Britain will hold a referendum over whether to stay in or leave the EU on 23 June. Current polls point to a very close vote. Brexit is not our base case, but the probability we assign to it – 30% to 40% – makes it a material risk.
Analysis of the potential economic and political consequences for the UK is growing. At Citi, we conclude that while the precise economic impact will depend on many factors, including the future trade arrangement between the UK and the rest of the EU (EUx), its direction will be highly negative. We are particularly concerned about political uncertainty in the UK, including a possible disintegration of the UK into its more pro-European (Scotland, Wales, and Northern Ireland) and less pro-European parts.
Unfortunately for the rest of the EU, Brexit would not be a zero-sum game – nor would the economic and political losses be confined to the UK. The rest of the EU would also take a hit, even if we expect the economic impact to be milder than in the UK. UK trade is a far smaller share of GDP for the EUx than EUx trade is for the UK. The assessment of the potential economic and political fall-out from a British vote to ‘leave’ is likely to determine the negotiation strategies of both the UK and the rest of EU over a follow-on deal. We note that technically, there would be no negotiations about the terms of access (in all economic dimensions) of the UK to the rest of EU; the EUx would determine (according to the Treaty unilaterally) the future terms of access of the UK to the EU. The UK would, of course, set the terms of access of the rest of EU to the UK (in all its economic dimensions). The negotiations on future economic (and political) relations between the UK and the rest of EU would, however, likely be very asymmetric with negligible bargaining power for the UK – much less even than in the negotiations on the EU changes required to keep the UK in the EU. [...]
Conclusions
It is not our base case that the UK exits the EU. If it did happen, it could have serious economic and political consequences for the rest of the EU. The economic and financial frictions could be limited if both parties would try to strike an amicable separation agreement, but political considerations, including the desire of the rest of the EU to prevent Brexit emulation, might result in a far more damaging outcome, not just for the UK.
A loss in soft power for the rest of EU following Brexit would be near certain, in our view. Brexit would likely further boost (intra-national and inter-national) political fragmentation in the EU and raise the risk of further EU and Eurozone disintegration. Brexit could therefore have very severe political ramifications for the rest of the EU, even if the immediate economic effects remain modest. The EU without the UK would be an even more impaired regional and geo-political player than the current EU, which already punches far below its economic weight as regards regional and global diplomatic, strategic, security, and military matters. The step from soft power to no power could well be a small one.
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