BREXIT AND ITS IMPACT ON SRI LANKA

Contents

1. Introduction .................................................................................................................. 2
1.1. European Union..................................................................................................... 2
1.2. European Union and Britain .................................................................................. 2
2. Brexit ............................................................................................................................ 3
2.1. What is Brexit........................................................................................................ 3
2.2. Why Brexit was happening ................................................................................... 3
2.3. The Result ............................................................................................................. 3
2.4. Reasons for Staying............................................................................................... 3
2.5. Reasons for Leaving .............................................................................................. 4
3. International Trade ....................................................................................................... 4
3.1. Absolute Advantage Theory.................................................................................. 5
3.2. Comparative Advantage Theory ........................................................................... 5
3.3. Porters Diamond Model ....................................................................................... 5
4. Impact of Brexit on UK and EU ................................................................................... 6
4.1. Impact on UK ........................................................................................................ 6
4.2. Impact on EU ........................................................................................................ 7
4.3. Protectionism policies for UK ............................................................................... 7
5. Impact on other countries ............................................................................................. 8
6. Impact on Sri Lanka ..................................................................................................... 8
6.1. Impact on Trade .................................................................................................... 8
6.2. Impact on Tourism ................................................................................................ 9
6.3. Foreign Direct Investment ..................................................................................... 9
6.4. Remedies ............................................................................................................... 9
7. Conclusion .................................................................................................................. 11
8. References .................................................................................................................. 12
9. Bibliography ............................................................................................................... 13

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 1. Introduction

This assignment contains a brief analysis of Brexit and its pros and cons, opportunities,
threats, connected to International Trade for Sri Lanka.

1.1. European Union

The European Union is a unique economic and political union of 28 countries, which
operates as a single market place allowing free movement of goods, capital, services and
people between member states. The member countries of EU are as follows with a total
population of more than 500 million. (BBC, 2017)

Germany Denmark Sweden Slovakia

Netherlands UK Austria Hungary
Belgium Ireland Estonia Slovenia
Luxembourg Spain Latvia Cyprus
France Portugal Lithuania Croatia
Italy Greece Poland Romania
Malta Finland Czech Rep Bulgaria
The economy of the EU generates a GDP (nominal) of around 14.303 trillion according
to the International Monetary Fund.

Five years after World War II ended, France and Germany came up with a plan to ensure
their two countries would never go to war against each other again. As a result, a deal was
signed by six nations pooling their coal and steel resources namely European Coal and
Steel Community (ECSC) in 1950. Seven years later in 1957, The European Economic
Community (EEC) was formed by a treaty signed in Rome which is the foundations of
today's European Union. Belgium, France, Germany, Italy, Luxembourg and the
Netherlands signed up to this common market (EEC and ECSC). European Union was
established under its current name in 1993 following the Maastricht Treaty. Starting as a
trading bloc, now EUs interests include reducing regional inequalities, preserving the
environment, promoting human rights and investing in education and research.

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Key features of European Union are as follows.

1. Voluntarily and democratically agreed treaties by its member countries

2. A single European currency (Euro)
3. Abolition of border controls between EU countries
4. The single or 'internal' market

1.2. European Union and Britain

Eighty-six years ago, Winston Churchill described the relationship of Britain to Europe
as: We are with Europe, but not of it. We are linked but not combined. We are interested
and associated but not absorbed, which describes the central and enduring aspect of
British Euroscepticism. In 1946, he proposed a United State of Europe, involving French
and German leadership. After another attempt in 1961, Britain became a member of that
in 1973.

Britain has more than 40 years of relationship with EU, as a member of European
Economic Community. 1975, right after the two years of joining to the EEC, a
referendum was called over the membership, and 67% of people voted to stay in.

