While Tata Motors-owned Jaguar Land Rover could lose 1 billion pounds by 2020, the rest of India Inc needs to hope for an eventually steady pound, decreased global financial panic and British access to the European common market.
New Delhi: When it rains, it pours. On Thursday, as the UK voted to leave the European Union, the Tata Group was hit with a double whammy.
Not only will Brexit will deeply impact two out of the conglomerate’s three major business, automobiles and steel, it also received another bit of completely separate, but still bad news from London: a court of corporate arbitration has ordered that the company pay nearly $1.2 billion in damages to NTT Docomo over a stake divestment disagreement.
The Tata Group’s exposure to Brexit – shares of Tata Motors and Tata Steel are currently down 12% and 9% on the Sensex – is emblematic of how India Inc (barring a few select industries) will be affected in the coming months and weeks.
Most corporate troubles stem from the fact that the UK is seen as an attractive business or entry point into the rest of the EU: Not only does the country rank high in the ease of doing business, it also has a favourable tax, legal and even labour regime (when compared to the rest of the EU). The cherry on the top is that unlike EU countries, a majority of the UK population speaks English.
So when the industry lobby Federation of Indian Chambers of Commerce and Industry says that “Brexit could create a lot of uncertainty for India Inc”, it is referring specifically to the fact that Indian companies are the third-largest source of foreign direct investment for the UK. The total combined turnover of Indian businesses in the UK hit 26 billion pounds in 2015.
“Out of all of India Inc, Tata Motors is perhaps the worst off when it comes to using UK as a base for EU. Even Apollo Tyres, which has UK operations, exports quite a bit from India to the EU and so is protected. Companies that have manufacturing bases in the UK are the most exposed,” said the senior executive of one India’s biggest automobile companies.
The exposure here refers to the import-export tariff barrier advantages that UK-based companies enjoy (because UK was a part of the EU) when compared to non-EU companies. Car companies like Honda, which for the longest time exported primarily out of Japan, pay on average a 10% import duty if they export cars from Japan to say Germany.
“Tata Motors on the other hand, through its luxury car subsidiary Jaguar Land Rover, because it exports from the UK counts as a local manufacturer since UK was part of the EU. Therefore, they enjoy a 10% price advantage when they make cars in the UK and then export them to other European Union countries,” CLSA analyst Mahesh Nandurkar told The Wire.
With Brexit, Indian business located in the UK stand to lose out on preferential access to EU markets and the advantages of import-export tariff barriers that they once joined.
This issue affects any Indian manufacturer based out of the UK: for instance Bharat Forge and Motherson Sumi, companies which make auto components, derive anywhere from 30%-60% of their consolidated revenues from the EU.
The impact of Brexit and the potential loss of an integrated UK-EU market is worse for Tata Motors because, in recent times, Jaguar Land Rover has done extremely well (accounting for almost 90% of the company’s operational profit) while the domestic (Indian) business has plummeted in comparison; the effects of Jaguar Land Rover therefore are likely to reflect quite harshly back on Tata Motors.
For Jaguar Land Rover, EU markets currently account for a little over 25% of its sales – the company also sources nearly 40% of its component requirements from the EU region. Just how badly will Jaguar Land Rover and Tata Motors be hit? In a statement, the company said that “access to our customers and suppliers is important to us – any changes could impact our sales, our costs and the skills base”.
An internal company report however, which was conducted for predicting future impact, places the worst-case scenario as Jaguar Land Rover losing an estimated 1 billion pounds by 2020; this analysis is based on a potential 10% levy on exporting vehicles to Europe and a 4% levy on imports of components.
Tata Steel is no better shape: the Corus Group, which it acquired in 2007 and now plans to sell off, exports 12% of its produced-in-UK steel to the EU. According to a CLSA note, these exports could now face higher import tariffs though this may be counteracted to a certain extent by a depreciated British pound.
