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Brexit would risk 'reserve status of sterling': S&P


A decision by the U.K. to leave the European Union in the June 23 referendum could jeopardize the British pound's position as a reserve currency "and the associated benefits to the 'AAA' credit rating," S&P Global Ratings has warned.

In a note published by the ratings agency on Wednesday, it warned that if a "Brexit" should occur (if the U.K. leaves the EU) its creditworthiness could be damaged.

Reflecting the changing tides of global economic power, the world's reserve currency has been the dollar since the end of World War II. The first reserve currency, however, was the British pound and it was expected that the pound was "as good as gold" – that is, that the currency could readily be exchanged for a fixed amount of gold at any time.

Chris Ratcliffe/Bloomberg via Getty Images

Although the "gold standard" was gradually abandoned throughout the 20th century, the dominance of certain currencies that were widely held and could facilitate international trade (such as the dollar and sterling) remained.

Should the U.K. vote to leave the EU in June, however, that reserve currency status could be damaged, S&P warned.

"Sovereigns controlling a reserve currency benefit from extensive external and monetary flexibility, which supports government creditworthiness," S&P Global Ratings analyst Frank Gill said.

"A U.K. departure from the EU could put sterling's reserve status at risk by deterring foreign direct investment and other capital inflows into the U.K."

Because last year's current account deficit was the world's second-highest in absolute terms, any decline in capital inflows into sterling-denominated assets would most likely produce two effects, S&P warned.

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"First, it would weaken growth; and secondly, it would weaken the pound, possibly considerably, given that central bank reserve managers might prefer to reallocate toward assets with less headline risk than the pound."

Number crunching

With the U.K. referendum on EU membership less than a month away, the rival campaigns to promote leaving the EU or remaining have kicked into fifth gear this week.

Earlier this week the U.K. Treasury, under the aegis of Chancellor George Osborne who is campaigning for Britain to stay in the EU, published figures warning of a "year-long recession" and "immediate and profound" economic shock if Britain left the political bloc. On Wednesday, that view was compounded by the Institute for Fiscal Studies think tank which said an EU exit could add two years to austerity.

Campaigners in the "Leave" group dismissed such analysis, however, and believe that leaving the EU would free the U.K. of bureaucratic regulations from Brussels, would restore the U.K.'s control of immigration and that the U.K. would be able to sign trade deals freely with other nations.

The latest opinion polls show that the "Remain" vote is ahead in the polls but the U.K. public appears nervous about the possible effects of the vote on the currency, in particular, with currency experts reporting that people were rushing to buy travel money in case the pound falls in value after the vote.

S&P noted that reserve currency status benefits the U.K. "in two measurable ways."

"Via seigniorage receipts (seigniorage is the difference between the value of money and the cost to produce and distribute it) and by reducing the cost to the U.K. of servicing foreign public and private debt."

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S&P Global Ratings estimated that seigniorage receipts for the U.K. are between 0.2 percent and 0.6 percent of GDP per year and said that "under higher cost of capital assumptions, the U.K.'s current account deficit would have been considerably higher than the reported 5.2 percent of GDP last year."

The pound and dollar have other rivals too, in terms of reserve currency status. Competition from other currencies for reserve currency status (which it defined as currencies with at least a 3 percent share of global foreign exchange reserves) is on the rise, S&P noted.

"The combined holdings of the Australian and Canadian dollars have increased from close to zero a decade ago to 3.8 percent as of end-2015. The importance of China to global trade will, in our view, gradually lead to the rise of the yuan in reserve holdings," S&P noted.

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