The Brexit Decision: Economic and Financial Implications ... IMF’s quarterly COFER report and ERPD Calculations. * Estimated from IMF's Regional Economic Outlook ** All central banks

The Brexit Decision:Economic and Financial Implications for the OIC Member States1 N o v e m b e r 2 0 1 7

E c o n o m i c R e s e a r c h a n d P o l i c y D e p a r t m e n t

I s l a m i c D e v e l o p m e n t B a n k

Background

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Brexit ReferendumOn 23 June 2016, UK voters voted in favor of leaving the European Union, i.e. the “British exit” or Brexit from the EU

OIC ResolutionICDT, SESRIC and IDB were tasked by the OIC Resolution 6/43-E to conduct a joint study on the potential implications of Brexit for the OIC Member States

IDB StudyFocus on “financial and monetary implications of Brexit, including the impact on investment”

Roadmap of the Presentation

I. Preliminaries

II. Channels of Transmission

III. Degrees of OIC MCs Exposure and Vulnerability

IV. Conclusions

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I. Preliminaries

• Financial impact of Brexit on OIC economies will not only depend on what happens after the UK separates from the EU (the actual Brexit), but also on what happens in the interim: economic uncertainty, market/policy responses• The June 2016 referendum (the “Brexit decision”) = the first step in the process• March 2019 = the point at which the EU treaties formally cease to apply to the UK

• After 2 years, UK and EU may settle on a temporary transitional arrangement before the final Brexit terms agreed

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#1 – “Brexit Decision” vs. “Brexit”

• We focus on the implications of the “Brexit decision” for:

1. Cross-Border trade flows Total merchandise trade and Trade in Services Implications for both Exporters and Importers

2. Cross-Border Financial Flows Income Flows and Transfers: Investment Income, Remittances, ODA Investment Flows: FDI, portfolio investment, cross-border bank lending

3. Value of Financial Stocks Assets: Official Foreign Exchange Reserves, SWFs Liabilities: Foreign debt

#2 – What Do We Mean by “Economic and Financial Implications”?

I. Preliminaries

1. Uncertainty about the final shape of the Brexit arrangement, i.e. the terms of separation: “hard” vs. “soft” Brexit Impact will depend on how the UK/global economy & markets react

2. Insufficient data to establish robust historical correlations between the path of the UK/Global economy and the financial flows to and from the OIC member states

So? We lay out a FRAMEWORK to assess… (1) potential magnitude of financial implications, and

(2) relative degrees of vulnerability of individual OIC countries

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#3 – Unconditional Assessment of the Brexit Impact = “Mission Impossible”

Brexit Decision

Stage 1:Expectations + Policy Uncertainty

UK/Global Real

Economy

UK/Global Monetary

Policy

UK/Global Asset Prices

Stage 2:Actual Brexit Arrangement

Cross-Border Financial Flows

Value of Financial Stocks

Trade Flows


I. Preliminaries



IV. Conclusions

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II. Channels of Transmission: (A) Real Economy

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Stage 1: Impact of the “Brexit decision” via its impact on economic/policy uncertainty

Source: www.policyuncertainty.com and ERPD calculations.

“Brexit Decision”Real Economy:- GDP growth- External Acct’s

Income FlowsCapital FlowsAsset Valuations

Consumption InvestmentExportsBank Lending

UK: Policy Uncertainty BoE: Real GDP Growth Forecast

Source: Bank of England (BoE) Inflation Reports and ERPD calculations.

http://www.policyuncertainty.com/

II. Channels of Transmission: (A) Real Economy

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Stage 2: Impact via Potential Disruptions to Trade and UK Banks’ Passporting Rights

Source: Haver Analytics and ERPD calculations.

