Analysis of Brexit referendum and impact on markets - Mr.Feroze Azeez

Mr.Feroze Azeez (Deputy CEO - AnandRathi Private Wealth Management)

So the British have voted in a referendum to leave the EU. What does that mean for markets?

Let's first get some important facts in here:

1. The referendum itself does not mean that UK will leave the EU.

2. The British Parliament will have to vote on it, and we have seen several times in the past where if deal terms are sweetened, referendums are called again in which the decision is reversed. This was a very close vote indeed with just 2% difference.

3. Assuming the British Parliament gives the go ahead, they have to notify the EU under Article 50 of their Constitution and there is a 2-year window within which a framework is drawn up to facilitate the exit as well provide post-exit relationship framework.

Now, how could this play out?

- Of course, there's a risk that more countries will possibly want to leave the EU. A long period of dislocation for the EU is on the cards.

- Economically, the biggest victim of this will be the UK itself - both politically as well as economically.

* For example, almost 45% of Scots wanted Scotland to leave the UK. This may gain momentum

- On the economic side, UK runs a large current account deficit which is financed by FDI and foreign portfolio flows.

* So, first impact is that the Pound will fall (in fact has already fallen almost 10% today as we speak).

* UK stocks will also fall as the economy gets tipped into a potential recession.

* Of course bond yields will drop as Bank of England will move aggressively to ensure lower rates.

* And of course, UK is only 3% of Global economy.

- For the smaller and struggling European economies too, there's a significant risk. Their bond yields will start to rise sharply. Why will this happen? Investors will start to worry; For example - For the Italian bonds they bought in Euros, there's a likelihood that they will be paid back in Liras! In anticipation, they will start asking for a higher risk premium or yield. Then, this could be a self fulfilling prophecy as the Italians would wonder that if they are being punished for a crime they didn't commit, might as well commit the crime and leave the EU.

- Higher interest rates will lead to a slowdown in these economies and they could also tip into recession. This is not necessary though as the ECB could step in to buy their bonds and keep rates low.

Coming to Indian markets, let's look at the facts

- India is largely a domestic economy (we don't depend a lot on international trade) and domestic fundamentals are improving.

- The economy is recovering and the prospects of a good monsoon will only help.

- On the currency side, India has negligible current account deficit (the gap between imports and exports) and therefore the currency isn't at major risk.

- So while the equity markets have fallen by almost 2-3% today and as has the Rupee, this is merely a knee-jerk reaction.

It's not that Brexit will not have an impact on India, but the impact is so marginal relative to the local factors, that I would strongly urge investors to use such dips to buy. It's kind of like when the Greek crisis was unfolding a few years back. Such panic falls present great opportunities for long-term investors. For clients already fully invested, this is definitely not a moment to worry in my view.

Source : Equity Bulls

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