Effect of Brexit on the spirits trade

On June 23rd 2016, the United Kingdom of Great Britain voted to leave the European Union. In the era of Twitter tags, this event has come to be known as Brexit. David Cameron, the prime minister of Great Britain, resigned very soon after the result was announced.

Currently, there are 28 countries which form the European Union. Further, there are 19 countries which use the euro as their currency (i.e. monetary union). The United Kingdom of Great Britain is not a part of the monetary union within the European Union. It has its own currency (i.e. the pound).

Around half of Great Britain’s exports currently go to the European Union. At the same time around half of Great Britain’s imports come from the European Union. Around one-third of Great Britain’s financial services exports are to the European Union. At the same time, more than half of the cross border lending that the banks of Great Britain carry out is to the European Union. Further, Great Britain receives half of its foreign direct investment from the European Union.

In the days to come all this will have to be renegotiated with the European Union. It is estimated that negotiations will have to be carried out with 60 non Euro Union countries where trade as of now is governed by European Union rules.

Calls are now being made in other European nations, including Spain and France, to get out of the European Union. Further, calls are now being made in Scotland, for a referendum to leave the Great Britain. In fact, the Scots as a whole have voted to stay in the European Union. If Great Britain decides to get out of the European Union, then Scots want to have their own referendum to get out of Great Britain, in order to stay in the European Union. So the disintegration of Great Britain is also a possibility now.

The financial markets have been in turmoil. The basic point is that financial markets hate any sort of uncertainty. And there is simply too much uncertainty surrounding the Brexit issue right now. Also, this has reinvigorated, the dollar as the safe haven trade all over again. This has led to money going out from all parts of the world and into the United States. This explains other currencies losing value against the dollar.

The Scotch Whisky Association, the industry’s trade body, has stated that the European single market is ‘central to the success of Scotch’ . Major Scotch Whisky giants Diageo and Pernod Ricard had also stated their support for the Remain campaign.

David Frost, Scotch Whisky Association chief executive, said: “Voters have spoken and decided that the UK should leave the European Union. All must now get behind the government as it faces the challenges, and the opportunities, this decision brings.

“The process of leaving the EU will inevitably generate significant uncertainty. Of course, we are confident Scotch Whisky will remain the pre-eminent international spirit drink. But equally, there are serious issues to resolve in areas of major importance to our industry and which require urgent attention, notably the nature of future trade arrangements with both the single market and the wider world.

“The government will now need to consult as it prepares its negotiating approach. We look forward to working closely with them on that. We urge thoughtful and serious consideration by all parties so that we can secure the best possible continued access to the EU and other export markets on which Scotch Whisky’s success has been built, whilst minimising costs and complexity.”

Brexit will affect the whisky market, Scotland’s largest drinks export, worth £4 billion pounds a year, in a number of ways.

The benefits for Scotch Whisky from EU membership are multiple. The EU has also managed to negotiate few important foreign deals for Scotch whisky as part of the FTA (Free Trade Agreements) that they cut around the world. The agreements include a deal with South Korea that reduced tariffs on Scotch whisky to zero, reducing tariffs in Vietnam on Scotch from 45% to zero over time (both of these are significant as the Asian market is a huge target for the industry), and an agreement with Colombia that makes it illegal to discriminate against foreign spirits, or to restrict availability of Scotch Whisky in their markets.

However, the EU has been unable to strike a trade deal with India, a potentially huge market that unfortunately has set Scotch Whisky tariffs at 150% besides huge individula state taxes.

Possibly even more important, it’s by EU law that the term ‘Scotch Whisky’ is under protection of Geographical Indication (GI) in the same way that Champagne is protected for the French sparkling wine of that region.

The UK’s alcohol industry would benefit more from Britain remaining in the European Union than leaving, the industry body Wine and Spirit Trade Association (WTSA) has said.

Britain’s wine and spirits industry is worth £45bn and supports nearly 600,000 jobs. The EU export market was worth £1.8bn in 2015.

Following the vote to leave the European Union the Wine and Spirit Trade Association vows to work to preserve our access to the Single Market and ensure the industry has a powerful voice in the international market place.

Chief Executive of the Wine and Spirit Trade Association, Miles Beale, said:

“The British public have voted to leave the European Union opening a new chapter in our history. While our members felt that the wine and spirit industry was stronger in the EU, we will work to assist government in preserving our access to the Single Market, supporting British drinks exports and agreeing the best possible international free trade agreements.

The WSTA will do everything it can to ensure that the UK’s wine and spirit industry has a powerful voice with a view to promoting the great British drinks industry’s leading position and fulfilling its huge potential in an increasingly competitive international market place.”

Prime minister David Cameron has also warned that leaving the EU could put the industry at risk if it had to renegotiate bilateral deals for alcohol sales such as South Africa, the US, South Korea, China and India.