UK: Exports of Goods & Services UK: Exports of Financial Services

EU’s Importance:

46% of goods exports39% of services exports33% of financial services exports53% of cross-border bank claims

Loss of the “passport” privileges would mean:

- Need to establish a local subsidiary in the EU- Provide additional regulatory capital- Duplicate currently centralized operations

II. Channels of Transmission: (B) Monetary Policy

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Source: Haver Analytics, Federal Reserve, and ERPD calculations.* FOMC participants' individual judgement of an appropriate FFR target by year-end

US Fed’s Delay in Normalization: Brexit referendum (“decision”) was explicitly mentioned at June 2016 FOMC Meeting as a factor behind the decision to keep the target rate unchanged

UK Monetary Policy

BoE’s Comprehensive monetary easing package:

- 25bp rate cut in August 2016- a new term financing scheme- 16% expansion of the QE target trough bond

purchases £60bn of extra global liquidity

“Brexit Decision”Asset Prices, Global Liquidity

Financial FlowsAsset Valuations

Rate Cuts, Further QEDelayed Normalization

II. Channels of Transmission: (C) Asset Prices

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Cumulative Change Since the Brexit Decision Value of the British Pound (GBP)

All initial asset price moves have been more than reversed, except:- UK interest rates/bond yields- Exchange rates, esp. GBP depreciation (-16%)

Units +1 day End-2016 Latest †

3m LIBOR USD bp -2 36 52

EUR bp -1 -5 -6

GBP bp -3 -22 -25

10-Year Bond Yields US bp -17 71 58

Germany bp -14 11 14

UK bp -26 -20 -42

Greece bp 82 -60 -102

Exchange Rates * EUR % -2.4 -7.6 -6.8

GBP % -8.1 -17.0 -16.0

IDR % -1.3 -2.1 -0.5

MYR % -1.5 -10.2 -9.1

Stock Markets ** SP500 % -3.6 5.9 11.4

S&P Europe % -6.8 5.1 10.6

UK % -3.8 11.2 15.5

Indonesia % -0.8 8.7 15.5

Malaysia % -0.4 0.1 5.8

Commodity Prices Gold % 4.2 -9.2 -0.7

Crude Oil (Brent) % -5.1 9.9 8.7* Exchange rates are measured gainst USD. The negative number means a depreciation. ** Measured in local currency terms. bp = basis point = 0.01% † 11 April 2017Source: Haver Analytics and ERPD calculations.

“Brexit Decision”Financial FlowsAsset Valuations

Interest Rates, Equity Prices, Commodity Prices, UK House Prices, Exchange Rates

FRAMEWORK

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Brexit Decision

Stage 1:Expectations + Policy Uncertainty

UK/Global Economy

UK/Global Monetary

Policy

UK/Global Asset Prices

Stage 2:Actual Brexit Arrangement

Cross-Border Financial Flows

Value of Financial Stocks

Implications for OIC Economies

Unconditional quantitative assessment = impossible

QUESTION: What are the OIC economies’ exposures/vulnerabilities?

Trade Flows


I. Preliminaries



IV. Conclusions

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III. Degree of MCs Exposure and Vulnerabilities

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A. Exposures via Cross-Border Trade Flows

OIC Economies’ Merchandise Trade with the UK, 2015 OIC MCs’ Trade in Services with the UK , 2015

- At around 47 million USD, average trade in Services represents over 5% of GDP for a small economy like the Gambia , as compared to nearly 3.5 bn for UAE (close to 1% of GDP)

Source: IMF’s DOTS; WTO Trade in Services Data Base and ERPD calculations.

- As a ratio to GDP, the average value of MCs’ merchandise trade flows with UK was relatively limited

- - UAE and Turkey recorded sizeable flows in 2015

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UK’ Merchandise Imports from OIC MCs, 2015 UK’ Merchandise Exports to OIC MCs, 2015

Large importers from the UK could see some favorable impact through the exchange rate channel.


- Exporters to the UK, mainly commodity exporters, are likely to be more impacted through growth (lower demand) and the exchange rate effect (lower exports earnings)

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UK’ Imports of Services from OIC MCs, 2015 UK’ Exports of Services to OIC MCs, 2015

Net importers of services like Guyana Mozambique or Afghanistan could benefit from the lower exchange rate. For UAE, the figures are more balanced.


- The Gambia may be highly exposed with exports services to UK, notably tourism services representing nearly 10% of GDP in 2015.

