The Brexit effect on China

The UK leaving the EU will be felt across the world, and China will not be spared.

The UK’s recent decision to leave the European Union will probably be remembered as the shock event for markets in 2016. The surprising result of the country’s referendum is an outcome that could have seismic consequences, not just in Europe, but in the rest of the world.

We have already seen high levels of market volatility since the June vote. Fears of a recession in the world’s fifth largest economies, a new prime minister entering office and a new cabinet, and the potential for prolonged talks between the UK and the EU over separation, all combine to create the kind of uncertainty that investors dread. The most notable casualty is the British pound, which is currently trading a more-than a 30-year low.

Much has been written about the market turmoil we have seen in global markets over the last few weeks, but what I shall focus on here is a topic relevant to us: the impact that the Brexit vote could have on China. It is a topic that can be considered from both a long-term and short-term perspective.

Brexit’s immediate impact has been to pull Chinese equities into the sharp fluctuations that have characterised global financial markets since the vote. It is something to be expected after investors receive a shock, and it increases demand for assets that are perceived as safe havens – such as the US dollar and the yen. As a result, the offshore spot rate for the yuan (CNH) will likely be under selling pressure over the near term. 

Looking to the medium-term however, and the referendum result could actually encourage a more positive market outlook as central banks global might be more likely to pursue more accommodative monetary policies.

The uncertainty really emerges when we try to work out how Brexit will affect China over the long term. It is an event that could be felt in a diverse range of areas that range from the economic to the political.

It could for example, have an impact on Chinese trade. If the UK enters a recession, it will import less from abroad, which in turn means it will buy fewer goods from China. The impact on the Chinese economy will be slight however, since the USD59.7 billion of goods that Britain imports accounts for just 2.6% of the country’s total.

The impact could also be felt on money going in the other direction, as the UK was the fourth largest destination for China portfolio investment in 2015. The sharp devaluation of the pound, if prolonged, will likely lower the attractiveness of investing in the UK – especially for Chinese companies that have been making acquisitions in the country, as well as individuals that have chosen to buy property in London.

The picture becomes less clear when we consider the long-term role that the UK is supposed to play in China plans to go global. Beijing and London had nurtured closer economic ties, something that was evident during Xi Jinping’s high-profile visit to the UK last year, and some of the projects that are at the core of this relationship could be impeded by Brexit.

London’s status as an international financial centre might weaken. The city is the world leader in foreign exchange, with the UK accounting for 40.9% of global forex trading volumes in 2013, according to the Bank of International Settlement, and the British government has actively supported China’s ambitions to make the renminbi an international currency. There have already been some significant milestones: in May, the first sovereign offshore RMB bond outside of Hong Kong was issued in London. But if Brexit causes the UK to lose its edge in foreign exchange business, China might consider adding other cities as potential renminbi hubs.

The UK also provided support in the formation of the Asian Infrastructure Investment Bank (AIIB), leading a number of European countries to join the organisation in the face of a more negative attitude from the US. This is another fruit of strengthening ties between the UK and China.  It is uncertain whether the Brexit vote weakens the UK’s influence on  other EU countries.

The UK was considered to be a gateway for China to access the continent, and the impact of its closest partner in the region leaving the European Union is unknown. It might result in China developing stronger relationships with other European countries, or it could result in a broader setback for its relationship with the European Union.

At this stage, we are only left with uncertainty. Although a new prime minister has been appointed today, we do not know how this new leadership will negotiate the country’s new role in Europe. What we know however, is that the UK – a country that typically exhibits high levels of political and economic stability – has thrown the world a topic that will capture the world’s attention for not just the coming months, but over the coming years. Investors in China, and the rest of the world, should monitor developments carefully.

The author is Victoria Mio, Chief Investment Officer China at Robeco.