On June 23, Britain will vote on whether it should remain in an evolving confederacy the European Union or not. As the world waits with bated breath for the outcome, S. Umamaheshwar traces how the result could impact the India story.
Over three years ago, Russian President Vladimir Putin’s spokesman dismissed Britain saying it is “just a small island … no one pays any attention to them”. While Britain lodged a protest over the Russian observation and started a long campaign to highlight that it is still a power to reckon with, nothing could have demonstrated UK’s power as its threat of leaving the European Union had done.
Nobody would have taken cognizance of Britain’s vote to decide its relations with the EU, if it was just a referendum deciding the fate of nearly 61 million people (0.82 per cent of global population or equivalent to Gujarat) or a country spread over 209,331 km (0.14 per cent of total land mass or little more than Karnataka).
This vote threatens to unsettle the fate of fifth largest economy of the world, the biggest economic bloc in the world EU, and the world’s second largest financial centre — London.
Any structural change in a country with such an influence will no doubt trigger tremors, which will affect all countries positively or negatively, directly or indirectly in varying degrees.
If Britain decides to exit the European Union, it will directly impact at least two global reserve currencies — the UK’s pound sterling and the EU’s euro as the Britain and continental Europe are inter-dependent and have huge trade volume.
Now, let’s think of its impact on India and its economy. Any depreciation in the rupee and strengthening of dollar would lead to lower currency-adjusted returns for foreign investors. This is something every investor would like to avoid. Hence there could be some flight of capital from stock and bond markets, putting pressure on our $339 billion foreign currency reserves.
This is a scenario which could be triple whammy for us, though the magnitude of impact will be dependent on the amount of dollar outflow and dollar appreciation. Let’s see the effects of this:
1) Rupee may depreciate due to the double effect of foreign fund outflow and dollar rise.
2) Outflow of foreign funds may reduce India’s foreign currency reserves and again exert pressure on rupee.
3) Fall in rupee price compared to dollar will increase petrol and diesel prices to an extent.
4) If the government does not want to pass on this, then it will have to reduce additional excise duty imposed on fuel when it was on downward trajectory. This will increase fiscal deficit, unless revenue was increased through other means.
5) Since India’s imports like oil are not dispensable, any increase in the rupee-dollar gap would lead to higher import bill.
6) The prices of gold, electronic goods, among others will increase.
7) Higher oil price may increase inflation to an extent.
8) On the positive side, cheaper rupee will make Indian exports, including IT and ITeS, competitive. If the country is marketed well, India could become manufacturing hub due to low cost.
Apart from its impact on financial markets and economy, the Brexit will affect Indian companies which have operations in Europe. Currently, most Indian companies based in London, due to obvious advantage of language among other factors, to run their European businesses. However, after the Brexit, London may no longer enjoy the advantages that it has with the European Union.
This could result in these companies setting up their offices in continental Europe, which could increase companies’ cost of operations partially.
On positive side, a Brexit could force Britain to forge closer ties with India and China apart from its traditional partners like the United States and continental Europe.
All these scenarios are contingent upon Britain exiting the EU. If it chooses to stay with the EU, it will remain one of the key pillars of the world’s largest economic block. Or else, Britain would really end up as the small island that nobody would pay attention to.