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B. Exposures via Cross-Border Financial Flows

OIC Economies’ Investments in the UK Remittance Flows from the UK to OIC MCs

- UK residents may have sent ~$25bn ofremittances abroad in 2015

- Estimate: $7 billion went to OIC, 85% of whichto Nigeria, Pakistan and Bangladesh

Source: IMF’s Coordinated Surveys,UK’s ONS, World Bank, Haver Analytics and ERPD calculations.

- No detailed data on geographic composition ofinvestment income flows (£155bn in 2015)

- Estimate: $4.5 billion of investment incomeflows from the UK to the OIC MCs (0.1% of GDP)


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UK Banks' Consolidated Claims on the OIC MCs*

Source: Bank for International Settlements, Haver Analytics and ERPD calculations.* Total foreign claims on immediate counterparty basis (Consolidated Banking Statistics)

UK Banks' Funding of the Local Banking Sector

Most of cross-border bank lending from the UK flows to the non-financial private sector


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UK’s Imputed Country-Specific ODA to OIC MCs *

Source: UK’s Office of National Statistics, IMF and ERPD Calculations.* Includes estimates of country-specific ODA via multilateral institutions

o $18.5bn – UK’s total ODA in 2015

of which to OIC economies:

o $7.1bn – UK’s bilateral ODA to OIC MCso $2.5bn – UK’s ODA to OIC via multilaterals

o 0.7% of UK’s GNI – stated annual ODA spending target of the pre-Brexit government (maintained during 2013-16)

o $740 million – an estimated decline in the US dollar value of the UK’s ODA in 2017 vs. 2015 due to the GBP depreciation to $1.25/GBP


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C. Exposures via Financial Assets and Liabilities

Official Foreign Exchange Reserves (Minus Gold)*

Source: IMF’s quarterly COFER report and ERPD Calculations.* Estimated from IMF's Regional Economic Outlook ** All central banks are assumed to hold the same share of GBP assets (5.8%)

5.8% – a share of foreign exchange reserves held in GBP-denominated assets by the emerging market and developing countries central banks in Q2’16


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C. Exposures via Financial Assets and Liabilities

Estimated Stock of Sovereign Wealth Fund Assets in OIC MCs

Source: Sovereign Wealth Fund Institute, Wikipedia, IMF and ERPD Calculations.* Combined assets of several sovereign wealth funds

o Most SWFs don’t disclose the breakdown of their holdings

o For many SWF, domestic and/or illiquid assets constitute a large share of holdings, which would not be impacted by asset price moves

B. Valuation of Liabilities

o 0.1%-1.9% of GDP – outstanding long-term external debt of OIC MCs denominated in GBP (World Bank data)

o Indonesia ($534 million), Sudan ($300 million), Bangladesh ($185 million), Egypt ($123 million); most MCs have no GBP-denominated long-term ext. debt

A. Valuation of Assets


I. Preliminaries



IV. Conclusions

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1. “Brexit” is a multi-stage process that started with the Brexit Decision

the financial impact on OIC MC will be stage-dependent

2. The final shape of the Brexit arrangement (the terms of separation) is uncertain

the financial impact is uncertain

3. Impact of Brexit Decision so far has been modest and mixed at best

slightly easier global monetary conditions/delayed MP normalization most other initial asset/commodity price moves have been reversed weaker GBP: the main casualty so for

4. Uncertainty/Poor Data Unconditional quantitative assessment is impossible

we focused on a FRAMEWORK and EXPOSURES/VULNERABLITIES

5. GOOD NEWS: For most OIC economies, exposure/vulnerabilities are very small

6. Combined vulnerabilities may be a source of concern for some small economies Exposure via USD-value of UK’s ODA & remittances and via trade flows More research warranted: Is there a scope for IDB Group interventions to fill the gap?

IV. Summary & Conclusions

Thank you

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Documents

The Brexit Decision: Economic and Financial Implications ... IMF’s quarterly COFER report and ERPD Calculations. * Estimated from IMF's Regional Economic Outlook ** All central banks