What is BREXIT?
The European Union - often known as the EU - is an economic and
political partnership involving 28 European countries. It has grown to
become a "single market" allowing goods and people to move around. The
United Kingdom Prime Minister, David Cameron at the time of his
election had promised to hold a referendum on whether the UK should
remain in the EU? The referendum has been held and the people of the
UK have voted 52:48 in favour of an Exit.
What were the stakes for the British?
The UK is one of 10 member states that pays more into the EU budget
than what they get out and only France and Germany contribute more.
The UK's net contribution for 2014/15 was �8.8bn - nearly double what
it was in 2009/10.
Post Brexit, Britain would also take back full control of its borders
and reduce the number of people coming to live and/or work i.e. it
will gain control over immigration within the UK-EU.
What happens next?
Technically, MPs could block an EU exit - but it would be seen as
political suicide to go against the will of the people as expressed in
a referendum.
The referendum result is not legally binding - Parliament still has to
pass the laws that will get Britain out of the EU.
Article 50 of the treaty with EU has to be activated by the UK PM. The
current PM has resigned and left it to the next PM to take a decision
on Article 50. Once Article 50 is activated, Brexit is certain. Brexit
should then be a two year negotiation process between the EU and the
UK. In a good case, it is possible that UK postpones invoking Article
50 for 6-12 months while negotiating better terms for the UK within
the EU and following up with a second referendum in 2017.
Brexit and Indian economy
It is hard to make a case of any meaningful impact on Indian economy
of Brexit – either direct or indirect. The UK is a small trading
partner of India – UK alone accounts for only 3.4% and 1.4% of
India’s merchandise exports and imports, respectively, as of FY16.
Even that should not be impacted as Brexit will change the terms of
trade between UK and EU and not with India. FDI flows from UK to India
stood at only US$1bn in FY15 and US$0.8bn in FY16; hence, not that
significant.
Source: Finance Ministry and RBI
Impact on Indian Companies
Brexit can have some impact on Indian companies that have businesses
in UK/ EU.
The medium term impact, if any, will be clear only post the revised
terms of trade between UK and EU are finalized. This should take 2-3
years from now.
In the interim, the GBP depreciation is an unexpected positive for
companies like Tata Steel and Tata Motors (JLR) that have
manufacturing operations in the UK.
Barring these companies, the impact on other sectors like pharma, IT,
banks and agrochemicals is likely to be marginal.
Capital outflows
A pessimist may argue that Brexit will lead to FII outflows from India
due to risk aversion. While there is no meaningful link between Brexit
and Indian economy, India is in a strong position even if there are
some outflows. Consensus expects India’s CAD to remain manageable at
about ~1.5% of GDP in FY17. Foreign exchange reserves at ~US$363bn
seem adequate to withstand volatility in the case of global risk
aversion. Net FDI inflows have increased to an all-time high of
US$36bn in FY16. Impact of any FII outflows even if it does happen
will not be felt by the economy, though stock
markets may be impacted in the very short run.
Interest rates
Considering India's relatively stable macro situation (CAD ~1.5%,
Fiscal Deficit ~3.5% and stable inflation), we do not expect any
negative impact on the debt markets. Even if there are some FII
outflows, which may lead to liquidity tightening, RBI is likely to
provide additional liquidity through repos and purchase of Gsecs in
the open market operations (OMO).
Uncertainty in EU is likely to lead to USD strengthening and lower
global commodity prices. Interestingly, Brent oil prices were down ~4%
today. This is likely to aid continued low inflation and provide room
for lower rates in India.
The impact of Brexit on all segments of debt markets today has been
fairly muted. In the money market (CP & CD) and corporate bond market
- yields have moved higher by just 2 to 3 bps. While the yields in
treasury bills and government bond market are flat to lower as
compared to the levels prevailing yesterday.
The INR was stable and depreciated marginally vs. the USD while
appreciating against the Euro and the GBP.
Global events - opportunities for Indian equities?
