Brexit: Political instability in the UK, global volatility in the offing

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It’s finally over now. Britons have voted to ‘exit’ from the European Union (EU) and its reaction on the markets has been brutal. From equities to commodities (except gold and silver) to yields, all have taken a beating. The most affected has been the FX markets, and volatility has been quite high and specifically in the pound, which dropped by over 8 percent in a single day session. The currency fell to the lowest level since 1985 and exceeded the sharp decline it suffered during Black Wednesday in 1992. Global stock markets were rattled on the day of the event and FTSE in specific crumbled by over 3 percent. US equities weren’t spared either after the S&P index fell by over 3.5 percent, the biggest one-day drop since August. In line with expectation, British Prime Minister David Cameron decided to step down after the defeat but the focus will now shift to the June 28 and 29 meeting, wherein the EU leaders will be focusing on the ‘BREXIT’ event.

Will Britain trigger Article 50?
The impact in the short term for the European Union as well as for the UK will be tough and will be felt by most of the economies across the globe. The ‘Black Friday’ event could now trigger Article 50, a part of the Lisbon treaty that sets in train a two-year process whereby the member state, in this case Britain, will notify the EU council of its decision to leave. In terms of trade implications, Article 50 has been constructed to give the negotiating advantage to the EU, and not to the country planning to leave. So if the UK triggers Article 50, Britain will notify to the European council its intention to leave the EU and begin talks of future relationship with the EU that has to be completed in a span of two years unless every one of the country in the EU agrees to extend the negotiations.

The global impact is expected to be severe and will lead to jittery markets. The G-7 economies have issued a joint statement saying they were monitoring global currency volatility and were prepared to act against disorderly markets. Some officials at the Fed also worry that the US economy could get a hit if growth in the EU, America’s largest trading partner, takes a hit from the UK’s decision to leave. The exit vote is likely to curtail free movement between the EU and the UK and also lead to possible re-imposition of tariffs as Britain exits.

What’s on card for India?
In financial year 2016, India’s trade with the UK has been over $14 billion and more or less has been stable in the last five years. Many Indian companies do have a direct exposure to the country but it will be too early to quantify the impact. But looking at the flipside, Brexit could lead to a slowdown in the global economy pushing commodities price lower. It is important that crude remain stable so that India’s current account deficit remains within target.

What next?
The pound has been battered by the Brexit referendum and our view on the pound continues to remain bearish. We expect weakness in the pound to be extended towards 1.28 levels as political instability and sluggish recovery would keep the up move restricted for the currency. In a scenario of uncertainty, gold has benefited and rallied by over 20 percent this year; postponement of rate hike decision by the Federal Reserve and weakness in dollar against its major crosses also supported the yellow metal. Probability of Fed raising rates in July has diminished and the only probability of it happening is likely in December.

For euro, we expect the currency to trade with a weaker bias but the fall in euro will be comparatively less than the pound - following instability in the UK. The Brexit has had a relatively less impact on the Indian rupee but the exit of RBI Governor Raghuram Rajan and maturity of FCNR deposits during September and November is likely to weigh on the rupee in the near future. But active intervention by the RBI is likely to curb the volatility for the rupee against the US dollar. However, other important factors for the Indian rupee weakness could be rising oil prices, weaker Chinese yuan and a rate hike by the US.

Abhishek Goenka- CEO & Founder of IFA Global

(IFA Global, established in 2005, is one of the leading FX and Treasury Solutions firm headquartered in India. They specialize in Corporate Treasury Management, FX Fund Management and Cash Management and Treasury Softwares)