Brexit May Cause ‘Momentary Shock’ to Indian Equities

If Brexit happens, a strengthening dollar may cause foreign funds to flee from emerging markets like India

• Rupee to be least impacted among emerging markets’ currencies.
  
• Indian equities may witness a “momentary shock”.
  

The anxiety over Britain’s possible exit from the European Union (EU) has wiped out nearly $2 trillion from the global equity markets over the past week.

Experts say that if Brexit does indeed happen, Indian equity and currency markets may witness some turmoil in the short-term.

Religare Capital Markets’ Chief Economist Jay Shankar expects volatility to increase before the vote.

One shouldn’t be concerned if there is say a 2 percent fall or rise in the rupee over a fortnight as RBI has enough dollars to stabilise the currency. 

Jay Shankar, Chief India Economist & Director, Religare Capital Markets

Indirect Impact

Shankar adds that since the volume of direct rupee-pound trade is low, the impact on the Indian currency will be mostly indirect. As investors look for safe havens, the dollar will appreciate and the rupee will fall.

Narayanan Sadanandan of SBI Capital Markets concurs. He says although India is not a very big exporter, it won’t escape unhurt as Brexit will result in a weakening of the euro and pound against the dollar, which in turn will negatively impact the rupee.

The Indian rupee has pared back losses against the euro in the last year. Indian investors looking to repatriate profits to India will worry that the euro depreciation can cut into profits. 

Narayanan Sadanandan, Executive Vice President, SBI Capital Markets

But Shankar points out that India will be better off compared to its peers. Shankar adds, “India will be least impacted relatively in terms of currency volatility among other emerging economies, due to sound domestic macro-economic variables.”

Will Foreign Funds Flee?

The currency volatility could impact foreign flows in equity and debt markets. If Brexit comes to pass, a strengthening dollar may cause foreign funds to flee from emerging markets like India.

There are so many funds investing in India, if there is a global risk-off, then probably we might see some funds getting pulled out of India. 

Dipen Shah, Senior Vice President & Head Private Client Group Research, Kotak Securities 

Sadanandan expects some of the outflow to be tempered by a further delay in rate hikes from the US Federal Reserve.

The Stock Market Impact

In its 20 June note to its clients, Bank of America Merrill Lynch’s research unit says that Britain’s exit from the EU will negatively impact those Indian stocks that feature in global benchmarks like the MSCI India index, and have relatively low liquidity.

Foreign flows (either into or out of) Indian equity are likely to be largely of the passive variety and should therefore be concentrated in stocks in the MSCI India index.

Dipen Shah of Kotak Securities says besides currency and fund flow concerns, depreciation in the pound and the euro will negatively impact Indian exporters, in turn weighing on their stocks.

Shankar says stocks of companies in metals, information technology and automobile sectors will be the worst hit.

According to Sadanandan, more than Brexit, the UK Migration Advisory Committee’s proposal to implement the immigration skills charge is a key concern. On 24 March, the UK government announced that it will levy a tax in the form of ‘skill charge’ on companies that employ migrants in skilled areas. If Britain exits, the immigration environment would be even more uncertain.

Indian IT companies may have to shell out more money, in case stricter immigration norms come into place, says Narayanan Sadanandan, Executive Vice President of SBI Capital Markets

Both Shankar and Shah opine that in the event of a Brexit, India will be less impacted than other emerging markets.

Sadanandan expects a “momentary shock” if Brexit happens. However, if Britain decides to remain in the EU, he says Indian markets will rally.