COMMENT The UK has defied expectations from opinion polls and bookmakers and voted to leave the European Union (EU). Apart from the inevitable plunge in the pound sterling (GBP) and drop in appetite for risk assets, we highlight the economic implications for Penang and Malaysia in four areas:

First, the UK economy is likely to head into a short term recession due to the loss in confidence and the uncertainty surrounding the process of exiting. However, with the GBP sharply lower and with the Bank of England providing stimulus, the negative impact will be mitigated.

Although the UK and Malaysia have long trading relationship, bilateral trade between the two countries have not been large recently. According to the Department of Statistics, exports to the UK ranges between RM10.5 billion (2004) to RM9.3 billion (2015); whilst imports from the UK ranges between RM6.6 billion (2004) to RM7.1 billion (2015).

Thus, trade balance of RM3.9 billion (2004) to RM2.2 billion (2015) has been in Malaysia’s favour. Collectively, the UK’s trade with Malaysia ranges between 3.6 and 8.8 percent of Malaysia’s total trade.

For Penang and in the year up to November 2014, exports to the UK was RM156 million versus imports of RM88 million, thus, generating positive balance of trade of RM68 million in Penang’s favour. Therefore, whilst the UK is an important trading partner, it is not the dominant one.

Besides, inwards foreign direct investments (FDI) from the UK in the manufacturing sector in Malaysia has not been extensive. For example, according to MIDA, FDI from the UK into Penang was only RM389,280 out of RM 5.1 billion in 2014. Likewise, the FDI into Malaysia was between RM15.4 billion (2008) to RM20 billion (2014). This amounts to 4.2 to 6.1 percent of Malaysia’ total FDI.

However, Malaysia’s direct investment in the UK is higher and has been rising steadily since 2008. For example, direct investment in the UK was RM 8.2 billion (2008) and has risen to RM21.3 billion (2014). Malaysia’s direct investment has also generated publicity, in particular in the properties sector. For example, SP Setia and EPF have been leading a multi-billion pounds redevelopment of Battersea Power Plant in London.

Therefore, the trade and investment impact to Penang and Malaysia from Brexit is likely to be indirect, via the fall in confidence in the global economy which affects crude oil prices and appetite for risk assets such as Malaysian equities and bonds.

Secondly, the impact on Malaysian households should be generally positive. For most Malaysians, a holiday to the UK would be more affordable. However, due to strong education and investment links (as we have seen in the popularity of the Battersea power station redevelopment amongst Malaysians households), some households and institutions will be affected through the fall in GBP.

Helping affordability of education costs

On the other hand, there are thousands of Malaysians studying in the UK, hence a weaker GBP would help the affordability of their education costs.

Thirdly, as part of diversification, several Government Linked Investment Companies and EPF have invested in the UK, predominantly in London properties. With the desirability of London as an international city potentially affected by Brexit, there could be risk of property prices falling. Therefore, the impact on these institutions might be compounded as GBP has depreciated as well.

Lastly, Brexit would have broader political and strategic implications, with the most obvious being the European project and the rise in nationalist sentiment among some EU members. Other countries or sub-states such as Catalonia will face pressure to follow the UK vote (or re-join the EU as could be the case for Scotland). Some Dutch politicians have already called for a Dutch referendum.

However, exit would be much more complicated for those that are members of the Eurozone. Whilst the result might not be immediate, but if the UK fares well outside the EU then other countries might be tempted to follow. This will create lingering uncertainty globally.

In conclusion, the economic consequences of Brexit are likely to be indirect through aversion to risk assets or reduction in confidence. However, the depreciation of GBP might affect Malaysian investors in the UK. The wider impact is likely on the political aspect of the EU project.

This statement is signed by DR LIM KIM-HWA, chief executive officer and head of economics; TIM NIKLAS SCHOEPP, chief operating officer; DR LIM CHEE HAN, senior analyst; DR NEGIN VAGHEFI, senior analyst; and ONG WOOI LENG, senior analyst of the Penang Institute.