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Brexit: implications for international food and drink businesses

What should food and drink businesses operating internationally consider post-Brexit?

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UK referendum outcome

On 23rd June 2016, a referendum asked UK voters whether their country should remain a part of the European Union (EU) or leave.

The final outcome was 52% in favour of leaving the EU, versus 48% in favour of remaining. In UK law referenda are considered to be advisory only, but the government has indicated that it will give effect to the result.

This turn of events was a surprise to many – all the major UK political parties backed EU membership and, in the days before the referendum, most polls suggested a narrow win for the “remain” faction.

A lack of historical precedent, an absence of clear plans for “Brexit” and concern over possible “domino effects” has triggered significant fluctuations in global currency and equity values.

Impacts of sterling weakness

The value of sterling declined slowly in the run-up to the referendum, with a further sharp drop immediately after. As of 1st August, sterling has fallen 13% versus the euro and 11% versus the US dollar compared with the start of the year. (The euro, meanwhile has gained slightly against the dollar, possibly because at least some uncertainty about the future has now been resolved). 

With sterling now at historic lows, items imported to the UK have become significantly more expensive over a very short period, even where specification and availability are unchanged. This includes items imported by food and drink businesses – not just goods for resale, but all of the other things needed to sustain operations (e.g.: packaging, capital goods, spare parts and professional services).

The food and drink market in the UK is intensely price-competitive and businesses will be reluctant to pass cost increases down the supply chain but, with margins slim, the ability to absorb cost increases may be limited. Impacts on profitability for food and drink importers are the likely outcome. Given that the UK accounts for about 20% of the entire Western European market for these goods, the impact on international businesses could be profound1

This may not happen immediately – businesses are, hopefully, protected from currency volatility by hedging arrangements and pricing may be fixed by previous agreements, so there is time to prepare. However, all hedging arrangements have limited lives and agreements eventually run their course, so the impact of sterling weakness on imported food and drink is in the UK likely to be inflationary in the mid to long-term.

This, in turn, may provoke product switching/substitution behaviours, as end users in the UK seek cheaper, more competitive, domestically-produced alternatives. Product switching may extend into other markets, because currency change will also make UK exports more competitive.

The pursuit of competitiveness often causes governments to devalue their currencies artificially, especially in times of economic difficulty – the effect can be so decisive that it causes retaliatory devaluations. In this case, the UK may have gained a benefit through natural “market” forces, but this does not necessarily preclude compensatory devaluations by other governments. Fortunately, global prices for many food and drink products are currently low, well below the highs seen in 2007-09 and retail prices are declining. This may mitigate currency effects for now.

Is weakness strength? 

The effects of sterling weakness for international food and drink businesses may go beyond price changes. Any sterling-denominated income (e.g.: profits from the UK operations of an international retailer) will also be worth less when converted back into the “home” currency. Furthermore, sterling weakness means that exports from the UK become more competitive in international markets. This may help to offset the cost disadvantages that the UK has in some areas (e.g.: meat production). Putting it another way, the abrupt shift in the value of sterling means that the UK now has the potential to export deflation and import inflation in food and drink. In this way, pressure on pricing and profitability may spread well beyond the UK.

This is one reason why some countries attempt to artificially devalue their currencies during periods of economic hardship, a policy that can become competitive, as countries vie with one another for trading advantage.

The latest shift in the value of sterling may give the UK a decisive trading “edge”, which will be hard for other countries to match, at least those countries within the euro area where individual action is impossible.

Off-setting currency effects

Future currency movements are hard to predict but, with Brexit being just one of a number of international stressors, further currency volatility seems likely.

Businesses may offset the impact of currency fluctuation through hedging. A range of options are available, depending on the appetite for risk and cost:

Source: AIB, July 2016 (reproduced with kind permission)

Generally, reducing risk involves greater cost and so businesses may prefer to combine a range of currency options.

Smart planning may also help to manage risk and so food and drink businesses operating internationally should consider:

  • What currencies should products be priced in?
  • What impacts will currency changes have on input costs or competitiveness of outputs?
  • What is their tolerance for risk and what hedging strategies suit them best?

