BREXIT and Its Implications - the Beneficiaries and Impact on India

The European Union (EU) is an economic and political partnership involving 28 European countries formed after World War II. It has since grown to become a "single market" allowing goods and people to move around, basically as if the member states were one country. The EU is founded on laws, and Britain, as a member of EU has to abide by these laws. In return, Britain, like any other EU member, gets relatively liberal trade access within the EU member countries. Supporters of BREXIT believe that Britain is being held back by the EU, which they say imposes too many rules on business and charges billions of pounds a year in membership fees for little in return. As per some estimates, 100 most burdensome EU regulations cost Britain GBP33.3bn in 2014-15. BREXIT supporters also want Britain to take back full control of its borders and reduce the number of people coming to UK to work. Those campaigning for Britain to stay in the EU say it gets a big boost from membership – citing reduced cost of trade with other EU countries and, they argue, the flow of immigrants, most of whom are young and keen to work, fuels economic growth and helps pay for public services.

On 23rd June, Britain will vote whether it wants to remain a part of EU or it wants to leave. A vote to leave the EU would start a long and complicated process that would result in a fundamental change in the UK’s relationship with the other members of the EU. There are pros and cons for both parties. Increasing restrictions and introduction of political borders increases the cost of trade and services. Financial Times estimates the GDP hit to be at 2-7% with most of the losses front-loaded if Britain leaves the EU and fails to strike a deal or reverts into protectionism. On the other hand, as per an independent think tank, Open Europe, if the UK stays with the EU and manages to strike liberal trade agreements with the members, the benefits would be 1.6% of the GDP by 2030. The EU remains the largest market for Britain’s exports, constituting 40-45% of its exports. The UK’s primary goal is likely to be to retain access to the EU’s internal market but it will find it difficult to gain liberal trade terms from the EU if it chooses to exit the EU. Economic factors will hurt both the parties. Britain is a strong member of the EU and losing Britain will weaken the EU, both economically and politically. A BREXIT could stoke separatist pressures within the EU, threatening its cohesiveness, something which the EU is already grappling with. This could also give Britain a headache as BREXIT could lead to demands of referendum within Britain (read Scotland) in the longer term.

BREXIT could trigger capital flight from Britain. It could have a profound effect on London’s real estate market, among the most vibrant in the world. Stricter regulations will curb capital flows both from within the EU and outside it (read China & Russia). Britain has among the highest current account deficit (~7% of the GDP) in the developed world and is dependent on foreign investors to plug the gap. BREXIT will only compound inflation and the sterling’s worries. London is widely regarded as the springboard to Europe. Given London’s status as a global nerve centre outside New York, BREXIT could weaken the EU as far as it share in world trade and commerce is concerned. For Britain, separation from the EU will mean stricter immigration laws. Pertinent to note that Britain has benefitted from the influx of skilled immigrants. The number of EU workers in Britain is now estimated at roughly 2.15mn. As per the OECD, immigration accounts for half of the UK’s growth since 2005 and immigrants have filed 2.2mn jobs since that period. Stricter immigration laws could make it difficult for EU skilled workers to work in UK.

Likely beneficiaries of BREXIT: In my view, dollar assets will emerge as the biggest beneficiaries of BREXIT. Events like these are usually followed by periods of volatility and economic pain. Given the current state of global economy, investors will be quick to rush to safer havens. Few asset classes can cope with capital flows of this magnitude. I believe that capital will flee to near-dated US Treasuries in the short term and will ultimately find its way into other dollar assets in the medium to longer term.

Impact on India: As far as India is concerned, in the near term it will heighten global volatility thereby impacting capital flows and in medium term we will most likely be impacted through currency exchange . India has a substantial trading corridor with EU. Any material depreciation of the Euro/Pound could lead to increased headaches for India in a sluggish export environment. Indian businesses have a material presence in both the UK & Europe. As per The Guardian, there are more than 800 Indian-owned businesses in the UK, with more than 110,000 employees. Besides, BREXIT could also endanger the flow of investment and personnel by diminishing Britain’s role in providing access to Europe.

To conclude: BREXIT – if it happens, will have implications; UK Real estate prices may correct (on account of thinner capital flows from EU), inflation will climb on expensive imports, London’s financial centre status may get threatened if money flow and settlements are hampered. Goldman Sachs estimates 15-20% drop in the sterling as a response to BREXIT. As of now, the British public is evenly split on BREXIT with 45% wanting to stay with the EU while 43% want to leave the EU. The long-term economic impact of BREXIT is hard to discern, but the short term disruption while the UK negotiates and renegotiates is only likely to be bad news for both sterling and Euro assets. So near term effect of BREXIT on both the currencies is pretty easy to predict.

It is difficult to gauge the precise medium to long term economic impact of BREXIT on both the parties concerned. However, the outcome of BREXIT in my view is the biggest macro risk affecting fund managers and investors – bigger than oil price or even the FED rate hike. Having said that, at this moment, it is almost impossible to predict the outcome. We will have to wait till June 23rd to know the future of EU and Britain.

Disclaimer: The views expressed are of Tata Asset Management Ltd. and are in no way trying to predict the markets or to time them. The views expressed are for information purpose only and do not construe to be any investment, legal or taxation advice. Any action taken by you on the basis of the information contained herein is your responsibility alone and Tata Asset Management will not be liable in any manner for the consequences of such action taken by you. Please consult your Financial/Investment Adviser before investing. The views expressed may not reflect in the scheme portfolios of Tata Mutual Fund.

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