More downsides to Brexit as bad news not fully discounted

The Brexit (the UK’s withdrawal from the European Union) was followed by one very bearish session, and by two sessions of relatively low volume and not much movement, in major Asian markets. However, most European bourses saw continuing losses and the US markets also saw losses through Monday, with a small recovery on Tuesday.

The UK will leave, now looks certain despite counter-petitions. While the fundamental details are unclear at the moment, it is more a question of assessing how much damage the Brexit decision will cause and the timelines. Most major investors and MNCs (multinational corporations) are waiting for more news flow to clarify the ongoing situation.

Bottom line: This will lead to a two-three year dip in GDP (gross domestic product) growth in Britain and most probably, a deep recession. Since the UK was among the largest EU economies (in nominal terms, the sixth-largest in the world) this will inevitably negatively affect growth across the continent. Since the EU is also the single largest economic entity in the world, it will negatively affect global GDP growth. By how much and for long, are the question marks.

Brexit is bound to negatively affect economic activity in India on several levels. Indian companies that have European headquarters in the UK now have a problem with EU access. Exports into the EU will be affected, at least in the short run. If English ceases to be an official EU language, that could also hurt Indian companies.

This means outgoing Indian foreign direct investment (FDI) into Britain has suddenly lost value. Indian companies looking to raise money via the UK's well-developed financial services industry have also run into a roadblock. In the last financial year, Indian FDI into the UK rose 65 per cent, making India the third-largest source of FDI into the UK. Between 2000 and 2015, the UK's FDI into India was also around $22 billion, about nine per cent of all FDI into India. That is liable to shrink this year, unless some capital fleeing the UK relocates to India.

There may be attempts to put a positive spin on the Brexit. I am sure Indian companies in the UK will "soon" renegotiate agreements with the EU, and the UK will also renegotiate its agreements with the EU. But there will be a contraction in trade and in FDI flows for a while. That contraction may be visible through this financial year and the next. All bets are off if other EU nations start to have copycat referendums.

The next set of policy decisions by major central banks will be interesting. My guesses are, the European Central Bank (ECB) will step up its QE (quantitative easing; liquidity enhancing measures) and the US Fed will delay its long-threatened rate hike some more. Japan might also step up its own QE to force the currency down because the Yen has appreciated a lot.

The Bank of England (BoE) has a very serious problem. It would like to stimulate economic activity in a recession. But the GBP has collapsed to 35-year lows and a loose policy could push it down further. What's more, the BoE would either have to establish a negative rate (since the policy rate is practically zero) or loosen money supply. The RBI's next policy decision (in early August) will also be very critical.

Net-net, there are downsides to Brexit and there is no way that the bad news has been fully discounted yet, if only for the very good reason that much of the bad news is not yet known.
The author is a technical and equity analyst