The EU, taken as a whole, is the UKs major trading partner. It accounts for 44% of
exports and 53% of imports of goods and services in 2015 in EU. Further, Britains net
financial contribution to the EU is 9.8 billion. The EU is a major source of inward
investment into the Britain. European Union found that the UK attracted more FDI
projects than any other European country in 2014 than 2015. Turning back to this great
partnership Britain had with EU, on 23 June 2016, Britain held a referendum asking
voters, and Should the UK remain a member of the EU, or leave the EU? Britain voted
to leave the EU mostly because of the unpopularity of unrestricted EU migration.
Negative views of free movement have been fuelled by misleading media stories and a
perceived mismatch between the British labor market and social security system, and
those of most other member-states.

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 2. Brexit

2.1. What is Brexit

Brexit is the term used to refer to the United Kingdoms decision to leave the European
Union (EU). It is a portmanteau of the words Britain and exit. The term was coined
by The Economist magazine in 2012. For the UK to leave the EU it has to invoke an
agreement called Article 50 of the Lisbon Treaty.

2.2. Why Brexit was happening

A referendum, a vote in which everyone (or nearly everyone) of voting age can take part,
was held on Thursday 23rd June 2016, to decide whether the UK should leave or remain
in the European Union. The mentioned referendum is being held as per a promise made
by Prime Minister David Cameron as part of his 2015 re-election campaign. It was
mainly because the growing calls from his own Conservative party MPs and the UK
Independence Party (UKIP). (Mohapatra, n.d.)

2.3. The Result

As the final result of the EU Referendum, UK voted to leave the EU by 52% to 48%. The
Leave campaign triumphed right across England and Wales.

2.4. Reasons for Staying

Prime Minister David Cameron including Sixteen members of his cabinet wants Britain to
stay in EU. Labour Party, SNP, Plaid Cymru and the Lib Dems are all in favour of staying
in while the Conservative Party has pledged to be neutral in the campaign.US president
Barack Obama as well as other EU nations such as France and Germany also wants
Britain to remain in the EU. The arguments of those who want to stay, are focused
narrowly on British self-interest. They see the situation as a basic economic necessity.

Around 40% of British trade happens with the EU. Leaving would have meant slower
economic growth, job losses, higher prices and potentially a recession for Britain. Staying
with EU will make selling goods to other EU countries easier. Membership in the EU
gives Britain the strength to negotiate favorable trade agreements with countries around
the world. Further, it will boost economic growth by attracting immigrants, whom are

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young and keen to work and helps pay for public services. Moreover, it will secure the
country as a part of a 28 nation club, rather than going alone as a single country. When it
comes to tackle threats to security, including terrorism and cross-border crime, the union
will better equip Britain. Also as part of a 500 million strong economy, Britain has a great
influence over foreign affairs. The small companies will get opportunities to grow
through the free trades within the EU. (BBC,2017)

2.5. Reasons for Leaving

About half of Conservative MPs, including five cabinet ministers, several Labour MPs
and the DUP are in favor of leaving. The British public are evenly split.

As per the voters who want to leave EU, Britain is held back by EU, by imposing too
many rules on business and charging billions of pounds a year in membership fees for
little in return. Leaving EU would give Britain control over its borders and free the
country through which can be reduced the number of people coming here to live and/or
work. This immigration crisis in Europe was a trigger for the Brexit. Some argued that
aiding the refugees was a moral obligation. But some saw immigration as a national issue
mainly EU opponents, as it affected the internal life of the country. UKs domestic
security would benefit more from greater border control than political union. In the
business aspect, The EU subjects Britain to slow and inflexible administration, making it
more prohibitive for smaller, more innovative companies. Further, it is argued that The
EU failed to address the economic problems that had been developing since 2008 in
Britain. For example, 20% unemployment in southern Europe was not well addressed past
years. Hence, it is for the betterment of UK to leave EU. (Swidlicki, Ruparel, Booth,
Howarth, & Persson, 2016)

3. International Trade

International trade is the exchange of goods and services between countries. It allows for
a greater competition and more competitive pricing. As a result of Brexit, UK would be
able to re-assume direct control of its external relations, including trade relations. Below
listed are some of the theories related to International Trade.

