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The Brexit Vote’s Impact on China

Goods exports to the UK account for close to 2% of China’s total goods exports, and those to the EU for around 15%

As such, first-order effects from any negative shock to the market for Chinese goods in the UK and rest of the EU will be limited. However, the basket of currencies against which the central bank is targeting the Chinese currency includes the pound sterling and euro: This will bring further weakness in the CNY:USD rate going into 2017 as sterling- and euro-denominated assets lose a degree of safe haven status. Together with the second-order impact on Chinese demand of weaker European demand for goods in other markets, and the shifts in capital flows, there is scope for a more sustained phase of stress for China’s balance of payments and for its exports-oriented manufacturers. As China’s industry is already facing excess capacity, with negative implications for financial sector stability, further negative shocks will be unwelcome, especially if these encourage capital flight.

The weakening CNY:USD rate is likely to increase the strictness with which Chinese banks block or delay cross-border payments (to prevent capital flight from eroding official FX reserves). Banks in Shanghai received instructions to monitor FX transactions more carefully in the wake of the Brexit vote.
 

Positive Implications

­By revealing to Chinese investors with mobile capital that political risk can strike "safe haven" London property, the Brexit vote may encourage some Chinese capital to stay at home. US and Australian property markets may be buoyed further by diverted Chinese demand.
 

Negative Implications

  • The central impact to date is on the CNY:USD rate, which we expect to weaken in the direction of CNY7:USD in 2016 and to trade around this level in 2017.
  • EUR:USD and GBP:USD weakness will cause the CNY:USD rate to depreciate. The yuan briefly hit CNY6.69:USD when markets reopened the week after the Brexit result.
  • Accounts receivable denominated in yuan will depreciate in US dollar terms and US dollar-priced exports shipped to China will weaken in competitiveness somewhat going into 2017.
     

Recommendations

Expect the currency to weaken towards CNY7:USD by the end of 2016 and to trade at around CNY7 in 2017. Expect and plan for a pattern of continued or increased delays in payments for services, royalties and capital transfers out of China. Assess pricing with Chinese suppliers and customers more frequently in the next six months to ensure your contracts with Chinese counterparties are priced competitively.

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