Cyprus with its large tourism, auditing, and financial sectors, and historical connections to the U.K.,Cyprus remains close to the top three economies most exposed to Brexit. Cyprus hosts a large population of U.K. pensioners, as well as two military bases, technically a British OverseasTerritory that accounts for 3% of Cyprus. Also, a large portion of Cypriot nationals live and work inthe U.K. We estimate that annual remittances of Cypriot nationals resident in the U.K. to Cyprus amount to around 0.2% of Cyprus’ annual GDP. This is a substantial figure, albeit below that forHungary (0.3% of GDP), Lithuania (0.4% of GDP), and Latvia (0.6% of GDP).
Cyprus is no stranger to external shocks, having managed to retain much of its business servicessector and to recover economically from the 2012-2013 financial crisis and sovereign default.Even so, Brexit could create headwinds for its economy, given the importance of migratory, export,and financial links between the two countries.
What’s Changed Since 2016?
Nine of the 10 countries with the greatest exposure to Brexit in 2016 are still in that group today,although there has been a reshuffling in the rankings. Perhaps the most notable change is that the Netherlands has moved up four places to become the third most vulnerable economy. Betweenyear-end 2015 and year-end 2018, Dutch exports to the U.K. increased by nearly 0.6% of GDP, andDutch banks still carry high exposures to U.K. counterparties.
For the 2019 BSI, we have included Portugal for the first time. Its ranking of 16 indicates relativelylow exposure, stemming from low FDI and financial sector claims on the U.K., despite significantexport and migratory exposures.
The other key difference we’ve observed is the contrasting approaches larger European bankingfranchises are taking toward their U.K. exposures. Compared with end-June 2016, the banking systems of Belgium, Germany, Ireland, and Switzerland have cut their exposures to U.K.counterparties–a trend in place long before Brexit was contemplated. In contrast, since the U.K.referendum, banking systems in the Netherlands, France, and Spain have increased their U.K.business, when measured on an ultimate risk basis.
At the same time, the financing of the U.K.’s large external deficits has shifted away from FDItoward portfolio equity and debt [see the U.K. Office of National Statistics (ONS) third-quarter2018 Balance of Payments report]. This indicates to us that, during 2018, concerns about theconsequences of Brexit for the U.K. have already led to a weaker global and European appetite tomake long-term investments in the British economy. This is something to watch, in light of theU.K.’s current account deficit of 5% of GDP, the second highest in the world in absolute terms.
The BSI: How Things Stand In 2019
Of the 21 sovereigns most exposed to Brexit, only two (Canada and Switzerland) are not EUmembers, and one (Canada) is not
Who Has The Most To Lose?
1. Ireland (BSI 2.9; 2016 Ranking: 1)The 2.9 result for Ireland is more than 4x the 0.7 median, implying significant reverberations in theIrish economy should the U.K. leave the EU, particularly should it do so without a formalagreement that includes a transition period. Ireland’s 499-kilometer border with the U.K.encourages vigorous trade in merchandise and services, as well as substantial migratory flowsbetween the two countries. At 8.5% of GDP, Ireland exports more goods and services to the U.K.than any other sovereign on the index. Deep supply chains extend between Ireland and Northernwww.spglobal.com/ratingsdirectMarch 28, 2019 3Brexit Sensitivity Index 2019: Who Has The Most To Lose? Ireland, not least in agro and food processing. Indeed, Northern Ireland is the U.K. region with theclosest trade links with Ireland, making up around 15% of total trade.Another byproduct of Ireland’s location is the large bidirectional immigration between it and theU.K. The sum of Irish residents in the U.K. and vice versa totals 16.7% of Ireland’s population,according to data from the ONS and the U.N.’s Department of Economic and Social Affairs. Thatfigure is twice that of the next largest bidirectional migratory figure, namely 8.35% for Malta, andfar exceeds two-way migratory flows from southern European countries such as Spain (1% ofSpain’s population), the seventh most vulnerable nation on our BSI.Ireland’s financial sector’s exposure to the U.K. is the fourth highest of all 21 economies surveyed,reflecting the size of Irish banking subsidiaries operating in the U.K. Yet financial sector claims aredown compared with that in 2016, as the Irish banking system continues to reduce its U.K.footprint.Given all of these connections with the U.K., there is little doubt that a no-deal Brexit wouldrepresent a sizeable shock to Ireland’s small open economy. Nevertheless, we would expect thatIreland’s highly flexible economy would reorient trade toward even larger trading partners, such asthe remaining EU countries and the U.S. We also think that Ireland is well placed to attract someof the FDI displaced from a post-Brexit U.K., should U.K.-based financial subsidiaries andbranches lose their coveted EU passporting rights, which currently enable them to sell financialservices in the EU market.
