A fall in the prices of commodities like crude would lead to large savings in import bill
We expect Brexit to trigger fears of centrifugal forces getting unleashed. Other disgruntled members of the EU, which are unhappy with the functioning of what they perceive to be an overbearing and opaque decision-making apparatus of Brussels-based bureaucrats, would now demand similar referendums from their national governments. This would be vehemently opposed by the governments in Germany and France, which are advocating an ‘ever closer union’.
This can open fissures, which would increase acrimony and social discord in the political discourse, which would have a chilling effect on economic decision making as businesses abhor uncertainty and would defer any investment decisions till a sense of clarity returns. In short, Britain’s exit from the EU would strengthen the domino effect among other nations in the EU.
Limited firepower in ECB’s arsenal
It makes the task of the ECB in reviving economic growth that much harder as it has used almost all the arsenal in its armoury.
It is continuing to buy bonds worth billions of euros on a monthly basis to stimulate growth and has imposed negative interest rates on banks to keep some of their reserves with the ECB. Despite this, the GDP growth rate of the EU area was anaemic at 0.6 per cent in Q1 of CY2016.
No immediate rate increase by US Fed
It would allay fears of any immediate rate increase by the US Fed, which would see a rising dollar (and falling currencies of its trade partners like euro, pound) as well as falling commodity prices as strong headwinds to US economic growth.
Spike in risk aversion and movement into safe havens
A spike in overall risk aversion would lead to money gravitating towards safe havens like dollar assets and gold. The pound and the euro will weaken the most, being the direct sufferers of slowing economic growth and currency turmoil. Industrial commodities will like crude and metals will weaken due to fears of slow economic growth.
Export-dependent economies to suffer the most
Many export-oriented economies like those from the Far East like Japan, South Korea and Taiwan, whose GDP is primarily export-dependent (roughly 60 to 70 per cent of GDP is net exports), will be hit hard due to global trade getting impacted as a result of this uncertainty. Commodity-exporters like Brazil, South Africa, Russia, Nigeria, Gulf countries (like Saudi Arabia, UAE, Kuwait) will suffer due to fall in their major export commodity basket.
Also, aggregate demand in these economies will suffer if their currencies weaken as a result of fall in prices of their major revenue contributing commodities as well as fears of flight of foreign capital into safe haven assets.
Impact on India
Once some semblance of sanity returns, investors will realise that nearly 65-70 per cent of Indian GDP is domestic consumption. We are primarily a domestic-focused & domestic demand-led economy.
A fall in the prices of commodities like crude would lead to large savings in import bill (every $1 drop in crude prices leads to roughly $1 billion savings in India’s oil import bill).
This would reduce India’s trade and current account deficits (CAD) and counter any negative impact due to foreign capital outflow that may happen as part of movement towards safe haven assets.
Imported inflation to fall
Lower commodity prices would dampen ‘imported’ inflation and help the RBI in pursuance of its stance of monetary accommodation.
With record foreign exchange reserves of $340 billion and expected forex outflows in September 2016 on the FCNR (B) front already covered, RBI is likely to intervene to stamp out any unusual volatility in the currency market. India emerged as the recipient of the highest FDI inflows in 2015 surpassing China and the US due to open door policy pursued by the Indian government by increasing the caps on foreign holdings in many crucial sectors and improving measures of ease of doing business.
The government’s adherence to fiscal discipline and narrowing of CAD would allay any apprehension in the bond market, which would otherwise betray a sense of nervousness due to likely FII outflows especially on the debt side.
Overall, we feel investors need to take a measured approach and not get carried away by doomsday scenario in so far as the impact on the Indian economy and markets are concerned. Once the dust settles, India will be seen to be a net gainer and inflows would continue to gravitate towards the Indian shores.