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 3.1. Absolute Advantage Theory

Absolute Advantage theory by Adam Smith states that fewer resources are needed to
produce the same amount of goods hence an economy can produce a good for lower cost
than another. For an example Sri Lanka has absolute advantage on Tea while Saudi
Arabia has absolute advantage on oil. Producing should happen for the goods which a
country has absolute advantage over. (Pettinger, 2012)

3.2. Comparative Advantage Theory

According to David Ricardo, a country has a comparative advantage if that country

produces a good at a lower opportunity cost than anyone else. It explains why a country
might produce and export something without producing it. It encourages free trade.
Countries should buy goods if they produce it less efficiently than other countries. For an
example, Sri Lanka has comparative advantage on tea over Kenya. (M, n.d.)

3.3. Porters Diamond Model

This model helps to understand the competitive position of a nation in global competition.
It suggests that that the national home base of an organization plays an important role in
the creation of advantages on a global scale. (Porters diamond of national advantage,
n.d.)

Porter's model includes 4 determinants of national advantage. The effect of one point
depends on other.

1. Factor Conditions: Specialized factors of production such as skilled labor and

technology can be created. These are relevant factors for competitiveness.
2. Related and supporting Industries: The success of a market also depends on the
presence of suppliers and related industries within a region.
3. Home Demand Conditions: When the home market is larger than foreign market,
local firms pay more attention on that
4. Firm Strategy, Structure and Rivalry: Local conditions affect firm strategy
which decides its position in the country.

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Figure 1: Porters Diamond of National Advantage

Source: www.toolshero.com

4. Impact of Brexit on UK and EU

4.1. Impact on UK

UK is a base for corporate HQs and a location for investment from Europe. With the
brexit, UK becomes less attractive as a gateway to Europe. UK has many advantages that
would be unaffected by Brexit such as language, light regulation and deep capital
markets. But UK may struggle to attract new investment following Brexit since other
locations inside the EU are likely to be more attractive for marginal investment decisions.
When it comes to the industry in UK, it always benefits from research collaboration in
Europe. While UK would gain flexibility over industrial policy outside the EU, through
Brexit, it would lose the benefits from scale and influence over policy in areas such as
energy. Being in EU allows free immigration within the region. Being disconnected from
EU will restrict the access to the required skills. The UK would be free to set its own
trade policy priorities. But with the experience they had with EU, it will not be much

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different from EUs. The impact of Brexit UK economy and wider British interests
would be severe across multiple channels. The new relationship between the UK and the
rest of the EU, would be also uncertain. (Booth & Scarpetta, 2017)

4.2. Impact on EU

The success of the UK in attracting Foreign Direct Investments (FDI) projects and jobs
creates opportunities and risks for other EU countries if the UK leaves the EU. One
precise challenge would be to attract European headquarters for multinationals away from
the UK. But this will depend as much on the business environment in individual
European countries. There are two ways which FDI can effect to the rest of EU. One is
distort location choices and draw investment away from the rest of Europe over time.
Other one is it could benefit firms elsewhere in the EU by putting pressure on their
governments to be more liberal and to take steps to improve the environment for
investment. On the financial aspect, The EU would lose a significant net contributor to
the EU budget. The direct impact on the rest of the EU would also be significant. The
export, supply chain, investment and policy interests of many large corporates would be
affected, but perhaps the single biggest impact will be on the cost of raising finance in
Europe which is likely to increase. However, all member states would feel the impact of
Brexit, both politically and economically.

