Economics & Markets

Remember Brexit? An important deadline looms for the UK’s economy

By Diana Mousina
Economist - Investment Strategy & Dynamic Markets Sydney Australia

The COVID-19 pandemic has overshadowed the progress of the Brexit negotiations, but a disorderly exit for the UK could send shockwaves through its economy.

The mid-year deadline to extend the transition period for the UK’s exit from the EU from 31 December 2020 is rapidly approaching. The transition period importantly allows for current trade arrangements to stay in place until December 31 this year, while negotiations are had. At this stage, progress on a free trade deal hasn’t occurred since mid-March

Brexit has been a complex issue, but economically, it’s clear what the important considerations are: if the UK doesn’t negotiate a trade deal that works in its favour, its economy is at risk of taking a big hit.

Recap: what Brexit is and where negotiations are at

Brexit is the decision for the UK to leave the European Union (EU), fundamentally changing its relationship on bloc trading, security and migration going forward. The referendum was voted by the UK national public in June 2016, with a narrow victory of 52% to 48% voting to depart the EU.

Whilst the UK formally left the EU on 31 January, for the time being trade between the UK and the EU will remain unchanged during the transition period until 31 December 2020. The UK will continue to follow EU rules and regulations to allow time for businesses to adapt to new trade agreements, which need to be set by the end of the year. Free trade between the UK and EU will come to an end if no deal has been agreed.

The transition period was designed to allow the UK and the EU to continue to discuss, aside from trade, other aspect of its future UK-EU relationship, such as EU access to UK waters; security co-operation; aviation matters; fishing territories; and governance issues.

The current free trade agreement allows UK goods to move around the EU without any checks or tax charges.

The mid-year deadline and why it’s important

The Withdrawal Agreement explicitly states an extension to the transition period can be only be allowed “once, for up to one-to-two years”. Any request to extend the deadline must be made before 1 July 2020, which is quickly approaching.

However, meaningful efforts to negotiate any terms of trade has been hampered by the UK and the EU government officials focusing all their resources to combating the COVID-19 pandemic in their respective territories.

Whilst European officials have already warned reaching an agreement before the deadline of 31 December 2020 remains a challenge, Prime Minister Boris Johnson remains adamant that the transition period would not be extended1.

Scenarios and economic risks

There are a number of scenarios that could occur in the lead up to both the July and December deadlines.

Firstly, the transition period could be extended for up to two years if no trade agreement can be agreed before December. However, the extension must be made before July and the EU would need to approve the extension.

Another scenario is if there is no extension to the transition period, the UK and EU can try negotiating a new trade deal between now and December 31. However, there are concerns there may be lack of time remaining to finalise a trade agreement, ready to be implemented by 1 January 2021.

The worst scenario would be no new trade deal is agreed to and the UK has a complete break from the EU. Europe is the UK’s most important export market and biggest source of foreign investment. Nearly 50% of UK exports that go to the EU would suddenly face higher tariffs, taxes, barriers to entry and border disruptions. In contrast, only 5% of EU exports enter the UK. So the UK has less bargaining power and more to lose in this situation coupled with the economic impact caused by the COVID-19 pandemic.

A silver lining for Australia?

From an Australian perspective, Brexit could potentially offer trading opportunities, given the UK wouldn’t be restricted to negotiating free trades arrangements with other countries. Whilst Australia only currently exports approximately 5% worth of trade to the UK, a stronger trade deal between the UK and Australia could further develop its trade and investment relationship by removing barriers to trade in goods and expanding its services linkages and investment. The UK is Australia’s eighth largest trade partner and the second-largest source of foreign investment in Australia.

Conclusion

Given the COVID-19-related economic disruptions to the UK and the EU and their ability to conduct meaningful discussions in the midst of a pandemic, an extension could assist with a more orderly exit. In its absence, negotiations can hopefully be struck by December 31, to avoid a huge shock to the UK’s economy.

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Article written by Diana Mousina

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