Brexit will shake investors’ faith in Britain to the core

It is no exaggeration to say that Britain stands at the edge of disaster. In two weeks time, UK voters will be making a momentous decision that will shape Britain’s future for generations. As the nation heads to June polls on whether to remain in or leave the European Union the stakes are high.  A majority vote in favour of a British EU exit (Brexit) could lurch the country into chaos for years. Its impact will be felt around the globe.

Britain is heading into the unknown and the country seems worryingly split down the middle. Judging by recent surveys, public opinion seems to be edging towards the Leave camp. If this continues, the final run-in to the referendum will be an anxious time for the nation and a source of rising instability for Britain’s financial markets.

International confidence in the UK could be shaken to the core. Britain’s strong growth record, its leading role as a global financial centre and even the survival of the 300-year old British union will be under a cloud. If Britain crashes out of Europe, Scotland has threatened another independence vote in order to stay inside the EU. Britain’s influence as a leading international power would begin to wane.

The main credit ratings agencies have already warned they would take a dim view of UK assets on a British break from Europe, warning that a sovereign downgrade might be inevitable. International confidence in UK investments would suffer badly. Britain is no stranger to currency crisis and the pound could take a beating. International investors would shun stocks, government bonds and industrial assets in the uncertainty. And it might take years before the UK can strike a favourable EU trade deal and forge a new working relationship with Europe.

International investors could lose out heavily, especially those that were coaxed into investing into Britain under Margaret Thatcher’s private sector renaissance in the early 1980’s, when international companies began flooding into the UK. Under sweeping structural reforms, Britain became a Promised Land of free enterprise and market-friendly deregulation for foreign investors. The added advantage was free admission into Europe’s single-market, with front-door access to the EU’s 500 million-strong consumer market.

Over the years, this has reaped rich rewards for Britain and brought strong inflows of foreign direct investments (FDI). Inward FDI has helped finance the UK’s current account deficit and provided vital support for the UK’s asset markets. The UK now stands as the world’s third largest destination for inward FDI behind the US and China, with the stock of FDI investments in Britain currently around 1.7 trillion US dollars. The UK is the top target for FDI flows into Europe thanks to Britain’s track record on providing a safe port for foreign money. All this could change very dramatically.

A beneficiary has been the UK car industry where Asian companies are major stakeholders. Since the 1980s, Japan’s Nissan, Toyota and Honda have built up significant UK manufacturing presences, while India’s Tata Motors has owned Britain’s Jaguar Land Rover since 2008. Any threat to Britain’s free trade access into Europe would cast these investments into doubt. Any barriers to free trading would be bad news for UK-based manufacturers and momentum to quit Britain and switch production to Europe could turn into a stampede.

As the United States learnt to its cost under the strong dollar regime during the mid-1980s, when many US companies switched manufacturing overseas to stay competitive, it has been extremely hard to win back business that has moved offshore. The US’s yawing trade gap is testament to that. Britain could end up in the same boat if international companies panic about losing eligibility for free trade status in Europe. FDI inflows would reverse, tearing a large hole out of Britain’s industrial capacity in the process. It would be bad news for UK growth prospects, for the balance of payments and for British industrial prestige.

Indeed, there is a possibility that Tata Steel’s recent decision to quit UK steelmaking is less to do with global over-supply and heavy loss-making in their UK plants and more to do with a loss of confidence in Britain’s industrial future due to Brexit fears. In addition, recent news of Tata Motors plans to build a factory in Slovakia, its first European JLR car plant outside the UK, could be a bad omen for British car manufacturing shifting into Europe if Brexit takes off.

Brexit also poses serious risks to Britain’s future as a global financial centre. The UK financial services sector is a vital part of the economy, employing over one million people, accounting for 12 per cent of total output and 11.5 per cent of UK government revenues. The City of London is not only home to over 250 foreign banks, but also the European headquarters for many of them. If Britons vote to leave the EU, London faces losing one of its top money spinners – the multi-trillion euros traded-derivatives business which the ECB would like to see housed on European and not UK soil. Furthermore, many foreign banks based in the UK might find it more prudent to comply with the EU’s regulatory framework by moving to Frankfurt or Paris. Brexit could spark a major bank drain out of Britain.

Britain’s economy looks vulnerable. Since the global financial crisis, the UK has grown faster than its Group of Seven partners, but only thanks to the economic fizz of zero interest rates, quantitative easing and loose fiscal policy. Without these policy boosts, underlying UK growth potential would be nearer to 1.5 per cent than the latest 2.0 per cent headline rate. The shock of Brexit, a quick foreign exodus out of UK investments and a collapse in British productive capacity and jobs could hit confidence hard, tipping the economy into a nasty recession.

In the worst case scenario, the UK could fall into a deep depression. Unfortunately, UK policymakers are running out of options to deal with new crises. UK interest rates are already at rock bottom and QE has already run its course. A sharply weaker pound would only be a small fillip for what little would remain of UK manufacturing locked outside of Fortress Europe. Foreign investors would be hit hard by the fall in their sterling-based assets. For international manufacturers, banks and financial services companies there are compelling reasons to get out quick while the going is good.