2. Luxembourg (BSI 2.7; 2016 Ranking: 3)Luxembourg’s sizeable claims on U.K. financial institutions, and high exports (many rebooked viaLuxembourg for tax purposes) explain its position as the second most vulnerable country. Tomeasure Luxembourg’s FDI claims on the U.K., we used ONS data, excluding claims by specialpurpose entities (SPEs), which we estimate make up over 95% of Luxembourg’s FDI in the U.K.SPEs, while legally resident in Luxembourg, are controlled by foreign parents; their purpose is toenable foreign companies to issue debt, and retain earnings including royalties in the mosttax-efficient way possible.As a consequence of the export and capital flows connected to these SPEs, Luxembourg’s BSIprobably overstates its vulnerability to Brexit. Nevertheless, as a small open financial servicescenter that uses its sovereignty to operate as a financial conduit for many of the world’s largestcompanies, Luxembourg is vulnerable to any effects that the U.K.’s departure from the EU mighthave on its vast financial and business services sectors.
3. Netherlands (BSI 1.9; 2016 Ranking: 7)Over the past three years, the Netherlands’ relative exposure to Brexit increased as a result ofseveral factors:- Significant exports of goods and services to the U.K., of 7.3% of GDP in 2018 versus 6.7% ofGDP in 2016 (ONS data), the third highest after Ireland and Malta.- Substantial inbound FDI (netted for SPEs) into the U.K., based on ONS estimates.- On an ultimate risk basis, Dutch banks’ increased claims on U.K. counterparties, up 24% to11.5% of GDP since the referendum vote on June 23, 2016. This is the fourth highest exposureas a share of GDP among the 21 economies in the survey. It also contrasts with declines in U.K.counterparty exposures in Belgium, Germany, Ireland, Switzerland, and Malta since the U.K.’swww.spglobal.com/ratingsdirectMarch 28, 2019 4Brexit Sensitivity Index 2019: Who Has The Most To Lose? national referendum.For the Netherlands, export exposures (ONS data) may be overstated due to high re-exports androyalty payments. However, these confirm just how open the Dutch economy is, with its largetransport and maritime sectors. The Netherlands remains the largest maritime freight transportcountry in Europe, home to the three largest ports by volume on the continent.
4. Cyprus (BSI 1.7; 2016 Ranking: 4)With its large tourism, auditing, and financial sectors, and historical connections to the U.K.,Cyprus remains close to the top three economies most exposed to Brexit. Cyprus hosts a largepopulation of U.K. pensioners, as well as two military bases, technically a British OverseasTerritory that accounts for 3% of Cyprus. Also, a large portion of Cypriot nationals live and work inthe U.K. We estimate that annual remittances of Cypriot nationals resident in the U.K. to Cyprusamount to around 0.2% of Cyprus’ annual GDP. This is a substantial figure, albeit below that forHungary (0.3% of GDP), Lithuania (0.4% of GDP), and Latvia (0.6% of GDP).Cyprus is no stranger to external shocks, having managed to retain much of its business servicessector and to recover economically from the 2012-2013 financial crisis and sovereign default.Even so, Brexit could create headwinds for its economy, given the importance of migratory, export,and financial links between the two countries.
5. Switzerland (BSI 1.6; 2016 Ranking: 5)Switzerland’s exposure to the U.K. is primarily via sizable FDI holdings and large financial sectorsubsidiaries and branches in the U.K. These entities book trading positions and engage inwholesale funding operations with U.K. counterparties. Compared with 2016, the Swiss financialsector’s claims (on an ultimate basis) on U.K. counterparties have declined by 14%, although thedownsizing of Swiss financial operations in the U.K. predates the Brexit referendum.Nevertheless, at an estimated 21.7% of GDP, Switzerland’s financial sector exposures to the U.K.remain the third highest after Spain and Luxembourg (compared with the second highest in 2016).Other links to the U.K. economy are more modest. Switzerland’s direct exports of goods andservices represent an estimated 2.3% of GDP versus the 3% median for the 21 economies on theBSI; bidirectional migration is minimal at 0.4% of the Swiss population compared with the 0.6%median.Although we did not include a currency risk channel in our metric, we note that the Swiss franc,along with all of the Nordic currencies, is vulnerable to flight-to-quality appreciation pressures inthe event of a no-deal Brexit, in our opinion.
6. Malta (BSI 1.6; 2016 Ranking: 2)Like Cyprus, Malta exports a substantial amount of tourism and business services to the U.K., andhas a large population of resident U.K. national pensioners. Malta’s financial claims on the U.K.are, moreover, larger than Cyprus’. However, excluding SPEs, Malta’s inward FDI into the U.K. isessentially zero.www.spglobal.com/ratingsdirectMarch 28, 2019 5Brexit Sensitivity Index 2019: Who Has The Most To Lose?
