Brexit impact on India limited,

some sectors could face heat

Rates could fall more, no significant downside to exports
June 2016
Britains decision to move out of the European Union (EU) comes at a time when the global economy is not in great
shape and growth forecasts for 2016 have been marked down. Brexit, therefore, has added to the weakness,
fragility and uncertainty, and not surprisingly, roiled markets.

Although Britain will remain a full member of EU for at least two more years, divorce negotiations with the European
Commission could commence under Article 50 of the Lisbon Treaty soon. How soon and how much these will
progress is anybodys guess.
The market reaction was more severe because in recent days most polls had suggested that the Remain camp
would win. This very strong reaction, more fundamentally, illustrates that we are moving into completely uncharted
territory, where the only certainty will be uncertainty, said Jean-Michel Six, Chief Economist, Europe, the Middle
East, and Africa of S&P Global, in a note titled Why Brexit Is Rocking Global Markets, released on Friday.
The political situation in Europe at the moment adds to the economic and financial uncertainty. This is because
important elections are due in France in May 2017, and in Germany in June 2017. More immediately, the October
referendum in Italy will likely turn the Italian government's attention to more domestic issues. What's more, crucial
elections take place on Sunday in Spain, the outcome of which remains uncertain. What this all means is that from
a European standpoint, one can fear that the real negotiations between the UK and the EU may not begin in
earnest before the middle of 2017, after the political air has cleared, Jean-Michel Six said.

These developments will shape the direct and indirect effects of Brexit and its short- and medium-term dimensions.
S&P Globals preliminary estimates suggest Brexit will knock off 100 basis points (bps) from the UKs growth and
50 bps from the EUs growth in 2017.
A weaker pound will help reduce the UKs current account deficit (CAD), currently around 5% of GDP, by
supporting exports and lowering imports. But other forms of capital flows such as foreign direct investments are
bound to suffer as investors postpone their decision or relocate due to heightened uncertainty.

CRISIL takes a look at both the macro and corporate level impact here:
1

Macroeconomic impact on India

The channels through which global shocks get transmitted to India include trade, credit, investments and capital
flows. Also transmitted is the element of confidence. During the peak of global financial crisis in 2008-09, and also
at the height of the Greek crisis, we saw all of these at play. Given the uncertainty with the Brexit process, it should
not be merely viewed as an event but as a process that will gradually unfold -- with intermittent mini-frights thrown
in -- as negotiations proceed. We have already seen how capital flows affect the stock and currency markets. So
how are these developments likely to impact the Indian economy in fiscal 2017 and the corporate sector in the
medium term? We take a look:
We dont presage big change in GDP growth this fiscal
Brexit is unlikely to have a notable impact on GDP growth in fiscal 2017, and we retain our forecast at 7.9%, with
agriculture as the swing factor. The spatial and temporal distribution of rains in July and August will matter more to
domestic growth.

No significant downside to exports

In the short run, we do not see a significant downside to India's exports. UK accounts for 3% of merchandise
exports from India. Further, Indias total trade (exports + imports) with the UK is only 2% of its external trade. Over
the medium term, Indias exports, especially in consumer-oriented sectors (auto components, textiles, leather and
footwear and precious stones and metals, which together comprise nearly 45% of exports to the UK), and also in
services, will depend on the severity of slowdown in the UK and ructions in the exchange rate.
Peer currencies key to Indias trade competitiveness
Indias trade competitiveness with the UK will not just depend on how rupee behaves versus pound, but also on
what happens to the exchange rate of Indias competitors. If their currencies also appreciate against the pound,
Indias relative competitiveness will not be impacted much. Indias trade competitiveness will also be shaped by the
movement on domestic costs and productivity.

CAD seen up 20 bps at 1.3% this fiscal

We forecast CAD at 1.3% of GDP in fiscal 2017, 20 basis points more than the 1.1% seen in fiscal 2016. Overall,
we expect export growth to be tepid through calendar 2016 given that global growth forecasts are edging lower. For
yet another year, low imports (due to subdued oil and commodity prices) will shield Indias CAD. But there will be
some upside from core imports (non-oil, non-gold), which are expected to rise on the back of a pick-up in domestic
consumption and to some extent investment demand. This will put upward pressure on CAD.

Re seen 50 paise weaker at 66.5/$ by fiscal-end

The rupee could see volatility in the coming weeks as global markets remain angsty. We expect the local currency
to settle around 66.5 per dollar by March 31, 2017, with a downward bias (our earlier forecast was 66).

The good thing is that over the medium term, subdued global outlook more so in Europe after Brexit could
divert investments to India because of stable outlook and higher-growth prospects compared with other emerging
markets. It is very likely that the world will once again be awash with stimuli-driven liquidity and monetary policies
will remain accommodative for even longer than previously anticipated.

Inflation seen flat around 5%

We maintain our inflation forecast of 5% for fiscal 2017 as domestic factors such as the monsoon remain
favourable. Global growth will be subdued, keeping oil and commodity prices benign, which is a positive for inflation
in India. Also, we expect lower food inflation resulting from a normal monsoon to offset higher services sector
inflation. Proactive measures taken by the government and continued fiscal consolidation will keep inflationary
pressures at bay in fiscal 2017.

