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Wednesday, June 22, 2016

Brexit: Its Impact On The World Economy And Markets

A country that once ruled many other nations across geographies is struggling to protect its independence and sovereignty today. The expansiveness of the British Empire was best described by this saying, “The sun never sets on the British empire.” However, tomorrow’s sunset will decide whether or not the United Kingdom will be a part of the 28-nation European Union (EU). “Brexit”, an abbreviated version of “Britain’s Exit” has been a buzzword these days. Currencies, financial markets, trade relations, and political equations all might change should Britain exit the European Union. Although political experts and market commentators often debate these days about the consequences of Britain’s probable exit, many of them fail to shed light on what led UK to review its membership to EU. If you are still to figure out what’s wrong with the EU or with the UK to be more precise, this piece is exclusively for you.
What is the EU?

Contrary to the belief of many, the EU is not merely a club of countries using the common currency. Rather, EU is not at all about a currency; it’s more about regional cooperation and oneness, of which a common currency is a part. EU has its own Commission, Parliament, Council and also has the European Court of Justice.

Why the EU?

In the aftermath of World War II, European nations decided to form a bloc by integrating their economies and cultures. The thought behind this was if nations have cordial trade relations, the cohesiveness of the region will remain intact. All member countries are bound by the policies of EU. Although mutually taken by the members, often the economic and political decisions of EU are the compromises these countries make on their national agenda in some form or the other. EU allows its members a free movement of people, capital, products and services within the region. So citizens of member countries can travel without visas and live in other member countries.

What’s wrong with Britain?

The dance floor remains crowded only until music goes on. Due to the unremitting economic crisis, weaker nations in Europe have been struggling with the problems such as the underutilization of domestic capacities, unemployment, massive indebtedness and budgetary deficits. As the prospects dimmed in their own country, people moved to other stronger nations within the bloc. What happens when you try pulling a car with wheels of two different sizes, make, tenacity, and durability? You can imagine the same for the EU in today’s economic context.

To ward off ill effects of the slowdown, EU nations are making many compromises. Until yesterday, what was seen as austerity is now being considered as restrictions on personal preferences and regional co-operation has become more a liability than a duty. This has precisely become the tipping point for Britain. There’s a growing dissent that the EU has been overshadowing Britain’s identity. It’s been interfering in the daily lives of people with its policies, disproportionately leaning towards weaker currencies.

That being said, let’s not forget, healthy nations in the EU have become stronger only because weaker countries provided a ready marketplace for their products and services. Domestic economies of stronger EU countries are otherwise saturated. So any nation leaving the EU would have these two crucial factors to consider. Just as Britain has...

What proponents of Brexit say?

The main argument has been that Britain would be more powerful should it leave the EU. It will have total control over its boundaries and will be able to monitor the immigration issues, which pose a serious threat to welfare programmes funded by British taxpayers. Moreover, believers of Brexit are of the view that, Britain’s contributions to the EU are much larger than its drawings. It’s been the third largest contributor to the EU for the year 2014-15, as revealed by BBC. The contributions of the UK in 2014-15 have nearly doubled from 2009-10 levels.

What do their opponents say?

The opponents of Brexit believe the UK has a huge advantage being a part of the EU. Its membership to the EU allows free movement of money, human resources, and products that help boost economic growth. In their view, UK leaving the EU will severely harm the reputation of the former.

What’s the bigger worry?

Simply the thought of leaving the EU to protect national interest is posing a threat to one of the most dominant regional blocs in the World. Out of 28 member-nations, about 10 contribute more to the EU than what they get back from it. Britain’s action, if it exits, may set a wrong precedent.

Who’s backing the Brexit and who’s not?

Conservatives are supporting the Brexit although they have assured a neutral stance, considering that the Prime Minister David Cameron along with his cabinet wants to continue with the EU’s membership. All other parties, including the Labour Party, favour the united Europe. As the opinion polls suggest, the feeling among citizens is evenly balanced, and there hasn’t been any trend in favour of or against the Brexit. Business majors in the UK are largely in favour of staying in. However outside the UK, those who want the UK to remain in, substantially outnumber those who don’t. The other main EU members and also the U.S. want Britain to continue its EU membership.

What would be the impact on world capital markets and currencies if the UK exits?

Even if Britain votes to leave the EU, the actual process would take around 2 years to reach completion. During this period, the UK will have a task of securing new agreements with the EU on every matter ranging from visas and work permits to taxation and movement of products and services. If at all it happens, the Pound may drop at least initially, and the US dollar may rise. The fear of other stronger nations following the footsteps of the UK are keeping global investors on the fence. Aversion to risk may reemerge and emerging market currencies, along with the Pound and Euro, may fall.

As compared to, if UK continues to be a part of the EU, world-equity markets may shrug off fears of uncertainty and may witness a relief rally. Currency movements may stabilise, and bond markets in EU may see some fresh buying. On the backdrop of the referendum in the UK, German bond yields slipped in negative this month. We might see the reversal of that, should Britain stay in.

What would be the impact on India’s trade, currency, and capital markets?

Indian Companies with significant presence and production facilities in the UK may face several challenges if it exits. However, the impact of the exit on India would be mixed. More than capital inflows from the UK, outflows from India are likely to get affected, more so as Indian immigrants seek to work in the UK. More than by multilateral or bilateral trade relations with the EU and UK respectively, Indian businesses with trading partnerships in the region are likely to get affected by massive fluctuations in a currency that possibly might take place post-UK’s exit. Individually, India shares cordial relationships with a majority of the EU nations including Britain.

Post Brexit, the action of Federal Reserve on Interest rates in the U.S. will gain more prominence in the world market as it would decide where the US dollar goes. The strength of US dollar has been the deciding factor in the movement of capital globally, these days.

What Indian investors should do?

Simple. Don’t speculate and stay calm. You must have faith in India’s domestic story to be an investor in the Indian market. Global events such as Brexit may come and go. They will affect India’s trade position and value of Indian currency for sure. However, for you to make money in Indian equities, Indian economy must do well abetted by reforms. The global investors, irrespective of such events, chase growth. So if India continues to be a bright spot, capital inflows in India would continue.

Equity markets have never been and will never be static. There would be a constant inflow of good news and bad news. Bulls will pick up more of good news and bears will scare you with depressing stories. To be a successful investor, it requires staying focused on your long-term financial objectives. You should invest as per your personalised asset allocation, and your asset allocation should be based on some factors including your risk appetite, risk tolerance, and financial goals.

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