KUALA LUMPUR (July 11): The United Kingdom's withdrawal from the European Union will not have a significant credit impact on Asia Pacific sovereigns, but potential market volatility may affect Asia Pacific sovereigns that depend on external financing, says Moody's Investors Service.

Moody’s in a report today entitled "Sovereigns -- Brexit and Asia Pacific: Limited Direct Credit Impact; Some Sovereigns Exposed to Market Volatility" said that over the coming months announcements related to Brexit could trigger financial market volatility.

“While not our baseline expectation, a shift in portfolio and/or banking flows that resulted in tighter financing conditions in some Asia Pacific markets would hurt growth, especially in countries where fiscal and monetary policy space is constrained,” it highlighted.

According to the report, out of those Asia Pacific countries that have large current account deficits, Mongolia relies in part on private sector financing flows. In addition, both Mongolia and to a lesser extent Sri Lanka have significant debt repayments due in 2016.

“Consequently, any severe and prolonged market volatility could heighten balance of payment pressures for these two sovereigns, and elevated government debt in both countries would constrain fiscal policy room to offset the impact of weaker external flows on GDP growth,” Moody’s said.

Meanwhile, the impact on financial flows into Asia from UK and other European banks is uncertain, according to Moody's.

As international financial centers, Hong Kong and to a lesser extent Singapore would be exposed if financing flows from the UK and European banks ebbed.

However, Moody’s also noted, there is a possibility that these centers could benefit if UK and European banks aimed to diversify their asset bases.

Besides, pronounced flows into safe havens would be credit negative for Japan, and to a lesser extent Hong Kong.

This is because the sustained rise in the yen would lower Japan's GDP growth and inflation, making it harder to achieve fiscal consolidation and inflation objectives, and 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,” Moody’s said.

Having said that, 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.

According to the report, most Asia Pacific sovereigns have minimal reliance on exports to the UK, Cambodia is the most exposed, with exports to the UK worth 5.8% of gross domestic product (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,” it highlighted.