Does Britain face 'challenging' election result?

From the looks of things, at least going by all the buffoonery masquerading as statistics in election polls, the UK is about to have a “challenging” election result on May 7. I use the term ‘challenging’ in the very British sense of the word; i.e. as a gross understatement; instead of more appropriate terms that an excitable writer could have used such as “regime change”, “disastrous” or even “catastrophic”. For the more market minded folks with UK exposure through investments or currencies, suitable epithets could range from “bone crushing” to “laxative replacing”.

But I am not that kind of writer, so will stick to “challenging”. Perhaps the more important question though should be why anyone else care what happens in an interminably damp little island off the coast of somewhere else nice to visit like France? Or to put it simply: why is this a big deal?

On the face of it, there is little to worry about – the UK has a middling economy that hasn’t driven global growth at any time over the past six or seven decades; and has previously gone through existential crises such as after losing its global reserve status and more insultingly after the country had to borrow from the IMF in the mid-70s. At that time, the UK voting public had the good sense to put in Margaret Thatcher, perhaps one of the most effective political leaders of the modern era, rivalling even the redoubtable Ronald Reagan in the breadth of reforms that were undertaken.

Sadly though, after her ouster the Conservative Party was never the same again, moving from one bland leader (John Major) to the other until finally in 2010 the long march of Labor was stopped by a Conservative-Liberal Democrat coalition government. By all accounts, this unlikely coalition performed quite decently, with overall deficit spending capped and investors expressing greater support for UK assets particularly its vibrant London property sector; but also for industrial investments such as in cars (Rolls Royce and Bentley sell more cars now than ever before, the Mini is global phenomenon but most remarkably Jaguar and Land Rover have turned around with expanding market shares in most segments). Research-based businesses including bio-technology have done well.

Importantly for the financial sector, London-based regulators have not tried to sock it to them through extraordinary fines and sanctions; if anything regulators have been quite measured and thoughtful in their responses.

This isn’t to say that they haven’t been tough – a number of measures such as higher capital requirements and bank levies as also the ‘ring fence’ of retail operations from the investment banking casinos all originated out of London. Alongside, a number of bad ideas such as pay caps and overly onerous supervision requirements that were sought to be imposed by other regulators such as those in Europe and the U.S., have been resisted. Rewards of such pragmatic-and-tough regulation are obvious in the results with employment continuing to rise, real estate prices at a decent clip and exports climbing.

All of that was until the end of 2014. From the beginning of this year though, numbers have been pathetic with exports to Europe taking a big hit (thanks to the Pound rising against the Euro) even as property markets have started slowing down and big banks such as HSBC discussing publicly their intentions to move headquarters out of London to lower tax jurisdictions such as Hong Kong.

Funnily enough for an advanced economy with a very long history of parliamentary democracy, the UK economy is actually suffering from political volatility of the kind less-developed economies would encounter. A number of previously core practices of the country are likely to change, hence the fears, some of which are explained below:

If a conservative-led coalition wins:

More cuts on immigration which would particularly affect students from Asia along with economic migrants from outside Europe (the normally responsible Tories have embarked on this move to retain voters who were moving the far-right UK Independence Party or UKIP)
A referendum on the UK’s relationship with the EU, especially with regards to omnibus laws that must be adopted (as above due to the emergence of the UKIP)
Continued cuts in defence and other government spending with a view to curtail the fiscal deficit; in turn further diminishing the UK’s military and peacekeeping roles

If a Labor-led coalition wins (which seems more likely based on the polls):

Anti-foreigner actions of a different kind namely the abolition of non-domicile status that benefits around 100,000 high earners in the country
Renewed deficit spending particularly in welfare related areas, reversing some of the good work done by the Coalition in for example getting more people back to work by tightening applications for employment benefits (this is the core Labor agenda)
Higher income and other taxes including on property ownership as well as populist measures such as the Mansion tax (a tax on houses and apartments worth over £2 Million)

As well, the Labor-led government would almost inevitably include the Scottish National Party, thereby making another referendum on whether Scotland remains part of the UK pretty much a given thing.

Now it becomes clear that the choices in front of the UK electorate and hence the markets, have become more Scylla and Charybdis than was initially imagined. The economic impact can be handled in a politically stable context; and political noises can always be managed if the economy is stable. The trouble for Europe in general – look at France, Italy and Greece as examples of this trend – is that political volatility turns extreme whenever the economy craters; and it is this factoid that makes the UK election that much more important.

In other words, we aren’t discussing anymore a ‘lost parliament’ or 5 years of sub-par growth if the wrong coalition governs the UK. Based on the record of the past few years across Europe, the wrong government would push the economy down, and with it, increase political instability with more fringe and extreme political leaders emerging with their own vote banks. That in turn would accelerate the economic decline as confidence evaporates, creating a vicious cycle.

For a change, the popular media have the broad story right here, it is not a case of scaremongering at all; but instead a truly scary situation. Barring an outright majority for the Conservatives (which looks pretty much impossible now), the following are what I expect to unfold in the markets post the UK elections:

Selling off in risk assets such as stocks (first) and real estate (later)
Declining GBP, I would expect the £ to test 1.3 against the $ over the first 6 months of any unstable coalition emerging from this debris
Increased investments by foreigners into UK government bonds (gilts) on expectations for Japan-style low or no growth environment over the next 5 years
Increased emigration out of the UK, which would favor other financial centres such as New York (the main beneficiary), Dubai and Singapore.

As always, these are just my opinions: always consult your financial adviser before arriving at any decisions.

Does Britain face ‘challenging’ election result?

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