Just as the financial health of Indian companies was recuperating, with early signs of earnings upgrades on the anvil, a major global event – which many hoped wouldn’t materialise – is threatening to derail the process of recovery. In the early hours of Friday, it became clear that a majority of the citizens of the United Kingdom (UK) had cast their vote in favour of Britain exiting the European Union (EU), a potential phenomenon that has been christened as ‘Brexit’ in recent days.
While the British Parliament will need to take a call on how it wants to act on the results of the public referendum and an actual exit from the EU may be not less than two years away, panic gripped the Indian bourses on Friday morning, with investors expecting the worst for Indian companies, especially those that have a significant exposure to the UK and European Union.
At 11.17 am, the S&P BSE Sensex, the benchmark index of the BSE fell by 977.90 points, or 3.64 percent to 26,024.32 points. While the massive decline in the Sensex may be a knee-jerk reaction to Friday’s events (since the full implication of the global development is yet to be ascertained), it is clear that Indian companies stand to be impacted in two ways.
First, there was a clutch of Indian companies that had used the UK as a base to export goods and services to the rest of the EU region. Since the EU was one economic entity earlier, countries within the Union could freely trade with each other. If the UK eventually breaks away from the EU it may not enjoy the free trade privileges that other EU countries do. What these new trade barriers for UK-based companies looking to do business in the EU may look like are yet to be seen, but this uncertainty impacts companies like British carmaker Jaguar Land Rover (JLR).
JLR, a Tata Motors Subsidiary, exports around 24 percent of the cars it manufactures in a year to other European countries, which makes Europe its biggest market. An article that appeared on the website of the British newspaper The Telegraph on June 21 stated that the financial hit for JLR owing to Brexit could be to the tune of £1 billion, on its bottomline by 2020. This could be a result of the 10 percent levy on vehicles being exported to Europe and a four percent import duty on auto components that British carmakers may have to face once the free trade arrangement comes to an end.
Not surprisingly, shares of Tata Motors plummeted by 11.59 percent during Friday morning trade on the BSE at Rs 431.45 per share. It is worth noting that while Tata Motors’ Indian business has been struggling to regain market share and has been a drag on the company’s consolidated financials, it is JLR that has been providing some measure of comfort and support to the company’s earnings.
“We respect the views of the British people and in line with all other businesses, Jaguar Land Rover will manage the long-term impact and implications of this decision: Nothing will change for us, or the automotive industry, overnight,” a JLR spokesperson said in a statement. “Europe is a key strategic market for our business, comprising 20 percent of global sales, and we remain absolutely committed to our customers in the EU. There will be a significant negotiating period, and we look forward to understanding more about that as details emerge. We look forward to working with the British government and the automotive sector to ensure that the UK’s automotive industry remains as competitive as ever, and that negotiations between the UK government and the EU will continue to recognise the importance of car manufacturing to the UK and European economies.”
“The knee-jerk reaction of the markets was expected,” says Sudip Bandyopadhyay, chairman of Inditrade Capital. “Many Indian companies have manufacturing operations in the UK from where they service the EU. With the possibility of free trade arrangements coming to an end following Brexit, their business operations would need to be re-adjusted.”
Bandyopadhyay also said that there are templates of European countries such as Norway that aren’t a part of the EU but enjoy free trade rights, but it remained to be seen if a similar arrangement could be and would be worked out with the UK.
“My sense is that many of these companies may look at Ireland as an alternative to the UK since it is also an English-speaking country and still a part of the EU,” Bandyopadhyay said. “There are also reports suggesting that Scotland may want to break out of the UK and remain a part of the EU, as was indicated by the recently concluded referendum on Brexit.”
Meanwhile, fears surrounding the potential fallout implications of Brexit also led the British sterling pound to plunge to its lowest level in three decades, weakening more than 10 percent in a single day, to hit around $1.33 at one stage. This is bad news for many Indian companies that earn in pounds from their British operations and repatriate the income back home, often converting it into dollars before doing so. The euro also declined by as much as 3.3 percent against dollar, its biggest fall in a single day since inception.
The other Indian company that is likely to be impacted for reasons similar to those affecting Tata Motors is auto components maker Motherson Sumi. The Vivek Chand Sehgal-led global auto components behemoth has significant operations in Europe and is a leading supplier to almost all European carmakers, including Audi, BMW, Volkswagen, JLR, Renault-Nissan, and Porsche. Motherson Sumi’s share prices tanked by 10.92 percent on the BSE on Friday to trade at Rs 268.90 per share.
Some of the other Indian industrial sectors that have significant exposure to the EU (and therefore are at risk of being impacted) include metals (Tata Steel and Hindalco) and pharmaceuticals (Lupin and Dr Reddy’s Laboratories). Share prices of all of these companies and their peers lost ground on Friday.
The currency fluctuations caused by the political developments in the UK on Friday also threaten to push up costs for Indian companies. The Indian rupee weakened past the 68 mark (versus the dollar). The depreciating rupee, along with a gradual rise in the price of crude, doesn’t bode well for the Indian economy (and companies such as energy firms that are dependent on oil prices) since crude, bought mostly in dollar terms, is the largest component of India’s import basket.
India’s Finance Minister Arun Jaitley said on Friday that the UK referendum verdict will further contribute to global volatility. “All countries around the world will have to brace themselves for a period of possible turbulence while being watchful about, and alert to, the referendum’s medium term impacts,” Jaitley said in a statement. “As regards, the Indian economy, we are well prepared to deal with the short and medium term consequences of Brexit. As investors look around the world for safe havens in these turbulent times, India stands out both in terms of stability and of growth. Our growth and inflation prospects are further improving in the wake of the good monsoon that are now moving well across India. The government and the Reserve Bank of India as well as other regulators are well prepared, and working closely together, to deal with any short term volatility. Our aim will be to smooth this volatility and minimise its impact on the economy in the short term.”