Britain decided to leave the European Union in what was clearly a shock to the markets. A consensus put the possibility of ‘Brexit’ at 9% a mere few hours before the EU Referendum took place on the 23rd June. As results started flowing in, so did the markets tumble. Several index futures including the S&P and Stoxx were down 5%, hitting their lower limits for the day. The pound took a massive beating falling to a 31-year low. Brexit came at a time when markets have already been struggling due to a weak global economy and has added to the prevailing uncertainty.
Even though Indian stocks moved in tandem with the global risk-off sentiment driven sell off in stocks, the market has been relatively resilient in the immediate aftermath of the result, thanks in no small part to the rock solid fundamentals. That said, it is expected that emerging markets will struggle to attract capital. The uncertainty surrounding the economic implications of Brexit has caused money to move to safe havens. The biggest worry about the Brexit vote is that it has opened a Pandora’s Box. Emboldened by the Brexit outcome, groups opposed to the EU membership in other European countries have already started demanding their own referendums. Far right political groups and parties in countries such as France, Spain and Netherlands have already called for referendums and the public discourse surrounding an exit from the EU is slowly gathering pace with the increase in violent attacks in the European states. The immediate impact of Brexit and growing clamour from other nations is an increase in risk aversion when it comes to investing.
Gold had been trading in a bullish trend since the beginning of the Brexit fear – trading above 1300 now
Risk aversion was immediately visible with gold rallying 5% while oil fell by 5%. Among global currencies only the US Dollar and the Japanese Yen appreciated, strengthening considerably, due to their perceived safety. Currency depreciation is further expected to increase risk aversion. Bullion which has been trading in the 1200 – 1300 range since the start of the year saw an immediate jump, going past the psychological resistance at 1300 and has been trading over this for the past four weeks. Oil, which has been struggling in 2016, has noticeably reacted to Brexit and is currently trading in the low 40s. EURGBP has hit a two-year low, trading below 1.2000, for the first time since early 2014. British imports have just become about 10% costlier, a rather significant number! With the financial industry facing a very tough year in 2016, Brexit could not have come at a more inopportune moment.
EURGBP moves from 0.7650 to 0.8300 in a few days, a depreciation of more than 10% for the GBP
Among other uncertainties, the most significant will be those surrounding the Free Trade Agreements (FTAs) and the discussions around trade and investment with emerging markets such as India. The EU has played an important role in the formation of bilateral treaties for its member states. India’s FTA talks with the EU, including trade and investment, are now bound to go forward under the assumption that the frameworks drawn will not include the Britain, even though the divorce won’t be final till 2017, at the very least. India is also a significant exporter of capital to Britain. It is quite likely that India will need to take stock of its bilateral agreements with the UK separately. These factors are likely to affect the GDP growth rate with many banks dropping their forecast for India’s GDP growth rate in the last few days, with the most significant being IMF’s downward revision from 7.5% to 7.4%. While the direct trade impact on the rupee is limited, global risk could weigh down on the rupee in the short term.
While the uncertainties had an immediate impact on the markets, there are significant arguments to suggest that Brexit could prove to be positive to the Indian economy and Indian markets by extension, in the long run. As per EU rules, an EU member can only recruit a non-EU citizen unless there is talent shortfall. Brexit is likely to be a boost in the opportunities available for Indians in the UK. Britain is also expected to look outside the EU, specifically targeting India, China and the US with respect to stronger trade ties, as it prepares itself for the split from EU.
FTSE 100 (Candle) has been outperforming SX5E (green line) since the initial concerns immediately post Brexit
Turmoil in the financial markets is expected to persist in the face of these uncertainties but the perception is that the risk-off sentiment that has scared investors towards safer assets is temporary. Markets have adequately recovered from the shock in the last four weeks. UK’s benchmark FTSE 100 has, in fact, outperformed the Eurozone benchmark SX5E (Stoxx 500 Euro) since the initial drop immediately post Brexit. However, it is likely that the negotiations and potential developments discussed above could lead to further volatilities and investor fear. Policy responses will need to take these into account.
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