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Britain's decision to opt out of the European Union-EU
(Brexit) has rattled markets across the world. With the Brexit result only a
few hours old and the situation extremely fluid it is extremely difficult to
forecast the economic and financial impact on Asia, however Nomura feels
financial, confidence and psychology channels are likely to be more important
than trade linkages during these times.
"We should not underestimate the global contagion of
the Brexit outcome," Nomura said, adding, "At first glance it would
seem that the financial and economic impact of this result should be largely
confined to the UK, given that its economic size is quite small at less than 4%
of world gross domestic product (GDP) and world imports in 2015. However, we
believe that this is too simplistic of a view and that the impact of the Brexit
will be far reaching and long lasting."
According to Nomura report, there are two reasons for
this. One, it expects non-trivial spill over to the euro area economy and
financial markets and second, Brexit could further inflame anti-EU
sentiments.
It says, "While the value of merchandise exports
from the rest of the EU to the UK is only 3% of the rest of the EU’s GDP, the
UK’s position as a global financial hub – UK financial sector assets account
for more than eight times of its GDP – leaves the rest of the EU much more
exposed to the UK in terms of financial and investment linkages, in part
reflecting the UK’s relatively liberalised domestic market and its strong legal
framework and institutions. For example, one-third of UK's financial and
insurance services exports are to the EU. Also more than half of the UK banking
sector's cross-border lending is directed towards the EU, while almost half of
the foreign direct investment (FDI) received by the UK comes from the EU."
In addition, it says, Brexit could further inflame
anti-EU sentiment in other EU member states, heightening fears of more
countries opting to leave the union. "It is largely due to these
non-trade-related channels that we expect a reduction in euro area GDP growth
by 0.5 percentage points (pp) and a weaker EUR/USD.3 While UK share of global
GDP is less than 4%, the rest of EU’s share is 18%, so once second-round
effects on Europe are taken into account, the global impact is no longer
trivial," it added.
Talking about the Brexit impact on India, Nomura says, as
Indian economy is largely driven by domestic demand, the economic impact (of a
Brexit) should be small relative to other open economies in Asia. “Still, India
is not immune, as it has strong trade linkages with the EU and is susceptible
to a loss of business confidence and a potential tightening of financial
conditions. In our view, any adverse impact could be partly cushioned by
upcoming domestic impulses to growth such as good monsoons, pay commission
hikes and a likely easing of policies (both monetary and fiscal) but,
nonetheless, we expect the growth recovery to slow.”
Nomura thinks a globally coordinated central bank
response to a global financial market meltdown is quite likely, such as
liquidity support through forex (FX) swap arrangements and possible FX
intervention. But with policy credibility at such a low it is unclear how successful
these emergency measures would ultimately be when there is extreme market risk
aversion, it added.
On the Brexit result, Nomura says it has tentatively
lowered its aggregate 2016 GDP growth forecast for Asia ex-Japan to 5.6% from
5.9%. The largest percentage point (pp) downgrades are for Hong Kong (1.0pp)
and Singapore (0.7pp), followed by Taiwan (0.6pp), Thailand (0.5pp) and
Malaysia (0.4pp). At the other end of the spectrum, Nomura says it has lowered
its 2016 GDP growth forecast by only 0.2pp for Australia, China, Indonesia and
the Philippines.
Nomura also expects significantly more monetary policy
easing in Asia. It says, dovish central banks, a weak growth outlook and a
dovish Fed are bullish for most Asia rates.
"Between now and year-end, we expect the Reserve
Bank of India (RBI) to cut by 25 basis points (bp) from no cut previously,
Korea by 50bp (25bp previously), Indonesia by 50bp (25bp), Taiwan by 50bp
(37.5bp), Thailand by 50bp (50bp), Malaysia by 25bp (no cut previously). For
China we have increased the number of RRR cuts by year-end from two to three,
in addition to one interest rate cut. The only Asian central bank that we
expect to keep rate on hold is in the Philippines. We now expect the Monetary
Authority of Singapore to re-centre the mid-point of the S$NEER policy band
lower at, or before, its October policy meeting," it added.
Talking about the economic implication on UK, the report
says, the impact (of Brexit) is likely to be prolonged rather than short term.
It said, "The uncertainty over the future of the UK means investors can be
expected to demand a higher risk premium for holding UK assets, which coupled
with the need to finance a 7%-of-GDP current account deficit, should result in
a large – and persistent – depreciation of pound."
"Beyond the trade channel, once financial,
confidence and psychology channels are taken into account, we caution not to
underestimate the depth and reach of financial market contagion to Asia,"
it concluded.
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