MUMBAI: If the risk aversion persists in the global markets due to Britain’s decision to exit the European Union, the benchmark Sensex could slide to 22,000 by the end of this financial year. While the initial impact of Brexit on India appears manageable, Ambit Capital said the second round impact could be lethal that would play out over several years. “Amongst the second round impacts, there are two things that are particularly worrying. Firstly, China could seize this opportunity to decisively devalue its currency and secondly Europe (which is already dealing with negative CPI inflation and negative interest rates) will now have to contend with the prospect of a drop in business confidence, which could tip Europe into recession and thus destroy Europe’s enfeebled banks. While the direct effects of Brexit on India appear worrisome, they appear to be manageable given that India’s export economy is relatively small. What is more worrying are the second round impacts of this momentous event which will play out over several years,” Ambit Capital said.
According to it, the trailing price earnings (PE) multiple of Sensex can be 14 times over an extended period of fear and risk aversion in the market as exhibited during the Lehman Brothers crisis. “Such a multiple implies a lower bound on the Sensex of 22,000. Hence, while our fair value for the Sensex as of end-FY17 is 29,500, there is a high risk of the index sliding to 22,000 as the 20th century construct of a global free market built around cross-border co-operation gradually breaks down,” it said.
Ambit Capital believes that Brexit could add to Indian rupee’s woes. There could be significant pressure on the rupee to depreciate as Brexit could lead to some of the $27 billion FII debt outstanding to head for the door; and India also faces a potential $25 billion (1.2 per cent of GDP) in outflows when FCNR deposits raised in 2013 matures especially at a time when India’s Capital Account Surplus (CAS) has been diminishing quarter after quarter.
According to Ambit, the combination of deflation and a recession in Europe would have far reaching consequences. Deflation has always been disastrous for banks anywhere in the world as it increases the real value of debt for the borrowers and does so in an environment where there is little demand (since customers postpone their purchases today in anticipation of lower prices tomorrow). As a result, corporates find it very difficult to repay their loans. “Furthermore, if deflation becomes entrenched, demand for new borrowing drops off. As a result, banks get crushed both ways in a deflationary world — NPAs rise and the loan book shrinks,” Ambit said.