Interest rates could fall more

The Reserve Bank of India (RBI) is likely to reduce its policy (repo) rate another 25 bps in the second half of this
fiscal. We expect the RBI to intervene and manage liquidity through open market operations and use its foreign
exchange reserves to tackle currency volatility and capital outflows. So far this year, the RBI has already conducted
Rs 700 billion of open market operations.
Yield differential improves in India
Brexit also creates a downward bias in domestic rates. While the Sensex and the Nifty fell ~2.5% each on Friday,
the rupee slipped as much as 1.5% against the dollar before recovering. On the other hand, 10-year G-sec yields
remained stable ~7.48% after opening at 7.50% on Friday. The fact that yields in major advanced economies have
fallen more means India offers greater yield differential, making its bonds attractive to foreign investors in the near
term. The possibility of the US Federal Reserve slamming the brakes on rate hikes for now improves the prospects
of fresh foreign portfolio flows into Indian debt, which, in turn, will put downward pressure on local yields.
as yields plunge in developed markets
The yield on 10-year US treasury fell to a four-year low of 1.47%, while the German bund and Japans JGBs hit
record lows of -0.17% and -0.19%, respectively, in the immediate aftermath of Brexit.

Central banks cock liquidity guns

Mark Carney, governor of Bank of England, has said he is ready with a 250 billion bazooka. He also said the
capital requirements of Britains largest banks are now ten times more than what it was before the crisis, thanks to
stress tests. As a result, banks in the UK have raised over 130 billion, and currently have more than 600 billion of
high-quality liquid assets. Carney hopes this will help banks to continue lending in the UK.

Meantime, global central banks, including the European Central Bank, the US Federal Reserve -- are expected to
do whatever it takes to avoid a liquidity freeze, including opening up swap lines. The RBI has also assured its
preparedness for any eventuality.
3

Impact on India Inc

Indian companies are likely be impacted in multiple dimensions such as:

Demand weakness on account of potential slowdown in the EU and the UK;

Volatility in commodity prices; currency impact on account of the potential depreciation of the rupee, euro
and the pound;

Translation losses for companies with significant operations in the UK and the EU; and,

Balance sheet impact on account of exposure to unhedged overseas borrowings.

Heres how we see the implications:

Auto, IT, textiles, pharma, leather & metals are the most vulnerable sectors
Companies in sectors such as automobiles, auto components, information technology services, textiles,
pharmaceuticals, gems and jewellery, leather, and leather products are most vulnerable to changes in demand and
currency value. Metal companies would be hurt by the likely downward pressures on prices and potential slowdown
in demand, at least in the near-term. Sectors such as shipping and ports that are reliant on global trade will also
have to grapple with lower growth and consequently lower freight rates and utilisation. Further, companies with
unhedged overseas borrowings will be affected by volatility or temporary sentiment-driven weakness in the rupee.

Compliance, administration costs to rise for companies

The impact of Brexit on global growth and trade in the long-term would depend on how negotiations between the
UK and the rest of the EU-member countries pan out something that is difficult to quantify at this juncture.
Companies may also, over the long-term, have to grapple with increased administrative and compliance costs, as
they may have to set up base in other countries also in the EU. Currently, most companies set up their European
headquarters in the UK, and use London as their gateway to the European market.

Auto parts makers in line of fire, but limited impact on OEMs

Within the automobile space, component suppliers will be more adversely impacted compared with original
equipment manufacturers -- with the exception of the JLR business of Tata Motors. The impact on the JLR
business will depend on how trade agreements between the UK and other EU countries are rewritten. On the
positive side, a depreciating pound will make JLRs exports from the UK more competitive, at least in the near-term.

A quarter of auto parts exports are to Europe

Around a quarter of Indias auto component exports are to Europe. The UK has a share of ~5% in overall exports.
Any dampening of prospects due to economic uncertainty and depreciation of the pound would have a
corresponding impact on the revenues of these companies. Furthermore, companies with plants in the EU/UK
would also have to contend with translation losses. Some auto component companies with significant exposure to
Europe include Motherson Sumi, Bharat Forge, and Apollo Tyres.

Price volatility, demand slump to dent metal companies

Global steel and aluminum markets are already grappling with overcapacity and concerns on demand growth in
China. Demand in the EU was already very weak, and the new bout of uncertainty means demand will slump
further, putting downward pressure on prices and profitability of manufacturers. This comes at a time when
leverage is high for many companies and some of them have significant overseas debt.

Garment exporters in the eye of the storm

Europe is the single-largest market for Indian garment exports, accounting for around 35% of such revenue.
Garment exporters are, therefore, bound to feel the pinch, in spite of tax and production incentives announced by
the Narendra Modi government recently. In 2015 as well, these exporters were impacted by a 4.5% decline in
demand from the EU. The weakening of the euro against the dollar affected revenues in dollar terms.

Double whammy for IT: fall in discretionary spending, rise in administrative costs
For IT services, Europe (including the UK) accounts for around 29% of total exports. The UK alone accounts for
~17% of overall exports. The economic uncertainty in the EU and the consequent impact on discretionary spends
such as IT would, therefore, hurt domestic software companies. Expenses of these companies may also go up if
mobility of professionals between the UK and the EU is restricted. On the positive side, however, large IT service
providers in India do not have much exposure to the pound and the euro. For example, revenue denominated in
pound and euro accounted for only 6.6% and 9.3%, respectively, of Infosys revenues in fiscal 2016. The
corresponding percentages are a tad higher at 13-14% and 7-8% of revenues, respectively, for TCS and Wipro.

Pharma largely unaffected

The European market accounts for around 12% of Indias total exports of pharmaceuticals. Of this, the share of the
UK is 3.5%. Therefore, the sector is unlikely to be significantly affected, but companies such as Aurobindo and
Wockhardt, with higher exposure to Europe, will see some impact.

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