Cyprus: Brexit?

The twenty-third of June 2016 is a watershed in recent British history, the day on which the electorate of the United Kingdom voted, by a majority of 52 per cent to 48 per cent, for their government to take steps to leave the European Union. The result of the referendum has variously been described as a new dawn for the UK, as an expression of protest against the government and its policies and as an act of economic and political self-harm, according to the commentator’s point of view.

Most people expected the result of the referendum to be a vote in favour of remaining in the EU and there has been turmoil in the markets and confusion and chaos in British domestic politics. As expected, the value of the British currency has declined in the immediate aftermath of the referendum result and investors have turned to safe havens such as gold and government securities. These are the classic textbook effects that any well-educated student of economics might have predicted. However, with the current political vacuum in the United Kingdom the longer-term effects are impossible to predict. Will the new government accept the result of the referendum when it is appointed or will there be some last-minute reconciliation between the UK and the EU? The referendum has uncovered such a depth of emotion and downright anger in the British people that it seems unthinkable that the government could ignore the outcome without provoking serious civil unrest, but the current state of confusion means that it will take years to effect the changes necessary to implement the decision.

Of course, the terms on which the United Kingdom leaves the EU are not within the sole control of the UK government: they are a matter for agreement between the UK on the one hand and the EU on the other, requiring negotiation with the EU Commission and unanimous approval by the EU Council. A great deal will depend on the attitudes of the various negotiating teams – will they take a consensual approach or an adversarial one? – and on the stance taken in the Council – will the aim be to drive a hard bargain in order to discourage any other countries from following the UK? Given all the complexities the final outcome is impossible to predict and nothing should be ruled out, including a dramatic last-minute reconciliation.

The overall economic effect is also impossible to predict. Assuming that a Brexit does take place, it could fall anywhere in the range from a soft landing to an extremely hard one. A hostile disengagement from the EU would translate into the erection of substantial trade barriers, pushing the UK to seek new alliances with countries that have hitherto been enemies, and to come to bilateral agreements with individual EU members on matters where they have autonomy. However, it is reasonably safe to predict that once the initial post-referendum volatility has gone, the downward pressure on the British pound will continue. Given the UK’s high reliance on imported fuels, raw materials, consumer goods and foodstuffs this will inevitably result in price increases and a return to inflation. The economic policy set by the government and the Bank of England will need to be finely calibrated in order to avoid recession and “stagflation” without creating a new credit bubble. Furthermore, the monetary policy tools at the Bank’s disposal are very limited, given the current historic low levels of interest rates and long term bond yields.

People in Cyprus naturally wonder how Brexit will affect the Cyprus economy. While there are some matters that can be predicted with reasonable assurance, the final balance between the positive and negative aspects cannot.

On the downside, credit rating agencies have assessed the Cyprus economy as being highly sensitive to a Brexit. The UK is Cyprus’s second largest export customer, accounting for around 8 per cent of exports. It is also Cyprus’s largest tourist market, accounting for 40 per cent of tourists visiting Cyprus. With the depreciation of the pound the price of these imports and tourist packages will increase. The natural corollary of this is a reduction in demand. Just how big this reduction will be will depend on a host of factors, including British government policy and the reactions of Cyprus’s competitors in the markets concerned.

On the other side, when difficulties emerge opportunities rise. Cyprus could be a viable alternative to the UK as a foothold in the EU. Its advantages include a legal and business environment based on common law and British procedures, a high quality of life and wide availability of English speaking staff. It has all the requisite business structures and a modern tax system, and its status as an EU member is in no doubt. It has adopted all the EU directives for investment businesses and has a robust regulatory regime.

For businesses without a base in the EU the uncertainty over Brexit effectively rules out the UK as a choice until matters are clearer. To choose a country that may not be in the EU within a few years as the base for a European presence would be very high-risk, to say the least. For businesses currently using the UK as a base for their European presence not enough is yet known in order to decide whether to stay or to go. However, if Brexit becomes a reality, UK financial services businesses may need a base in an EU member state in order to retain their ability to provide services in the EU. Cyprus is a potential home for such businesses. Furthermore, it has the benefit of a long-standing relationship with the UK through the Commonwealth and could work collaboratively with the UK to provide a mutually-beneficial alternative to other EU locations.  

For the time being, Britain remains a full EU member. Day-to-day business continues as before, and British citizens can move freely around Europe. The process of leaving the EU under Article 50 has not yet been triggered. And even when it is, two years of negotiations will lie ahead, no doubt followed by a lengthy transition period.  It is therefore unrealistic to expect an immediate exodus of business from the UK, to Cyprus or to anywhere else. Nevertheless, Cyprus needs to start thinking proactively and developing its strategy and the appropriate incentives now; otherwise it risks being left behind when the opportunities do come along.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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