, Sovereign Ratings, at S&P Global. This is No.80 in the series – the 100th article will appear on 23 June.

OMFIF’s series on the UK EU referendum presents a wide variety of perspectives from Britain and around the world ahead of the 23 June poll. We are assuring a balance between many different points of view, in line with OMFIF’s overall neutral stance on the issue.

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