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Britain’s decision to stay or leave the European Union will bring its fair share of volatility in the Indian bond and currency market. Needing, perhaps, heightened intervention by the Reserve Bank of India (RBI) and some effective communication by the authorities to soothe nerves.
Typically, before any such big events, financial assets factor in the possible outcome in prices. It is different this time. As the Brexit or No Brexit possibilities are evenly matched, market players have built their positions equally on both sides. As such, any outcome will lead to unwinding of positions and in the short term, both rupee and bond markets are likely to be roiled.
The situation will accentuate if Britain indeed decides to leave the EU. The attached dynamics and the risk aversion that would set in could push the rupee to 70 a dollar and bond yields to rise 15-20 basis points, said Arvind Narayanan, executive director and head of treasury at DBS Bank in India. The rupee is now trading at 67.5 a dollar, largely reacting to Raghuram Rajan’s impending departure at the Reserve Bank’s (RBI’s) helm. Ten-year bond yields are faring far better, maintaining 7.5 per cent for quite some time.
Any risk aversion scenario could be damaging for EMs in the long run, even as the central banks of these countries are ready with plenty of liquidity to support the local markets, wrote Citibank in a note on Friday. However, a sharp rise in the dollar after a Brexit could be the undoing.
“For now, the markets simply assume a benign Fed, and a soft dollar are all EM-friendly. Whilst the Fed remains dovish, we think EM investors can retain optimism but should be wary that any sharp rises in the dollar are likely to be the most damaging downside threat, if risk aversion continues to rise,” it wrote.
If Britain decides to stay, it will be relatively okay for the markets and things should settle after a few bouts of volatility, said Narayanan.
The Brexit possibilities have already started affecting the global markets. With chances of Britain remaining in the union held to be getting brighter, it has been pushing down the dollar against major currencies, including sterling and euro.
Maverick currency speculator George Soros on Monday said Britain's leaving EU will lead to a catastrophic market reaction that can push sterling down by more than 15 per cent. Soros broke the Bank of England and forced the central bank to abandon its 'exchange rate mechanism' by betting against the pound in a similar event in 1992. He said Brexit would be even more disastrous for the pound.
Obviously, any such event will lead to a huge volatility in the global currencies market and the dollar rupee rate would not remain immune.
At that time, the communication by the global central banks, and of course, by the RBI, would become crucial.
"Once Brexit happens, the market will be keenly examining what kind of statements come out," said Abhishek Goenka, managing director of IFA Global.
Goenka expects rupee to cross 68.20 level as the immediate reaction to Brexit, , despite interventions by the central bank. If Britain elects to stay back, rupee may strengthen back to 66.50 level.
Anticipating a volatility, RBI has already started putting out words of assurance for the markets.
RBI's governor Raghuram Rajan have said a number of times that India was prepared for any Brexit kind of events and have three line of defences ready. India has good policy, longer term maturity for debt holding by foreigners and of course, "plenty of reserves," Rajan said on Monday at an event in Mumbai.
"Brexit can be quite damaging if it happens. Of course, we have factored in some probability of it happening. If it doesn't happen, you could see some significant rebound. We are preparing for it and monitoring the markets," Rajan said at the event, adding:
"We will do what it takes to moderate market volatility, but once the initial bouts of wave abate, people look for good fundamentals."
Rajan had previously warned that London being a global financial centre, housing a lot of important companies' headquarters would certainly impact the global economy, including that of India.
From a trade perspective, however, Brexit may end up benefiting India in the long run, State Bank of India chief economist wrote in a research report recently.
"A Brexit-UK will have far greater latitude to negotiate with India as it will be free from the vast set of rules that come with EU membership. UK's investment and expertise in cyber security, its military technology are still competitive, and can become the point of convergence under Make in India. Hence UK may very well be compensated by loss of market in EU by gains in India," Ghosh wrote, adding Brexit may actually strengthen India's position as truncated EU may have to rework its negotiation strategy to gain market access.