4.3. Protectionism policies for UK

EU is UKs most significant trade partner. With UK leaving EU after the referendum,
European Union gives control over trade policy back to British officials. It will be
difficult for UK to create new domestic institutions and trade policies. On the
protectionist side, there are few initiatives UK can take in order to reduce the impact
caused by Brexit. (European, President, & direction, 2016)

Negotiating new trade treaties with countries like Australia, Canada, New
Zealand, and the United States.
Consider the possibility of trade negotiations with developing countries like China
and India. (Need to be careful since negotiations with these countries will lead to
objections from a range of groups)
Continuing as a member of the wider European Economic Area (EEA) as a
member of European Free Trade Area (EFTA)

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 Start planning trade and investment agreements, bilateral trade negotiations with
United States (Tariffs for EU-UK trade, Terms of the UK's membership of the
WTO World Trade Organization)
Trade agreement with the EU that reduces the import prices of protected goods
Negotiate in tarrifs controls
Negotiations with EU over protective barriers around manufacturing and
agriculture
Implement Import Taxs

5. Impact on other countries

Opening up the UK economy to trade with the rest of the is essential to economic growth
after Brexit. However, this would expose UK firms and workers to whole new levels of
competition from low-cost countries. Hence, it would be politically very sensitive.
However, there is likely to be a continued need for migrant labour to fill low-skilled jobs.
(Lester,2016)

6. Impact on Sri Lanka

The impact of Brexit on Sri Lanka can be identified in three main areas.

1. Trade
2. Tourism
3. Foreign Direct Investment

6.1.Impact on Trade

After the referendum, currency in the UK also experienced a shock as the British Pound
hit a decades low and lost over 10% of its value against the US Dollar. UK being a major
trade partner of Sri Lanka, its economy has an indirect impact on the economy of Sri
Lanka. Therefore, the government supported the UK remaining in the EU since the EU
provides major trade advantages. Currency depreciation will have a major impact on Sri
Lankas economy. Market volatility arising out of Brexit would affect sovereigns
dependent on external financing. The UK will no longer be part of the EU single market
and no trade concession, such as GSP plus, will be offered as a part of the EU policy. Sri
Lanka is looking to revive the GSP plus concessionary access to EU region. No longer

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will Sri Lanka be able to claim benefits from the UK in the event of successful
renegotiation of the GSP Plus. (Colombage, 2016)

UK is Sri Lankas second largest export destination. Nearly 10% of the exports are to
UK, while nearly 30% are to the EU. If the income of those markets fail, there can be a
reduction of exports to these important markets which have an impact on the Sri Lankan
Exports. Further, developments in the EU have a significant bearing on the Sri Lankan
economy. The depreciation of the euro coupled with the anticipated economic setback in
the Euro region will diminish the demand for Sri Lankas exports. Imports from EU to Sri
Lanka account for about 9 percent of total imports and imports from UK account for 2
percent. Given the depreciation of the euro and the pound, imports from Europe would be
cheaper unless the SL rupee weakens adequately to offset the effect.

6.2. Impact on Tourism

Brexit will affect the tourism industry a lot, since British citizens are the largest group of
tourists in the country. Moreover, lower income and the decline in the currency can cause
imported goods and foreign travels more expensive for locals. On the contrary, the
depreciation in their currencies makes outward tourism more expensive for the
Europeans.

6.3. Foreign Direct Investment

Brexit came at a time when Sri Lanka is under severe balance of payments pressures with
heavy external debt payments amid credit rating downgrades. The volatility in capital
markets and higher international interest rates caused by Brexit, owing to global
uncertainty could increase our cost of international borrowing. Hence, foreign borrowing
could be more difficult and expensive. (Colombage, 2016)

6.4. Remedies

Swap concessions on pricing

Swap concessions on pricing for a chance to set up better conditions for visas and
migrations. This will attract tourists and skilled work force to Sri Lanka. These types of
gives will smooth the path of great relationship. A Swap is where something is given in
return for a concession. This is a good negotiation practice. If you concede when you are
asked, rather than satisfying client, they will be asking more and more giving us new

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opportunities. In the travel sector can impose these kinds of swaps by giving discounts
and introducing promotions in order to attract people. Special travel packages / work
packages can be designed in a way which foreigners are attracted to the country. In order
to do that, a market survey should be conducted to get an idea on the expectations of an
individual and requirement of the countrys work force. (Iqbal,2016)

Diversify into several export markets

The Ceylon Chamber of Commerce states that the global economic downturn forecast by
the Brexit results proves the vulnerability of Sri Lankas economy to international market
forces. This was highlighted by PM Ranil Wickremesinghe earlier this year as he warned
British citizens in the iNews publication that pulling out of the largest trading bloc in the
world would affect over 80 countries that traded with the EU: We in Sri Lanka as well
as many other Asian countries cannot afford further financial turbulence and another
global economic downturn.