The following table lists some of the adverse developments in the
world over the last two decades, the impact on the stock markets in
the short run in India and the returns one year after the event. It is
quite evident that on most of these occasions, the correction in the
Indian stock markets was a good opportunity to invest for the long
term investor. This is so because the nature of Indian economy is one
of secular growth and global developments have only a marginal impact
on it.
Table: Past global events and the returns thereafter
Source: Bloomberg
In our opinion, the Indian markets will quickly discount/recover from
Brexit. Interestingly, due to focus on Brexit, the steady improvement
in the Indian economy has been ignored. The table below gives the key
macro-economic indicators.
Source: Kotak Institutional Equities Research
The correction of Indian equities at a time when the Indian economy is
improving on nearly all parameters has created a good opportunity for
the discerning investor. The chart below presents Market cap/GDP ratio
of India. It can be seen from the chart that the Market cap/GDP has
fallen to attractive levels.
India market cap to GDP ratio, calendar year-ends 2005-15 (%)
Source: World Bank, Bloomberg, Kotak Institutional Equities, updated
till 31st March, 2016
The policy direction in India is right and economy is making good
progress on most fronts. The economy and equity markets also appear to
be in transition from consumption to capex. Impact of higher infra
allocation and the several steps taken by government over the last two
years is expected to be felt strongly from FY17 onwards with Railways,
Power Transmission and Distribution, Mining, Roads and Urban
Infrastructure likely to lead growth.
Improving fundamentals of the Indian economy and attractive market cap
/ GDP lead to a positive outlook for the equity markets over the
medium to long term.
In a lighter vein, Gold prices went up by ~5% today making Indians
richer by ~$40bn. Equity markets lost ~$30bn in value today. Hence,
Indians are actually better off from Brexit!
To conclude, Brexit is not a material event for the Indian markets.
Indian economy is on a steady recovery path and valuations are
attractive. The correction in markets thus provides an attractive
entry point for the medium to long term.
political partnership involving 28 European countries. It has grown to
become a "single market" allowing goods and people to move around. The
United Kingdom Prime Minister, David Cameron at the time of his
election had promised to hold a referendum on whether the UK should
remain in the EU? The referendum has been held and the people of the
UK have voted 52:48 in favour of an Exit.
What were the stakes for the British?
The UK is one of 10 member states that pays more into the EU budget
than what they get out and only France and Germany contribute more.
The UK's net contribution for 2014/15 was �8.8bn - nearly double what
it was in 2009/10.
Post Brexit, Britain would also take back full control of its borders
and reduce the number of people coming to live and/or work i.e. it
will gain control over immigration within the UK-EU.
What happens next?
Technically, MPs could block an EU exit - but it would be seen as
political suicide to go against the will of the people as expressed in
a referendum.
The referendum result is not legally binding - Parliament still has to
pass the laws that will get Britain out of the EU.
Article 50 of the treaty with EU has to be activated by the UK PM. The
current PM has resigned and left it to the next PM to take a decision
on Article 50. Once Article 50 is activated, Brexit is certain. Brexit
should then be a two year negotiation process between the EU and the
UK. In a good case, it is possible that UK postpones invoking Article
50 for 6-12 months while negotiating better terms for the UK within
the EU and following up with a second referendum in 2017.
Brexit and Indian economy
It is hard to make a case of any meaningful impact on Indian economy
of Brexit – either direct or indirect. The UK is a small trading
partner of India – UK alone accounts for only 3.4% and 1.4% of
India’s merchandise exports and imports, respectively, as of FY16.
Even that should not be impacted as Brexit will change the terms of
trade between UK and EU and not with India. FDI flows from UK to India
stood at only US$1bn in FY15 and US$0.8bn in FY16; hence, not that
significant.
Source: Finance Ministry and RBI
Impact on Indian Companies
Brexit can have some impact on Indian companies that have businesses
in UK/ EU.
