World Economy

Brexit May Impact MEA Sovereigns

Brexit May Impact MEA SovereignsBrexit May Impact MEA Sovereigns

Any immediate effects of the UK’s referendum vote to leave the EU on Middle East and Africa sovereigns appear limited, Fitch Ratings says.

Short-term effects could come via market volatility, while a slowdown in British and European growth could weigh on MEA economies at a time of already heightened strains (10 out of 29 rated sovereigns in the region are on Negative Outlook), Reuters quoted the Fitch Rating Agency as saying.

The most immediate channel of contagion from Brexit is via an increase in investor risk aversion, with the impact depending on the degree of integration into the global financial system.

South Africa, which tends to experience large investment outflows during periods of ‘risk-off’ sentiment, saw its currency depreciate by 8% in the immediate aftermath of the Brexit vote, although the rand subsequently regained some ground.

Broad-based risk aversion would make accessing international financial markets more difficult and costly, but movements in MEA sovereign bond yields have been limited and several Sub-Saharan issuers saw their eurobond yields drop to the lowest levels for the year in late June, Fitch said.

Again, this may be in anticipation of central banks in developed markets easing monetary policy (or delaying tightening), which could encourage capital flows into EMs.

The Brexit vote has also triggered an appreciation of the US dollar against most floating emerging market currencies, which will add to the debt and debt service burden of countries with significant USD-denominated debt on their balance sheets.

For countries with USD pegs (including the Persian Gulf Cooperation Council states) or linked/managed exchange rates (including Ethiopia, Egypt and Angola), it will mean some further appreciation of trade-weighted exchange rates and loss of competitiveness, potentially adding to macroeconomic imbalances.

While Saudi Arabia holds most of its reserve assets in USD-denominated assets, the smaller rich Persian Gulf states (Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman) are believed to hold significant amounts of British and EU assets.

However, the size of their estimated sovereign net foreign assets (more than 400% of GDP in Kuwait and around 200% of GDP in Abu Dhabi and Qatar), despite ongoing deficits, are sufficient for them to easily absorb any portfolio losses that could result from market volatility.

Of Fitch-rated MEA sovereigns covered by the IMF Direction of Trade statistics, the Seychelles has the largest exposure to the UK, with merchandise exports to the UK accounting for 6% of GDP (excluding tourism).

None of the other MEA sovereigns have a goods exports exposure greater than 1.5% of GDP. Effects via weaker growth in the eurozone could also be significant for Tunisia, where exports to the eurozone account for 21% of GDP, and Morocco (12%). Morocco, Tunisia and Egypt also have a significant exposure to the UK via tourism, although security incidents have already had a substantial negative effect for Tunisia and Egypt.

Many sovereigns in the region are heavily dependent on commodity exports. The Brexit impact on commodity prices has been contained, but a downturn in the UK and Europe could still affect demand and prices.