“Britain will be stronger, safer and better off in a reformed Europe than out on our own, because we will have full participation in the free trade area, bringing jobs, investment, lower prices and financial security. That means real certainty so you can plan for the future,” David Cameron pointed out.

According to the Food and Drink Federation, the main industry body, food and drink is the single most important player in UK manufacturing. It accounts for one-sixth of manufacturing activity and employs around 400,000 people across 6,620 businesses. It estimates that the sector’s total contribution to the economy, in terms of Gross Value Added, is £21.9bn which, it argues, is almost equal to the combined contribution of the automative and aerospace sectors.

So, whatever happens in the referendum, this is an important sector. The remain campaign argues it will be better off with Britain in the EU as the zone accounts for just under three-quarters of all UK food and drink exports and that therefore the sector benefits from access to the single market.

For example, it is a common practice for British drinkers to buy cheaper wine and beer at French ports, and then travel back home with little or no restriction. For Scotch and more stronger drinks France is next only to the U.S. as the biggest importer of Scotch.

Diageo sources say that a decision to leave will threaten jobs and the sector that has been grown exponentially in the last decade. It would be “better for the UK, better for Diageo and better for the Scotch whisky industry that we remain in”. “The EU has so far concluded, or is negotiating, over 50 of these global agreements, many of which provide significant commercial benefits for Diageo,” he also wrote.

“Can we toast a return to growth?” asked Paul Skehan, Director General of spiritsEUROPE. “We want to celebrate the great performance of our exporters in 2015, offering a net gain to the European economy of almost €9 billion, but we do so with a wary eye to the future as we weigh the possible trade consequences of the BREXIT vote.”

Obviously, the BREXIT vote has imposed itself in the discussion, generating many more questions than answers. How will current and future EU trade negotiations be affected by the UK referendum to leave? Certainly, the EU’s trade position looks weaker, as our second biggest economy is shorn from the EU’s overall internal market. And in what ways might the nearly €3 billion trade in spirits between the UK and the rest of the EU be affected?

“For our sector, and many others, a strong UK within a strong EU is the scenario offering most certainty and the best prospects for growth” said Paul Skehan. “The referendum decision leads to uncertainty, with likely knock-on effects on investment, jobs and growth – not only within the UK and EU, but around the world”. That said, Paul Skehan stressed “We will work closely with politicians and our sector colleagues in this new political environment, to ensure the best possible outcome of this divorce.”

The spirits sector has always been a strong supporter for a robust EU trade policy: negotiating ambitious trade deals with key export markets to gain competitive advantage while targeting high import tariffs and other barriers such as discriminatory tax policies, insufficient IP protection and complex custom procedures. Enforcement of existing agreements can also be improved.

“We frequently bring to the attention of the Commission trade-restrictive measures that prevent spirits producers from doing business. Many of these cases are linked to the lack of enforcement of rules already negotiated at WTO level or in free trade agreements” concluded Skehan. At the launch of the spiritsEUROPE report, recent problems in Canada, China and Colombia will be highlighted.

Ultimately, for the beverage alcohol industry, Brexit’s largest effect is likely to be foreign exchange (FX) rate fluctuations in both the near and long term.

Since the vote to leave the European Union, the GBP has dropped in value against the US Dollar (USD). Conversely, the Euro to USD exchange rate has remained relatively stable over the past 18 months. While the majority of trading is speculative, it appears unlikely that the GBP/USD rates will revert to historical norms in the near term.

Presuming these rates signal a new normal, there are some general assumptions that can be made relevant to the beverage alcohol industry: Overall exports from the UK to the US will be more profitable for UK-based exporters.

Scotch Whisky is the biggest potential beneficiary. However, many of the major Scotch brands are owned by international corporations and these companies will protect brand positioning so it is unlikely that pricing will be reduced to gain market share. That said, incremental margin may be used for marketing spend to drive greater consumer awareness.

The UK is not a major exporter of Wine or Beer into the US so there are likely to be minimal impacts related to exchange rate fluctuations.

The UK is a major importer of beverage alcohol and a weakening GBP against the local currencies of most major producing countries will make the UK a much less profitable market.

For US based producers, this means that either prices will necessarily increase in the UK market, or export margins will be reduced.

Regarding pricing specifically, the UK market has traditionally been resistant to price increases. However, these foreign exchange shifts may make it possible to protect exporter margins over the medium term.

As the potential profitability of the UK export market declines, international producers are likely to look to other markets to achieve growth objectives, including the US.

To the extent that the Euro shows on-going weakness against the USD, this will make it possible for Euro-denominated producers to increase more on price relative to US domestic producers.

Overall, for the US Beverage Alcohol market there are two points to be made:

With a strong USD and a weak Euro, it is a good time to buy barrels and equipment from Europe. On the other hand, with 90 percent of the nation’s whisky stock shipped abroad, more than £1 billion pounds in sales could be at risk if the Brexit went through, industry leaders warned in the months ahead of the vote.

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