The decision for the UK to leave the European Union has significant and wide-ranging impacts, including in both an economic and regulatory context. Some of these effects will be felt immediately (eg, via the exchange rate impact on the cost of air travel) while others will be more longer-term in nature. In part, these effects will be dependent upon the precise terms negotiated as part of the exit agreement.
In a comprehensive look at the potential impact of Brexit on UK air transport by International Air Transport Association (IATA), the industry body predicted that preliminary estimates suggest that the number of UK air passengers could be 3-5 percent lower by 2020, driven by the expected downturn in economic activity and the fall in the sterling exchange rate. The near-term impact on the UK air freight market is less certain, according to IATA but freight will be affected by lower international trade in the longer term.
The UK vote to leave the EU paints a cloudy future. Considerable uncertainty remains regarding the precise detail of the exit and it could be two years or more before these issues are fully resolved; prolonged uncertainty will influence both the magnitude and persistence of the economic impacts.
The big issue is with aviation regulation and the UK now faces a trade-off between accessing the European Single Aviation Market and having the policy freedom to set its own regulations. TheBrexit scenario has wide-ranging impacts throughout the UK and, to a lesser extent, more broadly through Europe and beyond.
IATA says the immediate impact on air traffic will be governed by the effect of Brexit on two key variables: economic activity and the sterling (GBP) exchange rate. The referendum result is widely expected to present a significant negative shock to the UK economy.
According to HM Treasury, the most pronounced near-term impacts derive from heightened uncertainty causing businesses and households to delay spending and investment decisions, as well as transmission via financial channels.
There is a wide range of estimates of the economic impact that Brexit will have in the short term. Impacts vary according to the different scenarios and assumptions used, but broadly point to UK GDP being 2.5-3.5% lower in level terms by 2020 compared to the ‘no Brexit’ baseline, according the IATA report.
However, it is worth noting that the impact of Brexit is expected to be a permanent downward shift in the level of GDP, not a temporary impact that is recovered after a period of time.
In terms of exchange rate impacts, Sterling fell sharply in volatile trading conditions following the result, broadly in line with expectations. The general view amongst analysts is that it will recover somewhat over the medium to longer term.
Nonetheless, the currency is expected to remain weaker than otherwise would have been the case under a no Brexit scenario (in the region of 10-15%). “The impact that this would have on air travel is more clear-cut than the economic effects,” says IATA.
“The weaker pound has immediately made outbound trips for UK inhabitants more expensive (because a given amount of GBP will now buy less goods and services overseas). At the same time, for overseas visitors to the UK, their local-currency earnings will now stretch further than they did previously,” it adds.
All told, the short-term movement in sterling will affect purchasing power immediately and, over time, will serve to discourage outbound travel by residents and to encourage inbound trips by foreigners.
The precise effect of the GBP depreciation on air transport therefore hinges on two key variables: The inbound/outbound shares of air travellers and the sensitivity of inbound and outbound air travellers to the exchange rate.
The UK air market is dominated by outbound traffic, with such traffic accounting for just over two-thirds of total flows (in 2015 there were 53.9 million visits overseas by air by UK residents, compared to 26.2 million visits to the UK by overseas residents), reports IATA.
The immediate impact of Brexit will be most obviously experienced on the passenger segment of the air transport market. While exchange rate movements will affect the relative price of imports and exports, the near-term impact on the UK air freight market is less certain.
“Over the longer-term, however, there will be an impact on international trade when the UK does formally exit the EU and this, in turn, will affect air freight. For example, the OECD estimates that UK trade volumes could fall by 10-20 percent over the long run (to 2030), relative to the baseline,” says the IATA report.
Unlike the economic impact, there will be little or no immediate change to the regulatory environment. Once the UK notifies the EU of its intention to leave under Article 50 of the Treaty on European Union, it will have 2 years to negotiate the exit terms. The UK Prime Minister, David Cameron has indicated that the timing of this notification will be a matter for his successor but could occur as early as October.
Given the complexity and scope of the negotiations, the UK Government has warned that 24 months would likely be insufficient time to complete all the necessary processes. Indeed, some commentators have argued that the process could take more like 5-10 years, taking recent regional trade deals such as TTIP or the EU-Canada as a reference point.
The uncertainty around the future regulatory environment is likely to amplify these negative economic impacts, notes IATA. It also follows that the more protracted the process of agreeing new terms between the UK and the EU, the greater the negative impact on investment and many other types of activity.
“This creates a potential trade-off between reaching a quick deal to mitigate the short-term impacts and reaching the best deal to mitigate the long-term economic consequences of Brexit. In the longer term, the regulatory impact on the aviation sector will depend on the nature of the exit terms and future arrangements between the UK and the EU,” says IATA.
Taken as a whole, the EU is easily the single biggest destination market from the UK, accounting for 49 percent of passengers and 54 percent of scheduled commercial flights. Taking into account those countries that have access to the Single Aviation Market as members of the European Common Aviation Area (ECAA) which includes Iceland, Norway and a number of Balkan countries, IATA notes that the importance of market access becomes even more significant.
“Of course, the importance of the issue is not just relevant to UK consumers and airlines; the UK is also a very important destination market for air travellers across Europe and is an important source of business for all major European airlines,” said IATA.
Moreover, market access considerations go beyond UK-EU routes. The UK’s routes to the rest of the world will also be affected, it adds.
Along with other Member States, the UK is currently subject to a wide range of European legislation covering all areas of the aviation business from rules affecting safety and security, to consumer protection, the environment, economic regulation and beyond.
Membership of the European Common Aviation Area would provide the most straightforward avenue for continued access to the Single Aviation Market, which extends access to the single market to a range of non-EU members.
However, membership of the ECAA requires acceptance of EU aviation law across all areas, “thus severely limiting the UK’s policy freedom,” says IATA. The same would apply to regulations more generally if the UK were to join the European Economic Area.
An alternative to formal membership of the ECAA according to IATA would be to negotiate a bespoke horizontal agreement, equivalent to the EU-US or EU-Canada agreements for example. “This would potentially enable the UK to limit its exposure to the full raft of EU aviation law,” says IATA, but while this scenario might preserve some policy freedom for UK law-makers, it could come at the cost of more limited market access.
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