UK Edition
Brexit might trigger run on Britain's record financial debts, S&P warns
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-barrelled downgrade if the country takes a leap in dark, jeopardizing its trading and financial ties to its biggest market.
“We are categorical about this,” said Moritz Kraemer, the agency’s head of sovereign ratings.
“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 told The Daily Telegraph.
Mr 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 5pc of GDP – the highest in Britain’s peace-time history.
The level of debt coming due over the next 12 months is 755pc of the country’s external receipts, the highest for all 131 sovereign states rated by S&P. This compares to 318pc for the US and 316pc 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 Mid-East institutions. In theory, the liabilities are matched by assets and therefore simply ‘net out’ if stress forces banks to shrink their operations, but crises have a nasty habit of revealing skeletons in the cupboard.
“If there is no currency and maturity mismatch, then there is no big issue. But we don’t know that for sure,” Mr Kraemer said.
“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.
Mr 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 centres. Data from the Bank of England shows that a net £65bn 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 Mr Kraemer.
“To lose a member state for the first time raises serious questions about the ‘franchise value’ of the EU and the stability of the undertaking. Once virginity is lost, you can’t get it back,” he said.
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 EMU states, setting off another spasm of the eurozone crisis.
Mr 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.
France and Germany are expected to issue a joint declaration the day after any vote to leave, vowing to forge ahead with closer integration. But pious rhetoric does not address deep rifts along multiple lines of cleavage within the EU, and is at odds with the recent surge in euroscepticism across the Continent.
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 $58bn, far too little to cover its complex web of liabilities through a plethora of bodies. The agency warned that the ‘Juncker Plan’ for $315bn 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.
Mr 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.
The view in some capitals is that Britain could be kept in the EU even after a Brexit vote. The calculation is that there will have to be another referendum once UK voters discover that the terms of any deal are not what they expected, and the second time they will ‘get it right’.
If this proves to be wishful thinking, the rest of the EU will claw its way to some form of modus vivendi with Westminster. “Most countries want to find a solution even after Brexit, and Berlin in particular is a little more friendly,” he said.
“But they will not want to give the Britain a sweetheart deal and there are some countries that want to play hardball. Whatever happens, it is not going to be pretty,” he said.