Longer-term changes

An EU member state is allowed two years to negotiate exit, from the moment that it declares its intention – the referendum does not provide notification. In the meantime, the UK will remain a member of the EU, fully integrated into the single market …but with a more favourable currency position.

In time, currency volatility may ease as the UK’s strategic and economic position becomes clearer, but other uncertainties may take longer to resolve. Food and drink businesses operating internationally need to consider:

  • Constitutional change
    The referendum may trigger constitutional change in the UK and the consequences may go further – other nations also have anti-EU movements. These have gained inspiration from the UK; demands for further referenda have strengthened2. The structural integrity of the EU itself is, therefore, also potentially threatened by the departure of the UK.

    The opposite may occur, however, if the UK is seen to suffer as a result of Brexit – European national elections may give some indication of changing sentiment.
     
  • Credit markets 
    This factor could be critical to both businesses and shoppers. Base interest rates in most markets are low and monetary policy is loose. 
    This may be expected to continue with central banks keen to support demand, but retail interest rates offered to commercial and private borrowers may rise, to compensate for increasing risk.

    This would be damaging to those with large outstanding debts and it may also give businesses a reason to delay necessary investments or at least set higher ROI thresholds.

    The cost of trade credit insurance may also rise following the referendum - this could leave vendors with some interesting decisions to make (e.g.: pay extra for insurance or do without it and hope for the best).
     
  • Free movement
    This is one of the central principles of the EU common market, but it has been questioned in recent years due to geopolitical events. Some powers within the EU (and also Switzerland) are pressing for greater limits on movement, whilst seeking to retain free market access.

    The future performance of many European businesses will be determined by the final resolution of this issue - if any.
     
  • Trade terms 
    Many EU grocery businesses have an interest in continued trading between a post-Brexit UK and the remaining EU countries, whether they are buyers or vendors. 
    The ideal, perhaps, would be for free trade to continue post-Brexit, although this would require considerable concessions on both sides3.

    Other trading arrangements between the UK and EU are possible, but all would involve a lower level of freedom and, possibly greater cost or complexity, which might inhibit trade and drive up prices.

    Trading relationships beyond the EU will also be affected by Brexit. As an EU member, the UK negotiated jointly with the others and benefited from any special deals that were achieved. Outside the EU, the UK will need to seek new trading deals with third party countries, or else default to WTO terms4.

    In the uncertainty and confusion that may follow Brexit the negotiation of new trade deals between the EU and other nations may be affected, especially if the global economic situation remains difficult.

    Taking a downbeat view, it is possible that the principle of free trade may fall from favour if champions such as the EU are materially weakened – rising protectionism has been noted in previous periods of upheaval, despite the mutually-destructive results. On the other hand, free trade has been the norm in Europe and a goal for other regions for many years and it may take more than Brexit to dislodge this norm – trade is, after all, proven to create sustainable economic benefits for all concerned.

Clearly, the referendum has not yet delivered certainty, either for international businesses or for their shoppers – the long term impacts of UK exit from the EU will play out slowly and, good or bad, they will be profound.


 

Notes and sources

1 Data Centre, Retail Analysis, IGD; data is for 2016
2 National Front leader Marine Le Pen has promised a referendum in France, if elected in Spring 2017
3 On 28th June, French President Francois Hollande indicated that the UK cannot remain in the single market without accepting free movement of people
4 A good example would be the Comprehensive Economic & Trade Agreement (CETA) between Canada and the EU

Free report - Referendum 2016: possible outcomes for UK grocery businesses

Referendum 2016: possible outcomes for UK grocery businesses

Following a referendum on 23 June 2016, the UK has voted to leave the European Union

In the wake of this decision, we examine the key issues for grocery businesses and explore different scenarios and possible outcomes you should consider.

To download 'Referendum 2016: possible outcomes for UK grocery businesses' simply click on the link below and complete your details. 

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