Impact of Britain Exit from EU on Cotton

MUMBAI (Commoditiescontrol) - Impact of Britain Exit from EU on Cotton Against the most market expectations, Britain has decided to exit the Euro zone. Interestingly the other partners of UK, northern Inland and Scotland has voted to remain in the EU. Unfortunately there are no exit procedures designed in the Euro Zone. Hence while EU will now have to work on the exit modalities for UK, the UK itself will be endangered as two of its components wants to remain in Euro Zone. It will take months and years before these procedures are put in place and then implemented.

However the road to this destination is expected to be bumpy and full of uncertainty. And there are expected to be many more causalities en route. There are already other nations asking for an exit out of the EU. If that happens the threat of Euro break down is very real. Euro zone is an important economic block in the world, Euro currency is the second most traded currency in the world and global currency reserves are diversified in Euro in addition to Dollar.

This article focuses on the impact of Brexit on cotton. While India does not have any direct cotton trade relation with EU or UK but yet the impact would be felt on cotton trade as the event has a potential to snow ball into a much larger problem. Following are some issues that could cause an immediate volatility in Cotton Trade.

Currency Impact: Global cotton trade is denominated in dollar and the bench mark prices are quoted in USD. Turmoil in Euro zone has weakened Euro currency. Euro weakness will result in dollar strengthening. In turn all other global currencies would weaken against the dollar and strengthen against the Euro. Dollar being the largest traded as well as a reserve currency is also considered to be a safe haven in times of turmoil. Since rest of the world will depreciate against dollar the development has a potential of blowing into a full blown currency war.

In Indian cotton context two currencies will become crucial. One of course is INR. Indian economy is viewed as the economy that will bail out the world, just like China bailed out the world in 2008-09 crisis because it was the fastest growing large economy back then. India is today the fastest growing large economy that has a potential to grow at high rates for next few years. India also has large foreign currency reserves because of the prudent RBI policies that anticipated such global turmoil. For both these reasons Indian currency will remain resilient to current turmoil and it is possible that the INR depreciation remains comparatively less compared to some of the competing currencies. This will put burden on Indian cotton trade which is mostly export oriented.

Second currency that is a ticking time bomb is Chinese. China has wanted to weaken Yuan due to the economic distress at home. But she cannot, because that can potentially put the world in crisis as China is now the second largest economy in the world. Euro Zone is the largest trading partner for China. Yuan as a result will strengthen against the Euro. USD is strengthening and global currencies are weakening against USD. But China being the controlled currency is unable to devalue fast. As a result Yuan is strengthening against all the other currencies, and losing out against USD. The noose is tightening against China in these circumstances. For economic recovery they need weak currency. Chinese Yuan devaluation can trigger another round of global currency melt down.

Asset Class Impact: Commodity as an asset class will be impacted by strong dollar. Strong dollar effectively means the lower commodity prices. The melt down in other asset classes like equity, bonds and currency will also force funds to move out of commodities including cotton. Funds are currently net long; liquidation can possibly take the prices sharply lower. The new season in any case is fundamentally bearish due to burdensome stocks in China.

Demand and Supply Impact: While there is no direct trade of cotton with the EU or UK, both these markets are very big for the premium Textile and garment segment. Recession in this part of the world will down-the-line, dent the demand for raw cotton. Global economic slowdowns will also cap any sharp increase in demand. On the other hand with global weather turning conducive, the production is expected to rebound next season. The stocks in China have just changed hands, are not yet consumed. The next year scenario remains supply heavy, unless of course there are weather based damages to crops in India, China or US.

Indian cotton prices have run up very fast since end of March. Same is true for global prices. Some correction in both these prices is a real possibility. Indian monsoon also seems to have moved favorably inland. While acreage is expected to be lower year-on-year, the improved yields are expected to keep the total production same as last year or slightly better than last year. July imports of new cotton are also expected to reach the Indian shores. All of this indicates that the cotton prices in the near term could correct.

However the scenario is not bearish for rest of the season as very large exports have depleted all the extra cotton from the country. Weather risk till the new crop reaches market is also high due to low carry forward stocks. But Brexit definitely dents the long term scenario of cotton demand.

Stagnant demand with very high carry forward stocks in the global market and expected bounce back in the production is a heady mix for lower prices next season. In Indian context good crop with lower exports next year, combined with stagnant demand will keep the prices weak. However lower carry forward stocks and empty pipelines will see any meaningful correction in prices taking pace only toward Nov-Dec. Potentially lowers global prices and steady Indian prices could see imports much early in the season and higher for the whole next year.

(By Commoditiescontrol Bureau; +91-22-40015533)