The UK’s decision to depart from the EU has flooded global financial markets with uncertainty.
A wave of sell-offs is spreading across world stock markets, leading to a "risk-off" scenario where investors favour investments that are seen as being lower risk. The Indian financial market is also feeling the heat, with the BSE Sensex exchange tumbling by 900 points in its opening session after the referendum result, while the Indian currency weakened to around 68 rupees to the US dollar. Brexit is expected to delay the recovery in global growth, which could impact the flow of funds to India in the short term, as high levels of uncertainty and risk aversion would compel investors to seek shelter in safe-haven assets such as sovereign bonds and gold.
India is still a domestically driven economy, and most investors, both domestic and international, remain positive about India's prospects: The country's fundamentals are expected to help economic growth to remain resilient. Although India experienced a knee-jerk reaction in local equity and currency markets in line with the global response, the local debt market has not reacted strongly to Brexit. The fact that 10-year government securities' yields continue to trade at around 7.5% is testimony to investors' confidence in the Indian economy.
Commodities Face Challenges
The global slowdown is expected to delay the recovery in international commodity markets. This will help India to control import bills and imported inflation and will also assist the central bank in maintaining its monetary easing stance.
Concern for Businesses
The major concern for India relates to business sectors with high/direct exposure to the UK and Europe. The biggest impact could be among IT companies if clients in the UK and EU postpone spending due to uncertainty over how things will pan out in the near future; this would have a negative impact on revenue growth from Europe. The potential depreciation of the pound and euro against the rupee could also hit revenues from these economies. In contrast, the depreciation of the euro/pound against the dollar would make the cross-currency impact favourable for companies that convert their euro/pound revenues into dollars and sell them for rupees, helping them reduce the impact of pound-/euro-depreciation on their balance sheets.
The majority of Indian businesses choose to locate their European offices in the UK in order to benefit from the ease of operating in the UK while accruing the advantages of seamless access to the wider EU. Removal of this gateway would be a serious concern for Indian businesses headquartered in the UK, which might now have to relocate and direct investment to Europe and comply with two different sets of laws.
Trade and Investment to be Hit
In terms of bilateral trade with the UK, India has a surplus of USD 3.64 billion. India's total trade was worth around USD 14 billion in the 2016 financial year: USD 8.8 billion in exports and USD 5.2 billion in imports. India invests more in the UK than in the rest of Europe combined, and the UK is the third-largest FDI investor in India (after Mauritius and Singapore), with a cumulative inward flow of approximately USD 23.1 billion between April 2000 and March 2016. The flows in both directions could be impacted as a high degree of uncertainty threatens the UK's investment outlook and terms of trade. Meanwhile, Brexit clears the way for a possible bilateral trade deal with the UK in the medium to long term (which was not possible under the Eurozone trade agreement).
The major exports from India to the UK are textiles and clothing, followed by machinery and automobile ancillaries. India is a major exporter of pharma to the US, as well as to the UK and Europe, and this sector could also face a slowdown in orders amid post-Brexit regulatory uncertainty. On the other hand, imports from the UK—mainly spirits and uncut diamonds—would be cheaper in the event of the pound's depreciation.
Conclusions
The aggregate impact of the UK's Brexit decision is expected to be minimal for the Indian economy. A good monsoon and recovery in local demand would soften some of the negative impact and support economic growth. There could be some slowdown in investment activity from foreign investors in the short term, but the strength of India's macroeconomic fundamentals would compel investors to return to India's shores in the medium to long term.
Overall, global and local markets are currently experiencing a reflex reaction to the UK's historic referendum vote. Brexit itself is still far from a reality, and the formal procedure for the UK's exit from Europe is yet to be laid out. While the procedural window for withdrawal is two years (which starts once the formal withdrawal procedure is invoked), many policy initiatives and actions to stabilise the world economy and trade are anticipated. And although Indian businesses with direct exposure to the UK (and to the EU more widely) will inevitably face some challenges, the fact that Brexit has been discussed as a possibility for some time means that many such companies have already taken measures to limit the effects of the UK's decision.