The medium term impact, if any, will be clear only post the revised
terms of trade between UK and EU are finalized. This should take 2-3
years from now.
In the interim, the GBP depreciation is an unexpected positive for
companies like Tata Steel and Tata Motors (JLR) that have
manufacturing operations in the UK.
Barring these companies, the impact on other sectors like pharma, IT,
banks and agrochemicals is likely to be marginal.
Capital outflows
A pessimist may argue that Brexit will lead to FII outflows from India
due to risk aversion. While there is no meaningful link between Brexit
and Indian economy, India is in a strong position even if there are
some outflows. Consensus expects India’s CAD to remain manageable at
about ~1.5% of GDP in FY17. Foreign exchange reserves at ~US$363bn
seem adequate to withstand volatility in the case of global risk
aversion. Net FDI inflows have increased to an all-time high of
US$36bn in FY16. Impact of any FII outflows even if it does happen
will not be felt by the economy, though stock
markets may be impacted in the very short run.
Interest rates
Considering India's relatively stable macro situation (CAD ~1.5%,
Fiscal Deficit ~3.5% and stable inflation), we do not expect any
negative impact on the debt markets. Even if there are some FII
outflows, which may lead to liquidity tightening, RBI is likely to
provide additional liquidity through repos and purchase of Gsecs in
the open market operations (OMO).
Uncertainty in EU is likely to lead to USD strengthening and lower
global commodity prices. Interestingly, Brent oil prices were down ~4%
today. This is likely to aid continued low inflation and provide room
for lower rates in India.
The impact of Brexit on all segments of debt markets today has been
fairly muted. In the money market (CP & CD) and corporate bond market
- yields have moved higher by just 2 to 3 bps. While the yields in
treasury bills and government bond market are flat to lower as
compared to the levels prevailing yesterday.
The INR was stable and depreciated marginally vs. the USD while
appreciating against the Euro and the GBP.
Global events - opportunities for Indian equities?
The following table lists some of the adverse developments in the
world over the last two decades, the impact on the stock markets in
the short run in India and the returns one year after the event. It is
quite evident that on most of these occasions, the correction in the
Indian stock markets was a good opportunity to invest for the long
term investor. This is so because the nature of Indian economy is one
of secular growth and global developments have only a marginal impact
on it.
Table: Past global events and the returns thereafter
Source: Bloomberg
In our opinion, the Indian markets will quickly discount/recover from
Brexit. Interestingly, due to focus on Brexit, the steady improvement
in the Indian economy has been ignored. The table below gives the key
macro-economic indicators.
Source: Kotak Institutional Equities Research
The correction of Indian equities at a time when the Indian economy is
improving on nearly all parameters has created a good opportunity for
the discerning investor. The chart below presents Market cap/GDP ratio
of India. It can be seen from the chart that the Market cap/GDP has
fallen to attractive levels.
India market cap to GDP ratio, calendar year-ends 2005-15 (%)
Source: World Bank, Bloomberg, Kotak Institutional Equities, updated
till 31st March, 2016
The policy direction in India is right and economy is making good
progress on most fronts. The economy and equity markets also appear to
be in transition from consumption to capex. Impact of higher infra
allocation and the several steps taken by government over the last two
years is expected to be felt strongly from FY17 onwards with Railways,
Power Transmission and Distribution, Mining, Roads and Urban
Infrastructure likely to lead growth.
Improving fundamentals of the Indian economy and attractive market cap
/ GDP lead to a positive outlook for the equity markets over the
medium to long term.
In a lighter vein, Gold prices went up by ~5% today making Indians
richer by ~$40bn. Equity markets lost ~$30bn in value today. Hence,
Indians are actually better off from Brexit!
To conclude, Brexit is not a material event for the Indian markets.
Indian economy is on a steady recovery path and valuations are
attractive. The correction in markets thus provides an attractive
entry point for the medium to long term.
source: HDFC Mutual Fund, Bloomberg, Kotak Institutional Equities Research, World Bank
