As Britons prepare to vote in a referendum on whether to leave the European Union, some top Canadian pension funds are holding back on United Kingdom deals until after such referendum.
From his vantage point at the University of Botswana where he teaches finance, Ishmael Radikoko says that Botswana should exercise similar caution.
“At this point in time, investors in Botswana should also be cautious about investing in the UK. This is because there is currently a lot of uncertainty with regards to the outcome of the vote,” says Radikoko explaining that uncertainty itself is a risk which needs to be compensated for by increasing returns to investors if they are to invest in the UK market. “This uncertainty has an obvious impact of reducing business activity both in the EU and the UK itself and hence reducing growth in the UK. Capital markets in UK are currently volatile and there is lack of liquidity all of which have an effect of reducing total return from investments in the form of capital gains yield and dividends yields for equities.”
After 43 years of EU membership, Britons are divided on whether their country should remain in the politico-economic union of 28 states or leave. Being part of the EU takes away some powers from London to Brussels where the EU is headquartered. Those in favour of Britain’s exit (“Brexit” as it is called) argue that such move will restore full parliamentary sovereignty. Back in 1975 when Britons voted on whether or not to join what was then called the European Economic Community, there world didn’t take as much interest as it does now primarily because there wasn’t as much global economic integration as there is now. When he visited UK a fortnight ago, United States president, President Barack Obama, said that his country’s preference was for UK to remain in the EU.
“The UK is at its best when its helping to lead a strong Europe [and] a single market brings extraordinary economic benefits to the UK,” he said when addressing a press conference in London.
In their nature, trade deals take a very long period of time to be sealed and Radikoko says that countries like the US worry that their deals with the EU would have to be renegotiated and the outcome might not be as favourable as it was previously. Within the EU itself, Brexit could wreak havoc. Radikoko’s analysis is that the free movement of labour between EU countries, which is currently not restricted, would be adversely affected.
“Fears are that if Britons vote for the exit, then free movement of labour will be affected as there will be now strict controls. This has a potential impact on business activity particularly by reducing the ease of accessibility of talented human capital. Many companies, including some banks, are already threatening to leave the UK market if Brexit materialises citing the fact that there will be loss of business,” he says.
In terms of EU processes, a company authorised to provide financial services in one jurisdiction can provide them in another without having to be authorised in the latter. This is called passporting. Radikoko says that the business community is worried about losing passporting rights if the Britain leaves the EU. He explains that passporting is currently of great benefit to EU businesses because it comes with a less complex and less costly regulatory framework.
“So, if UK is to exit EU that will mean the UK will have its own regulatory framework from doing business in the UK which might not be similar to the EU one and hence create some complexity and cost in doing business in the UK,” says Radikoko adding that the risks of doing business in a stand-alone UK is not limited to these factors which is “a clear indication that investing in the UK right now pending the outcome of the EU referendum is a risky venture and as such investors in Botswana should also approach investing in the UK with caution.”
There is fear in the US that Brexit could panic the capital markets into recession and according to Goldman Sachs, such panic could cause the pound sterling to lose 20 percent of its value. With Brexit, Radikoko says that while some businesses would stop operations altogether, others would pull out from the UK market. When that happens, there would be a decline in demand for the pound sterling as the local currency and competing currencies will appreciate against it.
“This means that returns from investment which are remitted back to Botswana would translate into even less amounts when the weak sterling is converted into pula. Moreover, the weakening pound would mean that imports into the UK will reduce because it would be quite expensive to buy outside the UK using a weak sterling. This would mean that exports from countries that sells to the UK – like Botswana, would decline, causing us to lose revenues from selling our minerals and beef to the European market. This has a potential of squeezing government revenues and hence economic downturn in Botswana. Generally, when the economy is not doing well, return from investment in capital market will be low as investors disinvest from capital markets – especially equities, to other alternative assets which are assumed to store value during economic hardships,” Radikoko says.
At this stage in their development, Botswana’s capital markets are largely made up of equities than bonds as the bond market is still developing. Radikoko says that as a result of this, the greater impact on capital markets as a result of the economic downturn would be felt in Botswana’s equity market.
“Economic downturn comes with a period of high volatility and lack of liquidity, both of which have the effect of reducing total return from investments in the form of capital gains yield and dividends yields for equities,” he adds.
Radikoko also cautions that Brexit-induced economic hardship could come with high inflationary period and interest rates which would increase the cost of capital. In turn, the latter would drive down equity and bond values and making capital markets unattractive as an investment avenue in the UK.
While Brexit has been attended by a characteristic no-hurry-in-Botswana nonchalance locally, Radikoko’s analysis is that the country should not be relaxing over this issue. His advice is that the country should get ready to absorb as much of the impending economic shock as possible.
“The impact might not be felt immediately after the voting in favour of Brexit but as a way of getting ready as an economy, we might need to start reducing some capital expenditure projects that are currently planned and putting some projects on hold to observe the situation. Only projects that will translate into immediate economic impact will have to be considered,” he says.
He adds that at the same time, Botswana will have to come up with alternative ways of raising revenues because the mining sector, which is the backbone of the economy, is going through a rough patch.
“Brexit will worsen the situation, including any revenues that we get from beef exports.”