There is an upside though, that could mitigate some of the Brexit impact on India Inc. As a handful of analysts and industry insiders The Wire spoke to pointed out, if Indian companies in the UK are disadvantaged as a result of Brexit, the UK government in the future (to maintain Indian FDI inflows) could potentially offer tax breaks and other incentives that would help out Tata Motors, Tata Steel, Bharat Forge and other Indian companies that set up bases in the UK.
Indian IT – Boon or Bane?
Shifting focus from manufacturing to services, the impact on Indian IT doesn’t appear to swing other way decisively. On one hand, as IT industry body Nasscom has noted in a statement, short-term volatility and currency swings are expected to have an effect on IT companies. The shares of Infosys, TCS and Tech Mahindra are all slightly down (~3-5%), mostly caused by the plunging pound.
“The United Kingdom accounts for nearly 25% of overall exports for us [Tech Mahindra] and IT companies.Therefore if the pound depreciates it will affect us immediately for the next two to three quarters. But after that our currency hedging strategies will kick in and help us out. There is no large change or impact to the fundamentals of our business,” a Tech Mahindra executive told The Wire.
Another argument floating around is that the immigration-centric campaign of the ‘Leave’ faction will result in harsher visa regulations in the UK, resulting in a lower free flow of Indian IT engineers from India to the UK.
And yet, if the anti-H1B rhetoric in the US is anything to go by, anytime there is global financial uncertainty and pressure on the margins of multinational companies, there is greater push towards outsourcing.
“After the US, the UK is the second largest market for India-based BPO and IT service providers. One way of looking at the impact of Brexit is this. As a financial squeeze sets in, the drive to save costs will either result in greater automation of IT services or greater outsourcing of IT services. As of now, the costs of automation haven’t become cheaper than what it would cost to outsource work to India or other offshore centres. So even if visa regulations become a little harsher, there may be more outsourcing especially if financial turmoil continues,” the Europe head of a major IT Indian company told The Wire.
India Inc and Global Financial Uncertainty
Stepping back though, many of the problems of India Inc face are similar: a lack of employee mobility between Europe and the UK, swings in the British currency and an outflow of foreign money.
There’s decent evidence to show, however, that India’s markets and economy are well-suited to withstand the global financial panic kicked off by Brexit: Asian stocks and currencies have plunged over fears that global investors will pull out of emerging markets in favour of assets and instruments that are viewed as more safe such as gold, top-rated government debt and the Japanese yen.
The arguments in favour of short-term volatility smoothening out for India and the rest of Asia are that India-UK trade ties and China/Asia-UK trade ties will remain largely stable. While India-UK bilateral trade is substantial (worth $14.02 billion), it is unlikely to be greatly affected even if an eventual decline in UK imports happens over the next two years.
As for Asia: exports to the UK account for only 0.7% of Asian countries’ GDP, according to Capital Economics Senior Asia Economist Daniel Martin; a decline in overall UK imports would knock “less than 0.2% off from regional GDP”.
The biggest question that confronts India and Asia is how governments and country-specific central banks will manage their foreign exchange reserves while limiting short-term and medium term volatility: A few hours after the Brexit result became clear, finance minister Arun Jaitley issued a statement aimed at calming Indian and foreign investors, saying that “our immediate and medium-term firewalls are solid in the form of a healthy reserve position” and that the “the RBI and regulators are well prepared and working closely to deal with any short-term volatility”.
As the day continues, controlling the fall of the rupee and dealing with foreign outflows will be two major issues.
Pushing for a Common Market
While India Inc will have to potentially restructure their European operations as they deal with the fallout of the Brexit – and the consequent issues of export tariffs and employee mobility – the next item on the agenda will be the new treaty between UK and EU which will replace the terms of the UK’s EU membership.
If the UK is able to negotiate an arrangement where the nation will still have favourable access to the European common market, the way, as numerous analysts and publications pointed out, Norway currently does, it could go a long way in offsetting the disadvantages that India Inc will face.
However, if UK has to negotiate for preferential market access, it will also have to concede on various immigration policies including the free movement of European students and working professionals: which are concessions the ‘Leave’ camp is staunchly against. If a new Prime Minister of UK is appointed — he has until 2019, which is when the actual exit will kick in, to figure this out.