Brexit and the Impact on China

Britain's vote to leave the European Union has shaken global financial markets and the effects will be felt for some time. The so-called Brexit vote,which won by a margin of 51.9% to 48.1%,will mean lengthy negotiations over an exit formula. So far the UK has not formally submitted its intention to leave so it is difficult to say what the final agreement will look like or when it will be hammered out. But there is no question that the consequences that will be far-reaching and China can also expect to feel at least some of the effects. Although some of these effects will be negative,there may also be some opportunities as well. The following analysis examines the risks and the possible opportunities from this momentous decision.

Opportunities and Challenges

China and Europe have seen increasingly close relations in trade and economics in recent years and Beijing's ties to Britain have improved significantly. Although the direct impact on China from the UK vote will be limited in the near future there will be effects over the medium and longer term. If Britain slips into recession and demand for external goods declines as a result of a much weaker pound,China's exports will be hurt. But Britain accounts for less than 3% of China's total exports and its share of China's overall foreign direct investment and the nation's FDI stock are 1% and 1.5%,respectively. Therefore,the direct impact on the Chinese economy will not be severe.

However,Britain's departure from the EU would offer new opportunities for Sino-EU trade and economic relations as it will break traditional political,economic and trade patterns. After Britain withdraws from the EU,investment and trade between Britain and the EU would be undermined and the two parties will be looking for new market opportunities. This may mean a greater effort to boost trade with non-European countries. As a result,it could help China's "One Belt,One Road" program which Beijing hopes to use to boost infrastructure construction and financial cooperation with other states. There also may be opportunities to cooperate with Central and Eastern European countries in road and rail transport as well. In addition,the British decision to withdraw could be positive in terms of getting the EU to reverse its stance and recognize China as a market economy. China is the EU's second largest trading partner. Not long ago,the European parliament opposed granting market economy status to China and this hurt Sino-EU trade relations. In the future,the EU might see a policy shift as a way to boost its own trading position.

Second,the renminbi's exchange rate against the US dollar is under pressure though the Chinese currency is likely to hold steady against a basket of currencies. Recently,there has been an increasing emphasis on avoiding risk on foreign exchange markets. With a prospect for a stronger dollar and a weaker British pound and euro,China's exports could be hurt. Shortly after the British referendum,the renminbi was at a five-and-a-half year low against the US dollar and was down 1.3% compared to just before the vote. However,Britain's decision will slow the process of interest rate hikes by the US Federal Reserve,as the US central bank tries to avoid adding new shocks to the fragile global financial system. This will give China time to prepare itself for a changed environment,which could have an impact on capital flows. The renminbi's exchange rate against the dollar should become steadier in the future as the Fed holds off on rate hikes. The renminbi has already been performing better than most emerging market currencies against the dollar in the domestic onshore market and on the offshore market as well. Additionally,while the renminbi lost ground against safe haven currencies,such as the Japanese yen,its relative strength against a basket of currencies implies strong confidence in the Chinese currency. In the long run,the renminbi will gain further support from solid economic fundamentals and it should eventually outshine the British pound and the euro on global markets.

There are risks to the plans to internationalize the renminbi. China's big five state-run banks have made major commitments to the UK because of the status of London as a global and regional financial market. This has been a key part of Beijing's plan to make the renminbi a more widely accepted currency. The decision to leave the EU may slow the adoption of the Chinese currency in Western countries,however. London is already the s