Well, yesterday I was attending a training session on time management in the company I work for. The instructor was giving examples of where people waste their time and one of the examples he gave was "a 2-hour discussion on UK's exit from the EU" and everybody started laughing. Well that was funny, seeing people laughing at a serious issue. People do laugh such situations off without knowing that it does have long term effects on the entire world.
UK's exit from the EU doesn't affect the life of most of the people. But if your company is connected to a company based out in the EU or the UK (for example a distributor or partner), you need to be seriously concerned.
According to Article 50 of the Lisbon Treaty, any country in the EU may decide to leave the union based on its constitutional requirements. Once this article is invoked, negotiations with the EU on the exit will start. These negotiations will extend to 2 years. With David Cameron stepping down as the Prime Minister of the UK in October 2016, these negotiations will extend to 2 years and 3 months from this day.
On the day of the results of the EU referendum on 24th June 2016 IST, the Sensex plunged more than 1000 points. This was not for no reason. This is the first time ever a country has decided to leave the EU. Although Greece had threatened to leave the EU a number of times in the past, that wouldn't have created a huge impact on the markets world wide. The UK leaving the EU will have a big impact on the markets since a lot of industries in India are related to the UK, especially the IT companies and automobile companies like Tata Motors and Mothersun Sumi. Tata Motors tanked 15% on 24th June 2016 on Brexit worries as its subsidiary Jaguar Land Rover (JLR) is expected to lose 1 billion pounds in profit ($1.47 billion) by the end of this decade. Tata Steel is another worry for Tata because of its UK steel plant which Tata decided to keep.
There is a huge uncertainty lying in front of the global markets as this is the first time any country has decided to leave the EU.
So what's next for the global markets?
What can we expect next? What's next for the UK? What's important for any country is that volatility in the markets should be maintained, be it stock markets or domestic markets. There should be liquidity in the markets, there should be cash flow so that investments and trades can go on. This is what runs the economy. Shortly after the decision to leave the EU, European Central Bank (ECB) declared that it is all set to put in 250 billion pounds in the economy if needed. Further ECB will have to go for policy easing (cutting interest rates) so that companies can lend money. Policy easing will continue at least till new trade pacts have been made. This will take time. Until then, we can expect some more sell off in the markets and major companies devalued by a considerable amount. Currency volatility will continue. Major currencies including Pound and Rupee will depreciate. Yen is expected to gain more strength further increasing trouble for Japan and Maruti Suzuki and other Japanese companies operating the world over.
European Union might slip into recession as most of the countries are in the union just to get bailout packages as the ECB has major contribution in providing them. We have already seen how Greece has always threatened to leave the EU just to get more bailout packages.
On the positive side uncertainties in the market will remain only until new trade pacts have been announced by the UK. ECB will be backing up the economy. RBI on the other hand is all set to introduce more volatility in the markets if need be. Companies which import goods or services from the UK can reduce their import costs on the depreciating pound or even hedge their currency risks.
On the negative side, we can expect job losses in the IT space as that sector will be one of the worst hit. Many companies with operations in the EU will now have to take separate offices in the UK and other parts of the EU. This means more capex (Capital Expenditure). Depreciating pound would mean less cash inflows from exports. So decreasing profits and increasing capex will be main reasons for down side for IT companies. More over, number of projects in the EU and UK space will reduce since companies there will be reluctant to invest. Many European companies in India may shut down their operations or reduce their investment.
On the other hand, the UK may have put itself in a stronger position now. The UK now will not have to pay for the fees for staying in the EU. Plus the ECB will not have to pay bail out packages to countries in the EU which don't seem to improve despite billions of pounds spent on them. The UK will now be saving a lot of money, thereby increasing its cash reserve which is very important for any economy. Further to increase its cash inflows, the UK may increase the customs and excise duties. Given that the UK comes with more industries, we might be looking at a new super power in the making.
Down side for the tourism industry would be now tourists will have to get separate visas for the UK and the EU. This means pricing for tourism packages will increase which means less people willing to travel.
On final grounds
Uncertainty on the markets looks to be short term as most of the countries are well prepared for any down side coming because of Brexit. Companies which import or export goods or services to and from the UK will be affected. As long as companies play the economic game carefully (for example reducing risks by hedging), they will be able to sustain.
But one must be careful as Brexit is not the only uncertainty we have. We also need to focus on the economic outlook and change in leadership in the United States.
Thanks for reading this article. Check out my blog regularly for more articles on the Indian and global markets.
