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Brexit could cause both sterling and euro to drop against dollar, Cypriot economist says

Members of the public take part in a kiss chain at a stay in, pro EU Referendum event in Parliament Square, Central London, Britain, 19 June 2016. Britons will vote to stay or leave the European Union on 23 June.

By Stelios Orphanides

A UK exit from the European Union, likely to weaken the pound sterling and make it more expensive for Britons to holiday in Cyprus, plus hike up the price of Cypriot potatoes and halloumi sold in British supermarkets.

But according to one economist the parallel effect of a Brexit on a weakened EU would likely negatively affect the euro, which to some extent would mitigate a fall in sterling.

“Both the euro and the sterling could go down against the dollar,” economist and former head of the Cyprus Securities and Exchange Commission Marios Clerides said.

Since the beginning of the year however it is sterling that has remained under pressure as it lost about 7.3 per cent against the euro, which gained 3.4 per cent vis-à-vis the US currency, according to the European Central Bank’s website.

For the time being, the number of British tourists visiting Cyprus continues to rise – as much as 4.5 per cent last month and 14 per cent in January to May – as geopolitical tensions reduced demand for vacations in other destinations in the region of Cyprus. Overall, tourism arrivals rose 19 per cent and 21 per cent respectively.

Tourism makes up roughly around one quarter of Cyprus’ economy, directly or indirectly, and the UK is the island’s largest source of incoming tourism.

Demetris Georgiades, the chairman of the Fiscal Council, an independent agency tasked with monitoring economic and fiscal developments, the drafting and the execution of the budget in order to help Cyprus avoid fiscal derailment, said that he does not fear that a Brexit would have an immediate impact on the Cypriot economy.

“In the case of a Brexit, given that there will be a two-year transition period, someone could safely predict that the two sides (the EU and the UK) will negotiate the terms and the day after in a way that will be beneficial for both sides,” Georgiades said in an interview. “The free movement of capital, businesses, goods and labour shall effectively continue”.

Still, this doesn’t mean that there is no need to remain on alert, he continued. “My concern is that the Brexit won’t be the source, but rather the trigger of the long waited correction of some other major imbalances in the UK economy,” he said.

After a Brexit, the ability of the UK government to address macroeconomic imbalances which include an “unsustainable” current account deficit and a persistent “household deficit,” i.e. an increase of liabilities outstripping that of financial assets, would be limited compared to a non-Brexit scenario, Georgiades continued, as leaving the EU would accelerate the process.

The UK current account deficit, which was 5.1 per cent of the economy in 2014 and the country’s Office of Budget Responsibility, the UK’s fiscal council, considers this “large by historical standards” and expects it to narrow slightly over the next five-year period.

The household deficit is expected to remain around 3 per cent of gross domestic product. The situation could easily evolve into a financial and fiscal crisis causing bubbles in the UK economy to burst, Georgiades said.

A burst property bubble in the UK could also affect Cyprus, said economist Clerides, who is also the chairman of the Cyprus Economic Society, adding that in the case of a Brexit the impact would be even stronger.

“You don’t know how foreigner investors will react to a Brexit,” he said. “Will a Brexit affect the investment decision of Russian property buyers or Greek ship owners? To the extent that their decisions are based on an expected price increase, (then) the bubble further grows, but we know that the bubble eventually will burst”.

Another side effect of a Brexit on Cyprus would be that the Mediterranean island would lose a reliable ally in the EU when it comes to negotiations on tax and financial matters at an EU level, Clerides added as both the UK and Cyprus share similar interests.

A Brexit would give Germany, which traditionally favours more harmonised practices in tax matters, more “more say” in the EU, he added.

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