As UK votes for PM, it's a case of May be and May be not

Britain's Prime Minister Theresa May speaks during an election campaign event in Bradford, Britain, June 5, 2017. REUTERS/Phil Noble - RTX39625

Anubhav SahuMoneycontrol Research

When Theresa May called for a snap poll in April, markets expected the Tories (Conservatives) to coast to an easy win. Tories still appear the favourites, going by most opinion polls, but the margin of victory could be smaller than previously expected. Some opinion polls are even predicting a hung parliament. Broadly, pollsters are expecting Tories to win anywhere between 302 and 360 seats out of the 650 seats being contested.

 UK opinion poll expectation converging for leading parties

Source: Financial Times

Predicted seats as per Electoral calculus and YouGov

Source: Bloomberg, Moneycontrol

Election results are expected to set the tone for Brexit talks. But the immediate impact would be on the currency. A Bloomberg survey predicts a sharp depreciation in the Pound Sterling if there is a fractured verdict or if the Labour Party wins. A Conservatives win could boost the currency as it removes the political uncertainty and continues the political engagement with EU members on the Brexit.

A significant political capital – say a majority of 60+ - would help Theresa May in quelling the opposition within her party. Her current working majority is that of 17. (Conservative MPs less all other parties, excluding the Speaker, two deputy Speakers and Sinn Fein MPs.)

A conservative victory with a small margin would be a status quo scenario. It doesn’t necessarily mean that the decision to hold snap poll has misfired because it nevertheless provides extended period of continuity that is crucial for the Brexit negotiations in later years.

A hung parliament would mean a political deadlock for couple of weeks which becomes even more interesting in light of formal Brexit talks on the anvil (19th June)

A Labour party win, which is a least likely outcome, would weigh on the pound in the short term.

In the medium term, the currency could remain volatile as the Brexit talks would continue to sway the currency. The Brexit process, on the other hand, is not likely to reverse, even in the case of a Labour party win. Labour party leader Corbyn had already ruled out a second Brexit referendum.

Currency movements

Source: Moneycontrol

Impact on Indian markets

In our earlier note on the UK election, we had highlighted UK election as the event risk and had advised hedging the currency exposure.

IT, automobiles, textiles, gems and jewelry, metals and mining sectors are among the key sectors to be impact by any sharp move in the pound sterling.

IT, which continues to deal with the challenges from Brexit and immigration woes in the US, will be most sensitive to currency swings and the economic recovery in the United Kingdom. For the Indian IT industry, 28 percent of the services are exported to Europe, with UK constituting around 17 percent. A depreciation in the pound would further dent export revenues. Infosys has relatively lower revenue exposure denominated in pound (7 percent) and euro (9 percent) compared to its peers TCS and Wipro. Tech Mahindra has relatively higher exposure to the British currency.

In the auto sector, the UK and EU account for about 4 percent and 16 percent respectively of automobile export from India. Companies like Mahindra CIE, Bharat Forge and Motherson Sumi earn 40- 65 percent of their revenues from these regions. As far as Tata Motors is concerned, impact on the JLR business (around 40 percent of JLR’s exports are in dollars) in medium term depends on Brexit negotiations and trade restrictions within Europe.

Gems and jewellery is another segment to look at. Indian companies import rough diamonds from the UK and exports precious gems and jewels. UK accounts for about 10 percent of India’s gems and jewellery exports (USD 40 billion). However, most of the billing for the imports are done in dollar terms, so the impact is relatively less. However, for the sector, a matter of greater concern is the prospect of reduced demand due to relatively weaker economy.

Among metals and mining, Tata Steel and Hindalco are amongst those having a substantial and direct exposure to UK. In addition, the pharma sector has about 4 percent exports to UK.

Overall there are range of sectors and companies which could be impacted by sharp currency moves. Having said that, medium term trajectory for the currency depends on inflation expectations, BoE’s assessment of the economy and the Brexit negotiations.

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