Moody's: Brexit to have limited direct credit impact on Asia Pacific sovereigns

Moody's Investors Service says that the United Kingdom's (UK, Aa1 negative) vote to leave the European Union (EU, Aaa stable) will not have a significant credit impact on Asia Pacific sovereigns, but dependence on external finance poses a vulnerability for some countries.

Although lower GDP growth in the UK could dampen demand for products from the rest of the world, Asia Pacific's direct trade linkages with the country are generally limited.

However, over the coming months, announcements related to Brexit could trigger financial market volatility. While it is not Moody's baseline expectation that there will be a significant shift in shift in portfolio and/or banking flows to the region, if global financial volatility results in tighter external financing conditions, it would hurt growth in countries where fiscal and monetary policy space is already constrained.

Moody's conclusions are contained in its just-released report on the impact of Brexit on the Asia Pacific region, entitled "Sovereigns -- Brexit and Asia Pacific: Limited Direct Credit Impact; Some Sovereigns Exposed to Market Volatility."

Moody's report highlights that most Asia Pacific sovereigns have minimal reliance on exports to the UK: Cambodia (B2 stable) is the most exposed, with exports to the UK worth 5.8% of GDP in 2015. As a result, Moody's does not foresee a large impact on trade or GDP growth in the region.Only in severe downside scenarios involving a sharp and prolonged negative confidence shock to the EU economy would GDP growth in Asia Pacific be materially lower.

Still, potential market volatility resulting from Brexit would affect Asia Pacific sovereigns that depend on external financing, says Moody's. Out of those Asia Pacific countries that have large current account deficits, Mongolia (B2 negative) relies in part on private sector financing flows. In addition, both Mongolia and to a lesser extent Sri Lanka (B1 negative) have significant debt repayments due in 2016. Consequently, any severe and prolonged market volatility could heighten balance of payment pressures for these two sovereigns. In addition, elevated government debt in both countries would constrain fiscal policy room to offset the impact of weaker external flows on GDP growth.

Meanwhile, the impact on financial flows into Asia from UK and other European banks is uncertain, says Moody's. As international financial centers, Hong Kong (Aa1 negative) and to a lesser extent Singapore (Aaa stable) would be exposed if financing flows from the UK and European banks ebbed. However, there is a possibility that these centers could benefit if UK and European banks aimed to diversify their asset bases.

Pronounced flows into safe havens would be credit negative for Japan (A1 stable), and to a lesser extent Hong Kong. A sustained rise in the yen would lower Japan's GDP growth and inflation, making it harder to achieve fiscal consolidation and inflation objectives. A stronger US dollar and hence local currency would hit Hong Kong's economy. However, the government's very strong fiscal position would provide some easing room.