Brexit is a "tail risk" for India which is the third largest investor into the UK in terms of number of projects, Development Bank of Singapore (DBS) has said as Britain gears up for the crucial referendum next month.
"Brexit is a tail risk at this juncture," said DBS.
Tail risk is the risk of an asset or portfolio of assets moving more than 3 standard deviations from its current price. Tail risk is sometimes defined less strictly as merely the risk (or probability) of rare events.
Britain will vote on whether to remain in the European Union (EU) on June 23.
"Should the vote swing towards the 'leave' camp and trigger a broader risk-off reaction, India will feel the heat through heightened volatility in the global financial markets," the bank said.
"Admittedly, it is difficult to draw an empirical impact on India's real economy. But if the leave camp wins, it is likely that the UK will seek trade agreements with non-EU partners, including India," said the bank in an economic report 'India: monitoring external fault lines'.
But this will require the UK as a precursor to sort out its post-exit arrangement with its main trading partner i.E. the EU, first.
Thereafter, a bilateral trade agreement with the UK might become viable as an alternate to the tough and drawn-out negotiations on the EU Free Trade Agreement.
"These should provide a fillip to slowing India-UK trade. The UK accounts for 15 per cent of India's total merchandise trade, but its share has been declining," the bank noted.
Trade in services has also eased, with UK service imports from India slowing and making up only about 2% of the total, much lower than with the US and Asia, it pointed out.
Investment links are, meanwhile, notable.
UK is the third largest inward investor in to India, after Mauritius, and Singapore, with cumulative FDI equity investments of USD 22.7 billion from April 2000 to December 2015, i e 8 per cent of the total FDI inflows.
In turn, India is the third largest investor (number of projects) into the UK.
If the Brexit vote goes through, Indian businesses that tap the UK domestic markets are unlikely to face many challenges.
However, firms that intend to utilise UK as a base to gain access into European markets might have to rethink plans, DBS believes.
A risk here is the imposition of trade barriers, scrapping preferential rates and higher taxes between UK and rest of the EU, which might pose a hurdle for foreign companies to invest in the UK, said the bank.
"These factors could slow investment flows from India to the UK, until more clarity is available in this regard," it said.
"All said, there is still considerable uncertainty on how
this referendum vote (Brexit) will shape up. Hence, we should view this as a tail risk for India at this juncture," it said.
India is likely to watch external developments closely, especially the direction of oil prices, it said.
"While the domestic reform agenda is on track, a favourable global environment had helped to India's turnaround in the past two years," observed the bank.
"If the external backdrop turns less favourable, it may undo some of this improvement. These risks, thereby, warrant close attention," DBS said.
A combination of good policy, fiscal reforms and progressive monetary policy, and good luck with flush global liquidity and low commodity prices, have aided India's turnaround in the last two years, according to DBS.
Direction of oil prices warrant close attention as it matters most to India, according to the bank.
Currently, the Indian crude oil basket (in INR terms) is up 50 per cent from its January 2016 floor.
The other macro indicators will, however, feel the heat on a sustained rise in oil prices beyond USD60 per barrel.
From a risk perspective, the direction of global crude prices will be important for India, it said.
For now, it remains to be seen if oil prices stay firm in the face of a resurgent US dollar and oversupply from the oil producing nations.