7. Spain (BSI 1.5; 2016 Ranking: 8)Of all the economies whose GDP exceeds €1 trillion, Spain stands out as the most exposed toBrexit. This is chiefly a consequence of Spanish banks’ ownership of large U.K. retail bankingfranchises. We measure the exposure of a country’s banking system to U.K. counterparties on aconsolidated, ultimate risk basis, using Bank of International Settlements (BIS) data. Using thismetric (which includes Spanish commercial bank subsidiaries’ balance-sheet exposures), Spain’sfinancial claims on the U.K. amount to 30% of Spanish GDP, the second highest after Luxembourg.Had we used a non-consolidated estimate of cross-border funding instead, Spain’s financialclaims on the U.K. would have been considerably lower.Most of Spain’s financial sector business in the U.K. comprises self-funded retail banking ratherthan wholesale and trading businesses, in contrast to those of Germany, Switzerland, France, andmost of the other economies in this survey, excluding Ireland. This, however, arguably makes itmore sensitive to any economic fallout from a no-deal Brexit, should that include prolongedweakness of the real economy, including the labor market.Given the large Spanish financial franchises in the U.K., as well as large investments in telecoms,insurance, and infrastructure concessions, Spain’s FDI exposure to the U.K. economy is alsosubstantial, at 4.7% of GDP. This is the highest of all economies in our BSI with GDPs larger than€1 trillion. We estimate that about one-sixth of Spain’s total outbound FDI is in the U.K., a figurethat has roughly doubled since 2006.Spain’s exports to the U.K. have increased, by an impressive 0.3% of its GDP, to 3.1% of GDP sincewe last published the BSI, and is higher than that of other large member states, includingGermany. However, it is considerably lower than the trade exposures of smaller more openeconomies like Ireland, the Netherlands, Cyprus, Malta, and Norway. Migratory flows betweenSpain and the U.K. are large in absolute terms but, at around 1%, are less important than thepercentage figures for Ireland, Cyprus, Malta, and the Baltics.8. Belgium (BSI 1.3; 2016 Ranking: 6)As a small open economy, Belgium’s BSI of 1.3 indicates relatively high exposure versus the 0.7median. Since 2016, Belgium’s export exposure to the U.K. has increased to 7.2% of GDP from6.8%. By comparison, its FDI claims on U.K. residents have declined to 3.8% of GDP from 5.6%,largely due to retrenchment from financial services and London. At the same time, it is noteworthythat, like Germany and Switzerland, the size of Belgian financial institutions’ risk exposures toU.K. counterparties has reduced considerably, although (also like Germany and Switzerland) thistrend of derisking predates the U.K. referendum.9. Norway (BSI 1.2; 2016 Ranking: 9)Norway’s relatively high 1.2 BSI measure comes down to its gas exports to Britain, which weexpect would not be affected by the U.K.’s departure from the EU. Norway is not a member of theEU, but is part of the European Free Trade Association.The other economies we assessed are either close to or below the BSI median of 0.71.www.spglobal.com/ratingsdirectMarch 28, 2019 6Brexit Sensitivity Index 2019: Who Has The Most To Lose?
The OthersWhile we think the Nordic currencies are vulnerable to further appreciation pressures should theU.K. leave the EU on April 12 without a formal deal, their trade, migratory, financial, and FDIexposures are average (Norway is the exception).For the Baltics, we anticipate that Latvia and Lithuania (Estonia less so) would be affected byBrexit via the large number of nationals working in and sending remittances from the U.K.(estimated by Eurostat at 0.6% of GDP for Latvia and 0.4% of GDP in 2017 for Lithuania). OtherBaltic exposures are negligible. No Baltic country is a net creditor, thus reducing the region’svulnerability to a currency or balance-of-payments shock connected to Brexit.The U.S. isn’t in the top 20 since the vastness of its economy means its U.K. exposures arerelatively small, though large in absolute terms. Canada’s only financial claims total an estimated7.2% of GDP (down from 10.5% in the 2016 BSI) versus 8.1% of GDP for the median.Portugal’s exports of goods and services to the U.K., at 3.2% of GDP, and bidirectional migratoryflows are larger than Spain’s. But Portuguese banks and private sector have little in the way ofclaims on the U.K. economy.What Our BSI RevealsOur index does not reflect the potential political and market aftershocks of Brexit. Rather, itdistills the current real and financial economic links to the U.K. economy, the world’s fifth largest,while also indicating which sovereigns might be more exposed to an unwinding of the U.K.’sstandout macro feature: its current account deficit of 5% of GDP.As a major provider of equity and debt financing to the U.K., the Euro area is also the largest singleinvestor in the U.K. Any change in the nature of the U.K.-EU relationship will have significantimplications for Europe, but an even larger effect on the U.K., the only current EU member that wehave not included in our BSI Survey.AppendixBSI = Exports of goods and services to the U.K./GDP + consolidated financial sector claims on theU.K. on an ultimate risk basis (BIS data, % of GDP) + Inward foreign direct investment in theU.K./GDP (ONS data, excluding FDI attributed to special purpose entities) + Bidirectional migrantsas a percentage of the population.- The population = a country’s nationals resident in the U.K. + U.K. nationals resident in thatcountry, divided by the country’s population (UN Department of Economic and Social Affairs(2015).- Sources: Trends in International Migrant Stock: Migrants by Destination and Origin (UNdatabase, POP/DB/MIG/Stock/Rev.2015; population data from Eurostat)].- SPEs have been netted against inward FDI data to remove third-party debt from equity.This report does not constitute a rating action.www.spglobal.com/ratingsdirectMarch 28, 2019 7Brexit Sensitivity Index 2019: Who Has The Most To Lose?