Brexit Adds Uncertainty to Global Economy

Thu, 30 Mar Pre-Open

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The United Kingdom started the clock on two years of negotiations to withdraw from the European Union (EU) on Wednesday. Britain is poised to embark on an anxious and uncertain course that has little clarity.

There is currently no agreement between London and Brussels on core issues. Enough lines over money, trade and immigration have been drawn to suggest a tough process with costs to both sides. There's also Britain's commercial relations with the rest of the world and even the potential breakup of the UK as Scotland could use Brexit in their push for autonomy.

It's easy to see how consequences of Brexit for India and the global economy could be disastrous, what with the sharply rising odds of an unravelling EU and euro. Uncertainty and risk aversion will rise. Capital flows will be pushed away from the region and toward key safe-haven markets including the U.S. - especially treasuries - and to Japan. This will further lower market interest rates and raise relative currency values. The higher U.S. dollar also triggers additional pressure on China to float the yuan lower, as it is caught in the divergence between its two largest export markets - the EU and the US.

Over the past few months, and since the start of the year in particular, Britain has confirmed its intention to leave the single market and the customs union, and end freedom of movement within the EU.

According to an article in The Livemint, British businesses are warning against such an outcome and say that it would hit two key sectors particularly hard - the financial sector and a car industry that is currently in full bloom. By way of example, if Britain is forced to fall back on World Trade Organization rules for trading with the EU after it leaves, British car exports would face a 10% tariff at the EU border.

The least developed countries, including Malawi and Bangladesh, stand to lose £323m annually if existing preferential trade terms are not secured by the UK.

Also, with interest rates at rock bottom, some even negative, there is a limit to how much further stimulus European central banks in developed markets can give their economies.

Brexit affects the rupee through both trade and the financial channels. The UK and European Union account for 23.7% of the rupee's effective exchange rate which could lead to a prolonged period of risk aversion in the equity markets. This could spark HYPERLINK "https://www.equitymaster.com/5minWrapUp/charts/index.asp"foreign portfolio investor outflows and add to the rupee's weakness.

Also, those of the 800-plus Indian businesses operating in the UK that see it as a gateway to European operations will be worried. Automobile, pharmaceutical and IT companies will be particularly affected here.

Other companies could also benefit from a weakening pound. And the UK's interest in strengthening trade with India is certainly a plus. It's shaping up to be a long and uncertain two years.

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