Brexit and Japan

Britain’s vote last week to leave the European Union will not only affect Japanese firms that have invested in the country as a hub of their operations in the European market but adds to the uncertainty over global growth already rattled by slowdowns in emerging economies. World financial market jitters following the Thursday vote continue. Both the government and businesses need to remain on guard to stop repercussions of the Brexit vote from further damaging the prospects of Japan’s economy.

The Tokyo market was in a panic mode last Friday as it became clear that the British, despite indications of an opposite result just the previous day, voted after all to exit from the EU. The yen temporarily shot up through 100 to the dollar for the first time in 31 months and concern that the currency’s sharp rise would damage the earnings of major manufacturers led to an across-the-board plunge in share prices at the Tokyo Stock Exchange, where the nearly 1,300 point fall of the Nikkei average was the steepest one-day decline in roughly 16 years.

The TSE, which recovered some of the losses on Monday, ended nearly flat Tuesday as U.S. and European markets overnight continued to feel the weight of the Brexit vote, even as financial authorities have scrambled to ease market fears over its impact.

How the exit of the United Kingdom from the EU single market will affect Japanese firms invested in the U.K. may depend on the outcome of the exit negotiations, which will begin only after Britain chooses a new prime minister in September and are expected to take at least two years, and the shape of Britain’s economic relations with the continent that emerges from the talks.

According to Teikoku Databank, about 40 percent of the 1,380 Japanese firms that operate in Britain are in manufacturing. Automakers such as Toyota, Nissan and Honda export more than three-quarters of their vehicles built in their U.K. plants to the EU market — tariff-free as long as the U.K. remains within the single market. Former London Mayor Boris Johnson, who led the “leave” campaign within the Conservative Party and is now seen as an early favorite to replace David Cameron as prime minister, wrote that Britain could still maintain a free trade relationship with the EU and access to the single market. But if the exit talks prove otherwise, some of Japanese manufacturers may be forced to review their investments in Britain and shift some of their operations to the continent. The pending exit of Britain will likely complicate Japan’s talks with the EU for an economic partnership agreement, and the chances of concluding the EPA talks by the end of the year are now deemed low.

The larger impact of Brexit will be on the economy of Britain itself and the rest of the EU, which will no doubt add to the global uncertainties already triggered by the slowdown of emerging economies like China as well as doubts about a robust recovery in the United States. Britain, the second-largest EU economy, accounts for 16 percent of the bloc’s gross domestic product and roughly 10 percent of its population, raising fears that its exit will make the EU less attractive as a single market. Britain ships half of its exports to EU members while 40 percent of its imports come from the rest of the bloc, and it’s feared that Brexit’s impact on trade will drag down growth in both the U.K. and the EU.

How serious or how protracted the impact on trade will be may depend on the outcome of the exit talks. But the uncertainty in itself may deter new investments in either Britain or the rest of the EU. Japan’s economy may not escape the impact either.

The impact may also hit by way of the financial markets. The yen surged against the dollar in the Tokyo market as a safe currency in anticipation of confusion in European economies as a result of Britain’s exit. The prospect that the U.S. Federal Reserve will likely shelve its planned rate hike for the time being due to concern over the Brexit vote adds to the upward pressure on the yen. The continued reversal of the yen’s downward trend since late 2012, which aided the profits of major Japanese companies by inflating their export earnings in yen terms, adds to the uncertainties over the earnings of automakers and electronics firms, further clouding the prospect of Japan’s fragile growth in coming months.

Group of Seven finance ministers agreed to take steps to stabilize financial markets following the Brexit vote, and the government and the Bank of Japan have emphasized that Tokyo is ready to intervene in the market to halt the yen’s upsurge. But how much impact an intervention by Japan alone will have against such a market landscape over the long term remains unclear.

Efforts must be made to stop repercussions of the Brexit vote from turning into the source of another global recession, and Japan should play a major role in them.