Assessing Brexit risks in central and eastern Europe

With only around 5% of the central and eastern Europe (CEE) region’s services exports and 2% of goods exports going to the UK, the risk of the latter’s impending exit from the EU for CEE-based companies may seem limited on the face of it.

Even the impact of the UK leaving without a deal maintaining its commercial relationship with the bloc cannot be compared to that of a hypothetical economic crisis in Germany or Italy, which have far closer, more symbiotic links with CEE countries. Indeed, companies looking to relocate their operations from the UK to the EU are eyeing CEE, with its relatively low costs and skilled workforce.

Nonetheless, the potential shock to the European economy from a hard Brexit, disruption to international supply chains, and a reshaped EU budget in the wake of the affluent UK’s departure are all downsides for CEE companies to manage.

The UK is due to leave the EU on 29 March, under Article 50 of the union’s Lisbon Treaty. However, there is still considerable uncertainty about the process. Possible scenarios include a relatively smooth departure under a withdrawal agreement (WA) signed by the UK and the EU, a scenario that looks less likely after this week’s vote; a hard Brexit with minimal provision for continued trade on current terms; and a delay due to the UK rescinding or pushing back its Article 50 notice.

Support for a second referendum has gained traction in recent months, but this still seems an unlikely option. Even an exit under the terms of the WA would lead to uncertainty as the UK would enter a “transition period” lasting 21 months, which many analysts expect would be extended due to the complexity of trade negotiations.

If the UK leaves the Customs Union — which is the government’s long-term intention and would happen immediately in the case of a hard Brexit — goods and services could become subject to tariffs and rules of origin, increasing burdens on the finances of companies trading between central and eastern European EU member states and the UK. Delays at the UK/EU border would likely increase under this scenario.

“In our view, a slowdown of the euro zone would hurt the CEE growth to a greater extent than Brexit itself,” said regional bank Erste in a report issued on 24 October. The International Monetary Fund has said that a hard Brexit could knock up to 0.5% off EU gross domestic product. This would have a significant impact on central and eastern Europe, which consists largely of EU member states and nonmembers for which the EU is the overwhelmingly dominant trade and investment partner.

“When it comes to CEE companies, the risks are often directly tied to member state trade exposure and export, especially in some of the EU’s export-intensive economies,” said Luka Orešković, associate partner at consultancy and investment company Spitzberg, and an expert on CEE. “A ‘no-deal’ scenario would definitely exacerbate the aforementioned effects.”

While CEE exports to the UK are relatively small, companies in some sectors are at significant risk.

“Firms are increasingly having to take a careful look at what Brexit might mean for their operations, and the risks differ across different industries and countries,” according to a November 2018 ING Bank report.

“For exporters to the UK — direct and indirect — there might initially be a slowdown due to increased costs, and ‘relearning’ the import and export procedures,” said Zoran Stanković, group vice-president for finance at Croatian consumer goods company Atlantic Grupa. “However, in the midterm, the UK economy might slow down, and that would create a [further] slowdown on their exports. Importers from the UK — though there seem to be very few — will also have an initial slowdown, due to procedures and Customs, but in the midterm one shouldn’t expect any effect.”

Stanković suggested that in the run-up to Brexit the uncertainty could lead CEE businesses trading with the UK (and vice versa) to build up inventory, protecting the continuity of business, or to execute sales in larger volumes to take advantage of current Customs arrangements.

“On the face of it, whilst not welcome, even a fairly dramatic disruption of trade and financial wider relationships arising from a disorderly Brexit shouldn’t have a major impact on the CEE-EU economies,” said James Thornley, an independent consultant and former senior partner and head of audit at KPMG Serbia. “Having said this, there are potential impacts, and these shouldn’t be understated.”

These include disruption to EU-wide supply chains into which CEE member states have successfully become incorporated; the loss of EU development funding, to which the UK is a net contributor; and demographic changes due to the end of free movement of labour to and from the UK.

“CEE companies that want to be prepared for the fallout from Brexit will be looking at their supply and value chains in detail,” Thornley said. “Companies in the manufacturing sector may face disruption, and they will need to plan for this in terms of potentially extended timelines and the impact this may have on their working capital needs. They may also need to look at regulations — the impact here may be administrative rather than substantive, but time is money and this should be understood and assessed.”

On the financing side, Stanković noted that small and medium-size enterprises are less likely to be affected, as their financing is local and regional, and will be supported by the loose monetary policy of the European Central Bank (ECB). If Brexit leads to a euro-zone slowdown, the ECB may loosen further. However, given the importance of UK funds to the EU economy, changes should not be too significant, Stanković said.

He added that CEE companies linked to the UK should initiate hedging against sterling-euro volatility, consider the impact of rising costs, and take into account potential tax and operational optimisations.

“In terms of concrete steps CEE companies can take, I believe the following should be taken into account: supply chain analysis and tariff considerations; product compliance considerations, especially if the UK diverges from EU standards at some point post-Brexit; business contract (re)negotiations as a result of Brexit; and personnel status considerations, especially in terms of UK nationals,” said Orešković.

— Andrew MacDowall is a freelance writer based in France. To comment on this article or to suggest an idea for another article, contact Drew Adamek, an FM magazine senior editor, at Andrew.Adamek@aicpa-cima.com.