Brexit-hit Hungary Eyes Indian Corporates In U.K For Brexit Referendum

Impact of Brexit on UK economy

Describe about the Brexit-hit Hungary eyes Indian corporates in U.K for Brexit Referendum.

1. The Brexit referendum vote could not have come at a worse junction for UK. The economy was already underperforming and with the Brexit verdict, it is expected that the economy in all likelihood would slip into depression. This is indicated from the various macroeconomic data that has recently come in which reflects lower confidence on the part of manufacturers and service providers along with a negative GDP growth rate. In this regard, the various cyclical industries such as auto manufacturers, real estate companies and retailers have already hinted as difficult times ahead as the aggregate demand for various goods and services is expected to fall (Wearden & Fletcher, 2016). 

We are aware that GDP = C + G + I + NX

The consumption on part of consumers is expected to decline in the near future which is reflected from the consumer confidence which has already reached at a three year low. Further, in wake of lacklustre demand, new investments would not take place. Besides, there is a possibility of some industries shifting from UK to other EU countries for greater market access to EU countries. Meanwhile, the trade would also be negatively impacted as there would be higher trade barriers between EU and UK Collectively, it can be inferred from the above analysis that the UK economy is entering into a recessionary phase and is heading towards a trough (Koutsoyiannis, 2013).

It is imperative for the government to grant a stimulus to the economy so that aggregate demand may pick up and thus the output gap may be bridged. Firstly, incentives need to be provided to the existing business especially those owned by foreign investors. This is imperative as the European nations such as Hungary are making attempts to woo the businesses owned by foreigners particularly those that earn a big chunk of revenue from the EU (Bhattacherjee, 2016). In this regards, the exact etching of the exit treaty with the EU is also imperative which should to the extent possible allow for commerce to flourish in the region with minimal restrictions. Further, tax rebates and subsidies must be providing to the existing businesses so that they could weather the current crisis without much job cuts which would further lower the demand (Dombusch, Fischer & Startz, 2012).The cost saving of nearly £8.5 billion annually from Brexit (on account of non-contribution to EU) could provide ample funds to the government to provide fiscal stimulus. Besides, the government should also increase its spending in order to kick start the economy and increase the overall activity level (Lilico, 2016).

Measures to mitigate the effects

Secondly, the MPC also needs to further cut the interest rates from the existing levels so as to provide an economic stimulus to the economy. This would primarily happen in this manner. Due to cuts in the interest rate, the cost associated with loans would come down which in turn would lead to an increased demand in loan offtake. Due to the increased demand of loans, there would be an increase in the economic activity particularly in case of cyclical industries particularly automobiles and real estate. Slowly, as the consumer spending increases, the output gap would slowly bridge and hence the GDP growth would enter positive territory and the economy in turn would enter the recovery phase.  In case the lowering rates to zero levels does not show desired results, then even negative interest rates for short duration of time may be considered for providing impetus (McConnell, Brue & Flynn, 2014). This is not unlikely as is indicated from the notice sent by Natwest Bank whereby it is notifying its customers for a possible cost on their savings (Wallace & Morley, 2016).

It is imperative that the fiscal policy and monetary policy should work in tandem as for monetary policy to actually show results, there is a time lag. In this time, it is imperative for the government to make favourable announcements which generates positive sentiments amongst the households and also the businesses that the pain would essentially be short-lived. Also, the government in the short term should make attempts to bridge the gap between potential GDP and actual GDP by enhancing the government spending as the other components are unlikely to render much support in the short term (Koutsoyiannis, 2013). But gradually as the government fiscal support is provided along with an expansionary monetary, it is quite possible that recovery may not be too far.

2. Negative interest rates are symbolic of desperate measures on the part of the central bank to provide stimulus to the economy. It is a monetary policy tool which is deployed when even the zero interest rates are not able to provide the requisite stimulus to the economy. This refers to a situation when the nominal interest rates are negative and beats the theoretical lower limit of zero The impact of negative interest rate on the economy could be both positive and negative depending upon their precise usage by the policy makers (Dombusch, Fischer & Startz, 2012). The various effects of such a regime are briefly discussed below.

Positive effects of negative interest rates

The various positive effects of negative interest rate are highlighted below.

When the interest rates are negative, people are penalised for savings as parking their funds in the bank could entail a cost. Similarly, the commercial banks are also encouraged to lend to various commercial and retail borrowers and hence the intention on the part of the central bank is to increase the demand for loan and thereby provide a stimulus to the economy (CW, 2015). This would be accomplished through an increase in supply of loanable funds by the banks on one hand and reduction of savings by households on the other. Usually, such a regime if persists for long could give rise to high inflation and hence negative rates are usually introduced in economies which are in a deflationary trend or have almost zero inflation (Walker, 2016). In 2014, negative interest rates were introduced in a host of countries in Europe with the intention of providing economic stimulus by increasing demand. Further, the inflation rate in these nations was negative and this measure was taken to prevent the economy from entering into a deflationary spiral. This is because households would be willing to spend their money rather than save which would in turn increase the demand and stem the declining prices (Randow & Kennedy, 2016).

