Britain is the world’s most vulnerable state on a key measure of short-term debt and credit markets might suddenly seize up if voters opt for Brexit, Standard & Poor’s has warned.
The US credit rating agency is crystal clear that Britain will be stripped of its coveted AAA status immediately and may face a double-barreled downgrade if the country takes a leap in the dark, jeopardizing its trading and financial ties to its biggest market, Telegraph online reported.
“We are categorical about this,” Moritz Kraemer, the agency’s head of sovereign ratings, told the Telegraph.
“There is no clear ‘Plan B’ in the UK and we are not going to wait until we find out what the British position actually is. We could potentially see a two-notch downgrade,” he said.
Kraemer said the British financial system is extremely dependent on external financing. This is the Achilles Heel for an economy that relies so heavily on the City of London, and has a current account deficit above 5% of GDP—the highest in Britain’s peace-time history.
The level of debt coming due over the next 12 months is 755% of the country’s external receipts, the highest for all 131 sovereign states rated by S&P. This compares to 318% for the US and 316% for France, the next two states most exposed.
Much of this short-term debt is owed by banks operating in the city, some of them American, Japanese, European, or Mideast institutions.
“These sums are very large and have to be rolled over constantly. Nobody has ever hesitated in the past because it was always assumed that Britain is a safe haven and there is no risk,” he said.
Capital Flight
Kraemer said any storm is likely to blow over but there could be a dramatic impact if capital flight suddenly picks up or large sums switch from London to Dublin or other financial centers. Data from the Bank of England shows that a net £65 billion ($93.73 billion) left the country in March and April, the highest since the global financial crisis.
“Creditors might decide to rebalance their portfolios until the dust settles. All it takes is a little less money coming in, and a little moving somewhere else, and the implications could be large,” he said.
Standard & Poor’s also warned that the EU itself is at risk if Britain pulls out, a consequence that has been widely ignored. “The EU as an issuer of debt would lose one of its biggest contributors,” said Kraemer.
Europe’s Fragility
This question of Europe’s own fragility is rapidly becoming a hot issue as policy-makers in Brussels and EU capitals belatedly wake up to the shattering implications of Brexit. City veterans say one risk is that global investors would take a closer look at the debt sustainability of the weaker Economic and Monetary Union states, setting off another spasm of the eurozone crisis.
Kraemer doubts the EU itself would fracture, though stronger countries may be tempted to follow the UK out of the door. “We think the remaining Europeans would close ranks. The scenario that the EU would unravel has no credibility,” he said.
The Friends of Europe think tank in Brussels said this week that the EU may have to be dissolved and rebuilt on radically different foundations if Brexit goes ahead, a suggestion that raises serious headaches for rating agencies.
S&P currently rates the EU at AA+ with a negative outlook. It said the EU’s assets are just $58 billion, far too little to cover its complex web of liabilities through a plethora of bodies. The agency warned that the ‘Juncker Plan’ for $315 billion of investment projects contains “first lost” provisions that could effectively lead to a 20-day margin call on losses.
“This would significantly increase the EU’s off-balance sheet exposures over the short term, backing projects that target a higher risk profile. We see this as a marked increase in the EU’s contingent liabilities,” it said.
Kraemer doubts whether Britain’s rating would slip by more than two notches. “We think the UK has effective institutions and great intrinsic strength. It has its own currency and total monetary control, and can print its own reserves,” he said.
