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HEADWINDS FOR INDIA BREXIT AND ITS IMPACT VIA OTHER COUNTRIES.

DSDS
Rajan Govil and Janak Nabar
July 4, 2016 Insights 2016/01

Summary
The challenges India faces will be two fold the direct impact of any slowdown in EZ and the
policy response that may be unleashed in China , Japan and other countries to counter their own
economic slowdown, both domestic as well as external.
The ongoing slowdown in China is impacting the global economy, and especially commodity
exporters from the emerging market countries.
More than 50 percent of Indias exports are to emerging market countries, and thus the ensuing
uncertainty will further weigh on Indias external sector.
A weaker renminbi and an overvalued Indian rupee has begun to erode Indias competitiveness
as well as market share in recent years
Progressively weaker data out of China will add to the depreciation pressure on the Chinese
renminbi. Further currency depreciation by the Chinese authorities will hurt Indias domestic
industry unless reciprocated by a weaker rupee
Brexit offers India a great opportunity to ask the difficult but much needed question - what are
Indias top macroeconomic policy priorities? If India is to sustain growth of around 8.0% over the
long run, it will need policies that will not only help the country counter the risks in the global
economy, but also policies that will help boost productivity and increase the competitiveness of
Indian firms.

Headwinds for India Brexit and its impact via other countries
As the global financial markets grapple with the decision taken by the UK to exit the EU, it is clear
that the question of future referendums in other member countries and potential exits will likely
dominate the headlines in the coming months. The Indian economy has seen its total exports decline
for 18 straight months, hurt by an overvalued exchange rate as well as a weak global economy. The
uncertainty that will likely unfold in the major EU countries and especially the Eurozone (EZ) will add
to the headwinds for a recovery in Indias exports. The challenges India now faces will be two fold
the direct impact of any slowdown in EZ and the policy response that may be unleashed in China ,
Japan and other countries to counter their own economic slowdown, both domestic as well as
external. The EU is Chinas largest export destination after all and Chinas currency, the renminbi
(RMB) already faces depreciation pressures from capital outflows. A move by the Chinese authorities
to allow their currency to depreciate further will continue to hurt Indias domestic industry unless
reciprocated via a weaker rupee.

The recovery in the EZ has been a fragile one, with the region having only emerged from a prolonged
recession in 2014. The past year has seen a broad based recovery (as can be seen in the chart on EZ
industrial production below) which has continued into 2016 along with a decline in unemployment

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rates across countries. Given the results of the UK referendum and the consequent uncertainty, both
for businesses and households, the broad based recovery in the EZ will now remain suspect.

Figure 1: Broad based recovery in EZ under threat?

Index of Industrial Production (3mma, y-o-y, %)

6

Dec-14
Jun-12
Aug-12

Dec-12

Jun-13
Aug-13

Dec-13

Jun-14
Aug-14

Jun-15
Aug-15

Dec-15
Apr-12

Oct-12

Feb-13
Apr-13

Oct-13

Feb-14
Apr-14

Oct-14

Feb-15
Apr-15

Oct-15

Feb-16
Apr-16
-2

-4
IIP: France
IIP: Germany
-6 IIP: Italy
IIP: Spain
-8 Overall Industrial Production

Source: CEIC, Marketnomix

The broad based recovery in the EZ, which was expected to see GDP growth of around 1.6% in 2016,
has been supported by a gradual improvement in domestic private consumption. Besides an
improvement in intra-EZ import numbers that have supported this view, one can also see evidence
of this in the improvement in the export numbers on a trend basis for a number of countries that
export to the EZ. As can be seen from the chart below (Figure 2), exports from the US, China and
India are just on the cusp of seeing positive growth on a trend basis, while the exports from Japan
have seen a healthy pick up in recent months. Prolonged global risk aversion and a strengthening
Japanese Yen will have its own set of consequences for the Japanese economy and policy responses,
and which should be the subject of a separate piece altogether.

Our concerns here are focused on the direct and indirect impact on the Indian economy from a
potential slowdown in the EZ economy. The direct impact is clear a stalled recovery in Indias
exports to the EZ. The indirect impact, in particular from the slowdown in China, warrants closer
attention. The ongoing slowdown in China is impacting the global economy, and especially
commodity exporters from the emerging market countries. More than 50 percent of Indias exports
are to emerging market countries, and thus the ensuing uncertainty will further weigh on Indias
external sector.

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Figure 2: Exports to the EZ (3mma, y-o-y, %) reflect gradual pick up in EZs private consumption

70 India
60 Japan
50 China (Exports to EZ 6*)
US
40
China (Exports to EU)
30
20
10
0
-10
-20
-30
Apr-10

Apr-11

Apr-12

Apr-13

Apr-14

Apr-15

Apr-16
Source: Reserve Bank of India and Ministry of Statistics and Programme Implementation, Government of India.

