Euler Hermes: hard Brexit means recession for the United Kingdom in 2021
- On 31 January 2020, the transition period began, which until 31 December 2020 allows time to work out a final trade agreement between the European Union and the United Kingdom
- the probability of the risk of a "no trade deal" at the end of 2020 is 15%
- in the case of a hard Brexit, we forecast that UK GDP growth will fall to +0.6% in 2020 and -0.6% in 2021
- the UK's losses from exporting goods to the EU and all countries with which the EU has a free trade agreement would amount to more than GBP 20 billion (or EUR 22 billion) in 2021
The transition period has begun
The first months after the agreement
Brexit, which will formally take place on 31 January, will begin a transition period in which the free movement of capital, goods, people and services within the European Union will continue to apply. The final deadline expires on 31 December 2020, so by that date both sides have given themselves time to work out a final trade agreement. Commentary on the probable risk of no deal
After ratification by the UK parliament, the Brexit agreement was approved by the European Parliament on 29 January 2020. Consequently, on 31 January at 23:00 GMT the United Kingdom will find itself outside the EU and will not be part of European institutions or decision-making bodies in Europe. Under the agreement, it will have to apply European rules during the transition period, which expires on 31 December 2020. Until that date, the United Kingdom and the European Union will conduct free trade. Admittedly, finalising the first milestone of Brexit reduces uncertainty, but it does not remove it entirely when we consider the opening of the next round of negotiations on a new trade agreement with the EU. Moreover, the United Kingdom must renegotiate more than 50 other free trade agreements that the EU has concluded with third countries.
Reaching an agreement on a trade deal with the EU by June 2020 seems unlikely, paving the way for a longer transition period. Looking at the calendar of key dates for Brexit in 2020 (Figure 1), we expect that the debate will quickly shift towards the risk of a "no trade deal" scenario. Thus, even if Prime Minister Boris Johnson does not want to extend the transition period, we believe there is a high probability that he will eventually have to do so.
Figure 1: Key Brexit dates in 2020
Source: Various, Allianz Research
New comprehensive agreements
Naturally, the European Commission remains sceptical about the ability of both sides to negotiate a "new comprehensive agreement" by the European Summit on 18-19 June, which would cover goods and agricultural products, as well as services, while taking into account EU requirements regarding social and environmental standards, state aid, anti-abuse measures and labour standards. In our view, the greatest challenge will be the technical organisation of customs controls in the Irish Sea. Financial services would also lose the right of access to markets and would therefore need equivalent status product by product. Negotiations will officially begin on 1 March, but the technical details have so far not been clearly defined either in the Political Declaration or in the Withdrawal Agreement. Comparing the latter document with the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada, for example, specific words such as "sectors", "industrial", "financial services", "corporations", "market access", etc. are still missing.
In our view, the probability of the risk of a "no trade deal" at the end of 2020 is now 15% versus 30% in 2019.
Loss forecasts
Exit on WTO terms
We forecast that UK GDP growth will fall to +0.6% in 2020 (from +1.0% in the baseline scenario) before a recession in 2021 (-0.6% versus +1.6% in the baseline scenario), if a hard Brexit were to occur, i.e. an exit on WTO terms on 31 December 2020. This would mean an average tariff rate on imports of around 5% on goods imported from the EU and the rest of the world.
Who will lose out from a hard Brexit?
We believe there is a very low probability that the United Kingdom will be able to replicate some of the EU's existing free trade agreements (with Australia, Canada) before the end of this year or negotiate new ones (e.g. with the USA). The EU applies an average tariff rate of around 9% on imports from the USA, while the USA applies a tariff rate of around 5% on imports from the EU. In the absence of a free trade agreement, regardless of whether Brexit is hard or orderly, the UK could apply the same tariff rates to the USA. A free trade agreement with the USA seems unlikely in 2020, given the fact that, according to the United Kingdom's announcements, an agreement with the EU will take priority over an agreement with the USA this year.
Generally, the UK's losses from exporting goods (to the EU and all countries with which the EU has a free trade agreement) would amount to more than GBP 20 billion (or EUR 22 billion) in 2021 (Figure 2). For the EU, the economic impact would be more limited (around EUR 16 billion from goods). Outside the EU, Japan and Canada are at the forefront among the 15 most affected countries, because the free trade agreements they have with the EU will not apply to the UK (Figure 3).
Figure 2: Projected annual UK export losses by country in the hard Brexit scenario, GBP billion
Source: ITC, World Bank, Allianz Research
Figure 3: Expected annual export losses from the UK, taking into account the end of the single market
and concluded free trade agreements, EUR billion
Source: ITC, World Bank, Allianz Research
We anticipate trade and credit risks today, so that companies can have confidence in tomorrow.
Euler Hermes is the global leader in the trade receivables insurance market and one of the leaders in insurance guarantees and debt collection. With more than 100 years of experience, the company offers business-to-business (B2B) clients financial services supporting cash and receivables management. Its network of business intelligence agencies tracks and analyses daily changes in the solvency of small, medium-sized and international companies operating in markets accounting for 92% of global GDP. The company is headquartered in Paris and operates in more than 50 countries, where it employs more than 5,800 people. Euler Hermes is a subsidiary of Allianz and holds an AA rating from Standard & Poor's and AA3 from Moody's. In 2018, the company's consolidated turnover amounted to EUR 2.7 billion, and it insured business transactions worth EUR 962 billion worldwide.
For additional information, please visit the website: www.eulerhermes.com
Summary
Euler Hermes analysts estimate that the probability of a hard Brexit at the end of 2020 is currently 15%. If it were to occur, UK GDP growth would fall to +0.6% in 2020 and reach -0.6% in 2021, which would mean recession. Losses from goods exports could exceed GBP 20 billion in 2021.
The key challenge remains working out a new trade agreement with the EU by the end of the transition period, as well as renegotiating more than 50 free trade agreements that the EU has concluded with third countries. Experts point out that an agreement with the USA is unlikely this year, and that Japan and Canada will be among the most affected countries.
