Fitch: Brexit has no direct APAC sovereigns, bank ratings impact

The UK’s vote to leave the European Union ‘Brexit’ has no immediate direct ratings impact on Asia Pacific (APAC) sovereigns or banks, says Fitch Ratings.

The spike in political uncertainty in the UK and resulting effects on investor risk appetite could pose the greatest challenges for Asia in the short term. If protracted uncertainty has a sustained effect on investor and consumer confidence, the resulting tightened liquidity conditions and pressure on emerging markets capital markets could weigh on growth in the region. This is especially the case for more trade integrated economies such as Singapore, Taiwan, Hong Kong and Korea.

But it remains far from clear that such a sustained market reaction will develop. Some of the negative “risk off” market moves that occurred in the immediate aftermath of the Brexit vote have already been partly unwound this week. Furthermore, Asian market reaction has been far more muted than in Europe.

The potential for developed market central banks to act, namely the Fed slowing the pace of its rate increases, could also play a key role in calming markets.

The one outlier is Japan, where the immediate flight to safety saw the yen spike upward versus the US dollar and other major Asian currencies. This will add to the short term challenges for Japan to escape deflation as well as raise risks to the export sector.

The direct impact from UK trade on Asian economies is also likely to be limited. The UK is the world’s fifth largest economy, and Fitch expects a slowdown in short term GDP growth as a result of the referendum. But exports to the UK equate to less than 1% of GDP and account for less than 3.5% of total exports for every Asian country. Over the long term, it is also possible that a UK outside the EU may be able to make quicker progress on trade liberalisation with Asian countries than as a member of the EU.

Only Korea currently has a free trade agreement with the EU among Fitch rated APAC countries (some smaller Pacific island economies also have agreements).

The direct financial linkages are limited as well, and so the risks are more indirect with respect to Asia’s banking systems. But emerging Asia accounts for less than 15% of the total external claims of UK banks, according to BIS data. Singapore and Hong Kong, as offshore financial centres, are more significantly exposed relative to the size of their economies, but these are mainly local/regional claims from UK subsidiaries and unlikely to see significant withdrawal as a result of Brexit.

Indirect trade effects should the Brexit vote lead to wider political instability and a broader slowdown in Europe could be more significant for Asia, with the EU as a whole accounting for a much larger share of Asian exports than the UK alone. But the effects should take time to materialise, and Fitch believes that it is the smaller economies in Europe that are most at risk from Brexit as opposed to the larger economies such as Germany and France which account for the bulk of Asian exports.

Fitch maintains its base case for APAC sovereigns and banks. Emerging Asia will remain the fastest growing global region. Rising political uncertainty in Europe may lead to some downward revisions to regional growth projections, depending on how serious this turns out to be. However, China is likely to remain a much more significant driver of economic outcomes in APAC than Brexit, while risks from tightening US monetary policy also remain a key challenge.