Chinas recent economic indicators have continued to reflect the ongoing slowdown in the economy.
While growth in industrial production has been steady over the last few months, hovering around
6%, the trend in retail sales of consumer goods as well as fixed asset investment has continued to
slow. The massive buildup in total credit in the economy, which stands close to 200 percent of GDP
will continue to weigh on Chinas growth prospects. The authorities have already cut interest rates
six times since November 2014, and further monetary easing is likely to be limited. One of the
consequences of these rate cuts has been a sharp double digit increase in real estate prices in Beijing
and Shanghai. Liquidity will likely be a stress point in the Chinese economy going forward. Chinas FX
reserves declined USD 600 billion in 2015, undoing much of what was earned through a trade
surplus during the same period. The decline in FX reserves has continued on a year-to-date basis,
having declined around USD 140 billion to USD 3.2 trillion as of May 2016, while the trade surplus
has been around USD 220 billion on the back of a sharper decline in imports. Non-oil imports, a
proxy for domestic demand, has also seen close to double digit declines on a trend basis for some
time now.

Progressively weaker data out of China will add to the depreciation pressure on the Chinese
renminbi. With uncertainty now clouding the outlook for its largest export destination, the EU,
limited policy options with respect to the interest rate may force the Chinese authorities to choose a
path of allowing for a faster pace of depreciation of the currency, which will be detrimental to Indian
Industry.

The combination of a weaker renminbi and an overvalued Indian rupee has already been gradually
taking its toll on Indias domestic industry, eroding its competitiveness as well as market share in
recent years. Figure 3 is telling in that the exports of goods from China to India (Chinese imports into
India), grew around 7.0% y-o-y in 2015, the only country with positive export growth to India among
some of the major global economies exporting to India. The significance of Chinese imports into
India can be even better understood if one looks at Figure 4, which shows how imports from China
have grown multi fold over the last ten years. In 2005, the import of goods from China stood at
around USD 10 billion whereas in 2015, imports from China were around USD 60 billion. To the

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extent this competes with Indias manufacturing, it amounts to around 15% of Indias
manufacturing sector already (not a like to like comparison exactly, but value added in
manufacturing in India is about US$320 billion at 16.2% of GDP), and which is only likely to increase
in the coming years hurting Indias manufacturing.

Brexit therefore offers India a great opportunity to ask the difficult but much needed question -
what are Indias top macroeconomic policy priorities? If India is to sustain growth of around 8.0%
over the long run, it will need policies that will not only help the country counter the risks in the
global economy, but also policies that will help boost productivity and increase the competitiveness
of Indian firms. For now the growth risks in the Indian economy are tilted to the downside.

Figure 3: Chinas exports to India outpaced those of other major economies in 2015

Exports to India (y-o-y, %)

75

60

45

30

15

0
2000

2003

2006

2009

2012

2015

-15

-30
China Euro Zone USA Japan

Source: CEIC, Marketnomix

Figure 4: Imports from China are potentially competing with around 15% of Indias manufacturing sector

700 India Annual Imports by Country of Origin

(Rebased, 2005=100)
600

500

400

300

200

100 EZ US
Japan China
0
Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Jan-15

Source: CEIC, Marketnomix

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About Us
Marketnomix comprises a team of professional economists providing sound macroeconomic inputs
that capture developments in the global economy. Marketnomix aims to positively impact the
strategic decisions of individuals and firms.

Rajan Govil and Janak Nabar are co-founders of Marketnomix. Between them, they have close to 40
years of experience covering a number of economies. Their research experience spans the sell-side
as well as the buy-side, including as global asset allocators. They have provided guidance to
institutional clients, corporate treasuries, family offices and high net worth individuals with
businesses and investments across the world.

Rajan has worked as an economist with the International Monetary Fund (IMF) and as
economist/investment strategist with the private financial sector. He presently consults for the IMF
and the Asian Development Bank. Rajan has worked as Chief Economist-India and later Regional
Economist for Asia-Pacific at HSBC Bank, and as the Head of Investment Strategy, Asia at BSI Bank.
Rajan has taught at Delhi University, Indian Institute of Management Bangalore and Vanderbilt
University. He has a PhD in Economics from Vanderbilt University.

Janak was until the end of 2014, a Senior Investment Strategist at BSI Bank Ltd, Singapore, having
assumed responsibility for the Banks macroeconomic and asset price outlook for Asia in December
2013. He has worked as an Economist focusing on the Asia-Pacific region with IDEAglobal Ltd. His
work experience includes two years with the United Nations High Commissioner for Refugees in
Belgrade, Serbia. Janak holds an MSc (Econometrics and Mathematical Economics) from the London
School of Economics and Political Science, MA (Mathematics) from Balliol College, University of
Oxford (as a Radhakrishnan Scholar), and BA (Mathematics) from the University of Pune, India
(ranked first in the University). He currently also heads the Centre for Technology, Innovation and
Economic Research (CTIER), an independent think tank based in Pune focusing on innovation and
technology policy in India.

Contact Us
Email addresses: Telephone:
rajan.govil@marketnomix.com Singapore: +65 8149 3016
janak.nabar@marketnomix.com Bangalore, India: +91 77600 13847
Pune, India: +91 90493 54925

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