Another impact of the negative interest rate would be on the currency which would get devaluated. The devaluation of the currency would be caused due to the increase in demand of foreign currency against the home currency. This is primarily on two reasons. The foreign investors who are invested in debt would tend to liquidate their investments and would take their capital into a foreign country that offers positive interest rates. Besides, the local investors would also tend to invest their surplus money in foreign markets which would increase the demand for foreign currency. Additionally, the inflow of hot money into the economy would be curbed due to negative interest rate, thus effectively curbing the demand for the domestic currency even further. As a result of the above dynamics, the price of foreign currency would increase against the home currency (McConnell, Brue & Flynn, 2014). This would lead to depreciation of home currency. The negative interest rates have been successfully deployed by Switzerland (1970’s), Sweden (2009, 2010) and Denmark (2012) with the intention of stemming flow of hot money and curbing currency appreciation (Walker, 2016).

Economic stimulus

The negative interest rate tends to provide economic stimulus as has been explained above. Due to economic stimulus, the economy would grow at a faster pace and hence would lead to a higher output in the economy. This would enhance the demand for labour and would lead to a decrease in the unemployment (Dombusch, Fischer & Startz, 2012)/

The prevalence of negative interest rate regime for long term may also have some negative impact on the economy. Firstly, due to the negative interest rate, it is quite possible that the households may not park their surplus funds in banks as that would entail a cost. Instead, they could park their surplus funds in other asset classes or keep with themselves. As a result of this, there could be a run on the bank and as a result, the banks may face liquidity crisis which could defeat the objective of the central bank (Kane, 2016). Secondly, persistent negative interest rate may lead to a very high inflation and thereby effective guard needs to be maintained so as to ensure that it is used only for a limited period and must not be sustained for long. Thirdly, as explained above, negative interest rate leads to depreciation in the currency and hence in the long run may lead to currency wars especially amongst the export dependent economies which could try to devalue their currency so as to maintain cost competitiveness in exports (Das, 2016). It is therefore imperative to use negative interest rates only as an ad-hoc and last resort measure that too for a limited period of time till it serves its purpose (Koutsoyiannis, 2013).

References

Bhattacherjee, K 2016, Brexit-hit Hungary eyes Indian corporates in U.K, The Hindu, Available online from https://www.thehindu.com/news/national/brexithit-hungary-eyes-indian-corporates-in-uk/article8784623.ece (Accessed on July 27, 2016)

CW 2015, Why negative interest rates have arrived—and why they won’t save the global economy, Economist Website, Available online from https://www.economist.com/blogs/economist-explains/2015/02/economist-explains-15 (Accessed on July 27, 2016)

Das, S 2016, Opinion: Negative interest rates put the global economy on a razor’s edge, Market Watch Website, Available online from https://www.marketwatch.com/story/negative-interest-rates-put-the-global-economy-on-a-razors-edge-2016-03-29 (Accessed on July 27, 2016)

Dombusch, R, Fischer, S & Startz, R 2012.Macroeconomics, 10^th eds., McGraw Hill Publications, New York

Kane, C 2016, Here’s Why Negative Interest Rates Are More Dangerous Than You Think, Fortune Website, Available online from https://fortune.com/2016/03/14/negative-interest-rates-european-central-bank/ (Accessed on July 27, 2016)

Koutsoyiannis, A 2013. Modern Macroeconomics, 4^th eds., Palgrave McMillan, London

Lilico, A 2016, Why leaving the EU could actually be to our economic advantage, The Telegraph, Available online from https://www.telegraph.co.uk/news/2016/05/25/why-leaving-the-eu-could-actually-be-to-our-economic-advantage/ (Accessed on July 27, 2016)

McConnell, C, Brue, S & Flynn, S 2014. Macroeconomics: Principles, Problems, & Policies 20^th eds.. McGraw Hill/Irwin Publications, New York

Randow, J & Kennedy, S  2016, Negative Interest Rates, Bloomberg Website, Available online from https://www.bloomberg.com/quicktake/negative-interest-rates (Accessed on July 27, 2016)

Walker, A 2016, Why use negative interest rates?, BBC News Website, Available online from https://www.bbc.com/news/business-32284393 (Accessed on July 27, 2016)

Wallace, T & Morley, K 2016, Savers Fear Negative Interest Rates as Natwest warns businesses, The Telegraph, Available online from https://www.telegraph.co.uk/news/2016/07/25/savers-fear-negative-interest-rates-as-natwest-warns-businesses/ (Accessed on July 27, 2016)

Wearden, G & Fletcher, N 2016, Brexit vote hits confidence, hurts companies and weakens London housing market – as it happened, The Guardian, Available online from https://www.theguardian.com/business/live/2016/jul/28/uks-largest-estate-agent-warns-on-profits-as-brexit-hits-the-economy-business-live (Accessed on July 27, 2016)