For U.S. Dairy, More Questions Than Answers in UK Exit From EU

Historic vote is just the beginning of an unclear and unprecedented process that will reshape global trade links for U.S. dairy exports.

Britain’s vote last week to leave the European Union has so far roiled global financial and currency markets, and left a lengthy list of questions on how the split will be executed.

There are many dimensions to this development, and many nuances to the long-term implications for dairy trade. The immediate impact is likely to be relatively small, with global dairy supply-demand and pricing dynamics playing a much larger role, as they have traditionally.

The most immediate impact for U.S. Dairy Export Council members is around currency rates, with a decline in the Euro allowing European suppliers to establish lower prices in U.S. dollar terms. U.S. and Oceania competitors will need to meet those dollar-denominated prices to be competitive. It also means lower intervention prices in U.S.-dollar terms. Furthermore, weakness in the Chinese yuan and other currencies raises import costs, possibly impacting already strained import growth.

This comes as we had begun to see signs of small but significant price improvement in the global dairy markets – not recovery, but improvement. The fundamentals of an oversupplied global market still ring true, and this latest development is making sustainable price and market recovery all the more challenging.

In addition to currency rates, here are early thoughts on the issues and watch-outs for U.S. dairy exporters and the global trade system.

Timing and practical issues:

• Sift through the noise and you’ll be reminded that the United Kingdom is still a member of the European Union and as such all the previous rules and conditions still apply. To formally withdraw from the EU, British Prime Minister David Cameron must invoke Article 50 of the Lisbon Treaty. Then the U.K. and the EU have two years to negotiate their separation terms. Yet, disagreement exists as to exactly when Article 50 must be invoked. After the “leave” vote, Cameron announced his resignation, however, and said he would hand the process of filing Article 50 to his successor, who isn’t expected to be chosen until October.
• Other EU governments are pressing for an earlier invocation of Article 50 to shorten the period of uncertainty, but are forced to wait for the U.K. to initiate the process.
• Complete implementation could extend beyond the two-year negotiation window.
• Some are even seriously suggesting that that the U.K. exit may never happen since the vote was non-binding. While it seems unlikely, Scotland has made statements that it may use its powers granted to it within the U.K. to block parliamentary acceptance of an exit plan.

Short-term financial/business issues:

• In general, the biggest risk from a broad dairy standpoint is the threat to economic growth – in the U.K., Europe and elsewhere. The U.K.’s vote has created significant uncertainty, which is reflected in the global financial markets. In the subsequent two business days, the Euro fell 2 percent vs. the U.S. dollar, the British Pound fell 8 percent (to a 31-year low), the Dow fell more than 900 points and the Nikkei dropped 9 percent.
• A weaker Euro puts downward pressure on EU dairy export prices. Conversely, a stronger U.S. dollar makes dairy products generally more expensive for importers.
• Global oil prices dipped another 5 percent, which also serves to blunt the purchasing power of many oil exporters, most of whom are also major dairy importers.
• The U.K. is the biggest EU recipient of foreign direct investment, but protracted uncertainty and a likely tough EU stance on the U.K.’s exit terms will jeopardize and suspend investment decisions and slow U.K. economic growth. Further, the U.K. has a significant trade deficit, especially with the EU, so a weaker pound will have a negative overall effect on the U.K. economy. Analysts speculate that recession in the U.K. is possible, which puts renewed pressure on the Eurozone, already struggling with problem economies in Greece, Spain and Italy.
• This foreseeable future portends a huge distraction for EU business and political leaders.

Trade policy issues:

• The U.K. exit vote almost certainly puts the Transatlantic Trade and Investment Partnership (T-TIP) in a holding pattern. The remaining 27 EU states will need to focus their attention on their new relationship with Britain. In addition, the United States loses a frequently like-minded country in the talks, as the U.K. is one of the more free-market focused economies in the EU. That may mean the EU stance on GIs is likely to be tougher. In addition, TTIP is somewhat less attractive for U.S. dairy exporters with a net dairy importer like the U.K. out of the deal.
• The United States could eventually pursue a separate trade deal with Britain, but the administration has already assigned this a lower priority.
• This underscores the urgency to complete the Trans-Pacific Partnership (TPP). The United States needs more certainty in Asia to balance the uncertainty (and possible limited gains) from Europe.
• The U.K. is now tasked with renegotiating its WTO commitments, as well as the 58 treaties that it is a party to as a member of the EU. But these talks are unlikely to take place until after the U.K. negotiates its terms of departure with the EU.
• Progress on the EU-Canada trade agreement (CETA) will probably slow as Canada determines the impact of pulling the U.K. out of the deal. And if Canada wants to renegotiate with both the EU and the U.K., it may be difficult to get European negotiators’ attention for a while. Meanwhile, this may diminish some of Canada’s dairy farmer protectionism as it contemplates a delay in greater access.
• The development also will slow completion of the EU’s FTA negotiations with Mexico and Japan sustaining the U.S. tariff advantage in NAFTA and (prospective) TPP, respectively.

