Brexit woes: If China devalues yuan more, Sensex may hit 22,000

Last week when majority of UK citizens voted to exit from the European Union, global stocks, currencies and commodity markets witnessed a major carnage fearing the move would have a ripple effect on the financial markets in the long run. Although many expect India to be relatively less impacted due to the Brexit, domestic brokerage Ambit Capital has raised a concern that the second round impact could affect the country more profoundly over several years. [caption id=“attachment_2853156” align=“alignleft” width=“380”]  Reuters[/caption] According to a report by the brokerage, India’s foreign currency debt now stands at $0.5 trillion (25% of GDP), and if the Chinese further devalue their currency, yuan, this could trigger more pullbacks in the Indian markets. “When the Chinese devalued their currency in the mid-1990s to trigger the South East Asian crisis, India was a reasonably insulated economy, with low levels of foreign currency debt. Now the roles have been reversed – the South East Asian countries have throttled back on foreign currency debt whilst India has loaded up on the same. India’s foreign currency debt now stands at US$0.5tn (25% of GDP). Hence, a further devaluation of the yuan (which to us appears to be a high probability event considering Brexit) looks likely to be a catalyst for more pullbacks in the Indian markets going forward,” the report. The Chinese authorities continue to devalue their currency slowly but surely (FY16 against US dollars: 6%). Now Brexit is likely to create sustained demand for US$ as investors seek a safe haven in an uncertain world. This appreciation in the US$ gives China a golden opportunity to seize the opportunity thrown up by Brexit to decisively devalue its currency and thus boost its flagging GDP growth," says the Ambit report. In such a scenario, the brokerage sees a high risk for the benchmark Sensex falling to 22,000 level in FY17, as the 20th century construct of a global free market built around cross-border co-operation gradually breaks down. The brokerage also highlights that Europe could have to deal with a recession, which is already dealing with negative CPI inflation and negative interest rates. This would imply that a heightening EU’s economic challenges could prompt other EU countries to seek referendums on whether to stay in the EU or not. In fact, Japanese brokeage form Nomura, too, has shared similar views in its report. It said, Brexit could further inflame anti-EU sentiment in other EU member states, heightening fears of more countries opting to leave the union. Another major challenge cited by Ambit suggests that FIIs’ debt ownership, which now stands at $27 billion or 1.4 percent of GDP. As a result, with increasing global uncertainty due to Brexit and Raghuram Rajan’s departure from the RBI, it could trigger a flight of FII debt from India, which in turn is likely to push up short-term commercial paper and commercial deposit rates. Also, the UK’s exit from the EU will trigger four sets of direct adverse changes for India, namely: (1) an adverse impact on India’s UK and EU bound exports (as these regions deal with slower GDP growth); (2) a slowdown in FDI and FII flows into India as globally business confidence is disturbed; (3) concomitant pressure on the INR; and (4) a pressure on domestic money market liquidity. Nomura report also says the Brexit will have a far reaching and long lasting impact on global financial markets. The report suggests that while the value of merchandise exports from the rest of the EU to the UK is only 3 percent of the rest of the EU’s GDP1 the UK’s position as a global financial hub – UK financial sector assets account for more than 8 times its GDP – leaving the rest of the EU much more exposed to the UK in terms of financial and investment linkages, in part reflecting the UK’s relatively liberalised domestic market and its strong legal framework and institutions.