By Lingling Wei
BEIJING -- A few days before Britons voted to leave the European
Union, Chinese Premier Li Keqiang visited the central bank's
monetary-policy department to make a simple point: The yuan must be
kept stable.
That came on the heels of a meeting at China's top securities
watchdog, where officials emphasized that China's market turmoil
last summer must not be repeated this year, according to people
close to the agency. That directive will now be put to the
test.
China is on the receiving end of global market turbulence
triggered by the "Brexit" shock. And no part of its financial
system is more vulnerable than the yuan, already the subject of a
precarious central-bank high-wire act.
With all major currencies except the dollar and yen plunging in
the wake of the British vote, pressure grows on the People's Bank
of China to also let the yuan weaken. But if the gap with the
dollar becomes too big, capital outflows could speed up again.
How the Chinese authorities respond to the shock matters to
markets world-wide. Instability could easily add to global
jitters.
"Brexit will be a stress test for China's new exchange-rate
regime," said David Loevinger, the U.S.'s former Treasury
representative in China and now a fund manager at TCW in Los
Angeles. "Priority No. 1 will be avoiding a return of large
depreciation expectations and capital flight."
The growing financial links between China and the world were on
full display twice in the past year, when first the stock crash and
then a surprise currency devaluation sent shock waves through
global markets.
A continued surge in the dollar and plunge in other currencies
could present a "nightmare scenario" for the central bank as it
seeks to control the descent of the yuan, said a trader at one of
China's largest state-owned banks.
Both Chinese stocks and the yuan fell at the end of last week,
as the U.K. vote results became clear -- though not as
precipitously as elsewhere, with traders saying state intervention
cushioned the fall.
Early Monday, the PBOC set the yuan's official rate -- known as
the fix -- at 6.6375 to the dollar, a 0.91% drop from Friday's fix
and the biggest drop since August's devaluation. But it is only
0.34% weaker than where the yuan ended in Friday trading as the
dollar surged. The yuan is allowed to move up and down 2% of the
fix in mainland trading.
The benchmark Shanghai Composite Index dropped 1.3% Friday,
compared with the 6.8% stock fall in Germany, 8% slide in France
and the more than 12% declines in Greece, Spain and Italy. The
Shanghai benchmark was down a further 0.5% early Monday.
Many of China's large state-owned banks in the past several days
have cautioned customers about heightened risks in trading of
currencies and gold as a result of market mayhem following the
U.K.'s vote.
The Brexit decision has heightened uncertainty for markets and
"will cast a shadow over the global economy," China's finance
minister, Lou Jiwei, said Sunday.
At a closed-door Communist Party conclave in December, President
Xi Jinping named "unpredictable" international situations as a
major risk faced by China in its attempt to move toward a "new
normal" of slower but more sustainable growth, according to
officials who attended the meeting.
Conflicting messaging from Beijing in the past year contributed
to volatility, and Chinese officials have gingerly moved toward
more openness.
Late Friday, China's central bank issued a brief statement
saying it has plans in place to withstand any shock from the Brexit
vote. International Monetary Fund Managing Director Christine
Largarde called the statement "very helpful and very
reassuring."
Speaking at the IMF headquarters in Washington on Friday, Zhou
Xiaochuan, governor of the People's Bank of China, said China is in
talks with the IMF, global central banks and other authorities to
"safeguard financial market stability."
China's lines of defense include restrictions on money flowing
in and out of the country, a large, albeit dwindling, stockpile of
dollar reserves that can be used to prop up the Chinese currency
and otherwise buttress the financial system, a relatively low level
of foreign debt and room for further easing to bolster growth.
The British decision to leave the EU will also affect investment
and trade flows with China, but that impact will take months if not
years to play out. In the near term, the most immediate impact on
China will be in financial markets.
Officials at the China Securities Regulatory Commission pledged
at their meeting on June 17 to "protect the markets" over the next
two months, the people with knowledge of the gathering said.
Foreign investors have limited access to stocks traded in the
mainland, while Chinese individuals' abilities to buy foreign
stocks are also tightly controlled.
Beijing's tougher task is how to continue its strategy of
letting some air out of the yuan without triggering cash outflows
and market instability. Analysts estimated as much as $1 trillion
streamed out of China in 2015. China recently tightened controls on
companies and individuals trying to move money out. UBS Group AG
estimates that outflows dropped to about $40 billion a month
recently from more than $150 billion a month in December and
January.
In recent months, the central bank has sought to make China's
exchange-rate regime more predictable and shift the focus away from
how the yuan trades against the dollar to its value against a
broader group of 13 currencies.
Still, its maneuvering remains driven by the dollar and stands
to get more perilous if fallout of the British vote keeps the U.S.
currency rising for an extended period, traders and analysts
say.
Many traders expect the central bank to more aggressively
intervene in the currency market to support the yuan if it weakens
past 6.7 against the dollar.
Write to Lingling Wei at lingling.wei@wsj.com
(END) Dow Jones Newswires
June 26, 2016 22:20 ET (02:20 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.