Scotlands leading exports include food and beverages, chemicals, engineering and
financial services but it also trades in textiles and renewable energy services. There is an
opportunity there for Sri Lanka to obtain another export market either through Scotland
being part of the EU via the GSP+ scheme or via its secession.

Managing exchange rates and interest rates

The Central Bank of Sri Lanka (CBSL) plays a key role on exchange rate policy, strategy
in capital account liberalization, and monetary policy operations. Central banks can allow
exchange rates and interest rates to be flexible and adjust it so that the negative impact
from Brexit can be minimized. Local demand is controlled by interest rates. For Sri
Lanka, the channels through which the impact of Brexit could transmit include reserve
revaluation, trade and tourism with the UK and EU, remittances and investment flows
from both and the policy responses to Brexit from other countries. If the economies of the
UK and the EU are going to slow down as a result of the vote for Brexit, the demand for
goods and services in this region will also be lower which means Sri Lankan exporters
would go through a tough time, with lower demand for their export products.
(Charles,2017)

Foreign Exchange Reserve

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By end-April 2016, the Sterling Pound reserve holdings of the CBSL amounted to about
10% of total foreign reserves, the third largest in the currency composition of reserve
assets. In reserve compilation, all foreign exchange assets are valued at mark-to-market
basis in US dollar terms. Accordingly, a sharp depreciation of the Sterling Pound against
the US dollar is likely to result in some valuation losses, which, in turn, would lead to a
decline in the external reserves of the country. The rule of thumb for holding reserves as a
consequence of the increasing of financial flows is known. Hence, banks can increase
their holdings of Euro dominated assets to reduce the impact over Eurozone crisis. (Ltd
W.N., 2016)

7. Conclusion

The Eurozone crisis or Brexit, was held on Thursday 23rd June 2016, to decide whether
the UK should leave or remain in the European Union. It was held as per a promise made
by Prime Minister David Cameron as part of his 2015 re-election campaign. This crisis
started lots of discussions around the world and created political debates around the
world. UK is the key player of this situation. With the brexit, UK becomes less attractive
as a gateway to Europe. UK has many advantages that would be unaffected by Brexit
such as language, light regulation and deep capital markets. But UK may struggle to
attract new investment. The new relationship between the UK and the rest of the EU,
would be also uncertain.

This crisis occurred in Europe can trigger balance of payment issues in Sri Lanka. Market
volatility would also affect sovereigns dependent in external financing. UKs vote to
leave the EU will not have a significant credit impact on Asia Pacific sovereigns. But
dependence on external finance poses vulnerability for some countries. However, the
United Kingdoms vote to leave the European Union will not have a significant credit
impact on Asia Pacific countries.

The impact of Brexit on Sri Lanka can be identified in three main areas. Trade, Tourism
and Foreign Direct Investment. UK being a major trade partner of the country, its
economy has an indirect impact on the economy of Sri Lanka. Currency depreciation will
have a major impact on Sri Lankas economy. Market volatility arising out of Brexit
would affect sovereigns dependent on external financing. Further, the depreciation of the
euro coupled with the anticipated economic setback in the Euro region will diminish the

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demand for Sri Lankas exports. The tourism industry, will be affected a lot, since British
citizens are the largest group of tourists in the country.

As a solution, Sri Lanka can take initiatives such as using swap concessions on price,
diversifying export market, managing interest rates and exchange rates and using foreign
exchange reserves.

8. References

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