Brexit: Expect Waves Of Contagion on Asia

By Rupert Hargreaves 

Analysts across Wall Street and the City of London are currently weighing in on the implications of Brexit for the UK, Europe, the US and the rest of the world.

Nomura’s Global Markets Research division is warning on the potential contagion effects Brexit could have on markets in Asia.

Nomura’s analysts expect a globally coordinated central-bank response to the ‘leave’ vote to prevent a global financial market meltdown. Liquidity support through FX swap arrangements and possible FX intervention is likely.

However, with central bank policy credibility hanging by a thread, it’s unclear how successful these emergency measures will ultimately be when there is extreme market risk aversion.

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But it is clear that the UK’s decision to depart the European Union will have a large effect on Asian economies.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 is much more significant. The UK financial sector assets account for more than 8x its GDP. What’s more, Brexit could further inflame anti-EU sentiment across the European block and for this reason, Nomura is forecasting a reduction in the Euro area GDP growth by 0.5 percentage points going forward. The multiplier effect here is substantial. 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.

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Moreover, it’s important to gauge how significant each country’s exports are in their GDP. Asia is very exposed here. The share of merchandise exports in GDP is over 100% in Hong Kong and Singapore, and over 50% in Malaysia, Taiwan, and Thailand.

Brexit: Expect Waves Of Contagion on Asia

There is also the big Chinese dragon to consider and the possible effects it could have on regional markets if it decides to devalue the RMB.

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Despite Europe’s sizeable trade balance with the rest of the world, Nomura expects the global impact of the Brexit to be more through the financial, confidence and psychology channels than simply through trade:

“Our warning is to not underestimate the depth and reach of global financial market contagion, which seems to have increased since 2008. For instance, during the European crisis of 2011, when there were significant fears of EU breakup, Asia’s stock and bond markets became much more highly correlated to the Euro Stoxx 50…as Hyun Song Shin, economic advisor and head of research at the BIS, recently described it (see Global liquidity and procyclicality, 8 June 2016), “the real economy appears to dance to the tune of global financial developments rather than the other way around”, through wealth, confidence, loan collateral and liquidity effects.”– Nomura on Asia 

Analysts have increased their forecasts for rate cuts and now expect the following dovish measures from central banks across Asia:

“The central bank of India to cut by 25bp (no cut previously), Korea by 50bp (25bp previously), Indonesia by 50bp (25bp), 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).” — Nomura on Asia 

Furthermore, Nomura is lowering its aggregate 2016 GDP growth forecast for Asia ex-Japan from 5.9% to 5.6%. Hong Kong’s GDP growth now is expected to slow by one percentage point compared to previous forecasts.