Trade flow issues:

• Currently, as a member of the EU, dairy trade flows relatively seamlessly between countries. Depending on the separation terms, once the U.K. is out of the Union, it could be treated as any other non-EU country. Trade terms such as rules and standards likely won’t be an issue in light of the historical relationships. Further, with a two-year window to negotiate terms of exit, many supply arrangements should be sorted easily with little disruption.
• There will, however, likely be new customs paperwork involved, raising the cost of business, and perhaps new duties and quotas. The U.K. is a net dairy importer from the EU, especially from Ireland (about 30 percent of the U.K.’s dairy imports), France and Germany. Britain takes nearly 40 percent of Ireland’s dairy exports, including about 60 percent of its cheese exports, about one-third of its butterfat shipments and one-fourth of its whey exports. As noted above, for the time being there is no disruption in intra-EU trade. By 2018 or later, if the separation terms are an obstacle, Ireland could potentially need to re-direct more product elsewhere on the world market.
• The U.K. imported 482,000 tons of cheese and 68,000 tons of butterfat last year.
• In their early comments, European dairy and food companies have stated that the most important thing in U.K.-EU negotiations is the free movement of goods without import and export quotas or tariffs. One of the most impacted is Arla Foods, based in Denmark but which gets more than 20 percent of its revenue from the U.K., while Danone, Mueller and Glanbia, among others, have significant U.K. exposure as well.
• An independent U.K. poses a dilemma for companies who have substantial investment in Britain, as these assets may no longer be able to serve the EU market in the same way.
• It’s uncertain how the EU’s import TRQs will be parceled out, since some access was predicated on selling into the U.K. market. An example is a New Zealand quota for over 70,000 metric tons of butter, which was originally tied only to the U.K. until it joined the EU years ago. Now, most of that butter is sold in the EU, creating a potential friction point.

EU political issues:

• The EU is expected to extract a high price from the U.K. to discourage other countries from following Britain’s lead. EU leaders have stated the U.K. shouldn’t expect the free-trade benefits of being inside the Union if it’s elected to leave. Immigration was one of the biggest issues for the U.K., as EU citizens can move freely between member states. To tighten its borders, the U.K. will probably have accept less-favorable access to the EU.
• There is no single prescribed form for the separation agreement. Norway, for instance, retains access to the EU’s single market, but has to accept unchallenged most of its standards and regulations. Switzerland has a set of bilateral deals. Turkey is handled like a customs union. The U.K. and EU may even opt to settle relations based on WTO rules, which are the same that the United States uses with the EU.
• The vote will make it more difficult for U.K. farms and companies to attract workers from across the EU.
• The U.K.’s vote could validate or encourage nativist, xenophobic or separatist tendencies in other countries. Meanwhile, populist leaders in France, Italy, Denmark and elsewhere are already calling for exit referendums of their own.
• Scotland voted strongly to remain in the EU (more than 60 percent), and leaders have already raised the issue of voting again to leave the U.K. with the intent of rejoining the EU. Northern Ireland, which also voted to stay in the EU, has a dilemma as well, since a new hard border with the Republic of Ireland will impair their relationship.

EU farm issues:

• The U.K. is a net payer into the Common Agricultural Policy (CAP) – it pays more than it gets back in aid. The remaining EU-27 will need to pay more into the pool to maintain CAP subsidies at current levels.
• Many U.K. farmers depend on CAP subsidies and will fold without them. Leaders of the “leave” campaign promised farmers they’ll continue to get as much aid from the U.K. government, though budget pressure may create challenges to that commitment.
• It’s unclear how long the U.K. will have a voice in EU farm policy issues as complete separation approaches.

Geopolitical issues:

• We expect there is deep satisfaction in Russia that a historically united and forceful EU is reversing course, at least in part. An outside possibility exists that Russian president Putin may seek to aggravate the breakup by providing special concessions to the EU as opposed to the U.K., which was a strong supporter of sanctions.
• We do not expect any change in NATO military cooperation from the EU or the U.K. Yet, Britain’s exit costs the bloc one of its wealthiest members and one of its biggest military powers. It also creates an additional crisis in the EU, which is already weighed down with economic and migration crises, turmoil in the Middle East and Russian aggression.
• Some analysts point to the British exit as a symptom of growing frustration with globalization. As a result, the EU could become more defensive on globalization in the years ahead.

What comes next for Britain, the EU and the world economy? The full implications of the U.K.’s exit from the EU will take time to become clear. Britain’s vote is only the beginning of what will be a lengthy process of negotiations over its trade, business and political links.

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The U.S. Dairy Export Council fosters collaborative industry partnerships with processors, trading companies and others to enhance global demand for U.S. dairy products and ingredients. USDEC is primarily supported by Dairy Management Inc. through the dairy farmer checkoff. How to republish this post.