Referendum on Britain's exit from European Union (EU) - Impact on Indian Financial Markets
Written on Friday, June 24, 2016
By Alok Agarwal
The global financial markets saw a panic reaction driven by the results of a British Referendum that voted in favor of Britain's exit from the European Union (EU). Popularly known as BREXIT, this event was known earlier. Still it took the markets by surprise because the markets were complacent going into this event. This partly explains the sharp reaction on friday.
Indian markets also fell in the global carnage, but the fall was lower in comparison to other developed & emerging markets. Attached herewith is a note that contains our views on Brexit and its impact on Indian markets in a simple manner. Here is a deep analysis and "Action Points" for an investor.
Brexit - Background
A referendum was held in Britain to decide on whether they should remain in EU or exit.
The results show that almost 52% of voters have voted in favor of an Exit from the EU; Voters in favor of an exit outnumbered those favoring remaining in EU, by almost 1.3 million.
Technically, this referendum is not binding on the UK government and the Parliament may choose to remain in EU even after this referendum.
British Prime Minister David Cameron who was in favor of remaining in EU, has resigned following the referendum verdict against his stand.
This raises concerns of Left winged parties (they favored an Exit from EU) winning the next elections in Britain.
People fear that it may set a dangerous trend - voices calling for an exit from EU may be raised in other EU member countries.
Brexit - Panic Reactions in Global Financial markets
Prima facie, it seems that financial markets and the political circles were complacent going into the Brexit Referendum assuming that UK will vote in favor of remaining in EU. However, the results have surprised them and hence the panic reaction.
A Risk Off trade seems to have started today globally leading to unwinding of carry trades and flight of capital towards safe havens such as US Dollar, US Treasuries, Gold & Yen
British Pound has fallen to its 30 year lows vs. the US Dollar, depreciating by almost 10% at one point in time, its sharpest single day fall in history
At the time of writing this note, Gold is up 4.1%, Japanese Yen is up 3% vs. US Dollar, US Dollar Index is up 2% & yields on US 10Y treasuries are down 22 bps
Brexit - Reactions in Indian markets
Indian markets have reacted negatively, tracking global markets, driven by FII selling
Selling in Indian markets is sentimental as seen from the advance decline ratio. Sentimental selling normally tends to pause and recover in near term
Advance Decline ratio is at 1:9 - Advances 5, Declines – 46 which shows extreme sentiments (likely to reverse)
High Beta sectors like Metals, Banks. Realty, Auto are the biggest losers
Defensives have fallen less – FMCG, Media, Pharma, IT
Brexit - Impact on Indian markets
UK is India’s 12th largest trading partner; Among very few countries with whom India enjoys a Trade Surplus (Trade Surplus of $3.64 billion in FY16)
UK is the 3rd largest investor in India after Mauritius and Singapore with a cumulative inward flow of $22.56 billion between April 2000 to Sep 2015
Some Indian companies have material revenues from UK operations – Tata Motors, Tata Steel, TCS, Tech Mahindra
A global risk off trade drives Indian markets lower too (although to a lower extent) as foreign investors reduce exposure to Risk Assets
Such "flight to safety" may also lead to lower commodity prices which, though it will be largely positive for a net commodity importer like India, may impact some Indian commodity companies whose revenues may come under pressure
If Britain exits from EU, British Pound falls sharply, in which case, Indian exports to UK may suffer. India’s trade surplus with Britain may narrow thereby increasing India’s trade deficit and putting pressure on the Rupee
Britain’s exit from EU and a weaker British economy may impact Indian companies operating in Britain; Investments flowing into India from Britain may suffer if British economy weakens
Outlook on India post Brexit
India's economic story is more about demography, domestic demand / consumption and infrastructure investments, than about exports
Exports have anyways been falling over the last 12-18 months. The recent recovery in growth has been led by reforms, government spending in infrastructure and improving domestic demand. These drivers are unlikely to be impacted materially by Brexit
Global Risk aversion - Unless Brexit threatens the very existence of EU (which is a far fetched possibility at this juncture), the risk aversion should subside in the next few days. Global cost of capital is unlikely to rise much (lower German, US and Japanese yields) and with global growth stagnating, foreign capital is likely to resume its chase for better growth and yields. India shall remain an attractive destination for such capital
A few businesses may suffer in the short term, but the impact on wider markets is likely to be limited
Monsoon’s have been above normal so far (though a bit delayed) and geo-spatial distribution of rainfall has been good. As per latest reports, all drought affected areas have received good rainfall; Monsoons, 7th Pay Commission and OROP to drive rural and urban consumption
Rural consumption, Urban demand, Rising Infrastructure Investments as well as focus on manufacturing to lead to better growth in Indian economy
Government focus on infrastructure spending, reforms in key employment generating sectors such as road construction, ports, railways, textiles, garments, drug manufacturing, etc. to lead recovery in investments
Cleaning up of PSU Bank NPAs, infusion of capital in PSU Banks, consolidation in PSU Banks, focus on Micro Finance to strengthen credit availability to MSMEs are big positives that shall drive growth
"NO ACTION" is best during times of panic
Once the dust settles, the next step is to assess the fundamentals and take decisions accordingly
Panic phases give rise to good REBALANCING (buying / profit booking) opportunities in investor portfolios
Hold your investments. Do not exit in panic
Let the dust settle. Today’s selling was emotional (led by sell off across global markets). Such phases tend to settle down in a few days and are followed by recovery
Continue with your SIPs / STPs
Start 6 month STPs in Diversified Equity Mutual Funds today
Hold on to your Debt Mutual Fund investments – 50% in Accrual; 50% in Duration (mostly in short term debt funds)
Diversify your portfolio into Gold ETFs / Gold Savings Funds