British conundrum for carmakers

Remain or leave? This is the core of the Brexit debate where voting began on Thursday and the results will be out today.

From the auto sector’s point of view, this becomes especially critical for leading players like Jaguar Land Rover and Nissan as reported in these pages last week.

There are three potential impact zones as a result of Brexit. In Scenario 1 where ‘Everything stays the same’, the UK needs to follow EU economic standards and directives; trade with EU member states stays tariff-free; free trade agreements (FTAs) with overseas countries will continue; and the UK needs to contribute to the overall European budget.

In Scenario 2 which is ‘Leave with FTA’, traded goods to the EU need to be standardised; the UK regains full sovereignty over regulations; an FTA with the EU will be negotiated within five years after the referendum; and a potential FTA with the US might happen in the short-term.

‘Leave with WTO’ is the core of Scenario 3 where no standardised goods are traded to foreign countries; there is no tariff-free trade with EU member States with an additional risk of increasing non-tariff barriers; the UK regains full sovereignty over regulations; negotiations on post-exit arrangements could be more difficult; and reaching a FTA deal with the US could take longer than in the FTA scenario.

If Brexit does happen, it will impact UK light vehicle sales in the near term. Sales in the FTA scenario are expected to recover much faster than one in the WTO when uncertainty starts to diminish. In the WTO setting, however, sales would be significantly lower even in the long-term.

The downside scenario for light vehicles assumes that sales are likely to be affected by two factors:

* Total UK GDP is expected to be lower under the FTA and WTO scenarios than if the UK remains in the EU. A weaker economic development could have a dampening effect on registrations.

* Investment/consumption is reduced because of uncertainty about post-exit arrangements.

Likewise, for car sales, the downside assumptions are:

* In the short-term (2017-2019), registrations could be between one lakh and 3.2 lakh units lower depending on the exit scenario.

* In the FTA scenario, sales are mostly affected by post-exit uncertainty which should be resolved within five years of the referendum. As soon as uncertainty diminishes, car sales are expected to return to normal level.

And, finally, in the case of light commercial vehicles, they include the following assumptions:

* LCVs are investment goods. Demand is closely connected to the economic development which is assumed to be weaker under both scenarios.

* Again, increased uncertainty could lead to an increased cost of capital that could reduce business investment.

* In the WTO scenario, an assumed increase in tariffs and non-tariff barriers hampers the economy which leads to lower sales in long-term.

While both scenarios might see the same impact in the short-term; long-term projections prefer the FTA scenario if the referendum votes for an exit. Assembly is expected to be influenced negatively by any Brexit scenario. However, the FTA scenario should be less inhibiting than the WTO agreement for the UK’s light vehicle production.

The interdependency between the UK and EU on vehicle assembly only drives home the importance and potential impact of the Brexit referendum. The impact on European producers is expected to be higher than for UK-based brands.

Assembly is forecasted to see its lowest point in 2021 leading to an excess capacity of 0.63 million units due to long-term effects of the Brexit negotiations and uncertainty. Accordingly, capacity utilisation is expected to decrease to 74 per cent until 2022, highlighting the divergence between demand and supply in the UK light vehicle assembly market.

By the end of the day, carmakers will hope for a happy ending where Britain continues to be part of the EU. Anything to the contrary could just end up complicating matters.

The writer is Partner, Price Waterhouse

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