Broker's View

China likely to unveil fresh stimulus as exports to UK and Europe set to cool in post Brexit world, CICC says

PUBLISHED : Tuesday, 28 June, 2016, 7:08pm
UPDATED : Tuesday, 28 June, 2016, 8:10pm

China’s exports to Britain and Europe will face headwinds in the post-Brexit world, weighing on the mainland’s economic growth and opening a window for Beijing to inject fresh stimulus to help guard against a slowdown, according to a report by investment bank China International Capital Corporation (CICC).

China’s export growth to the EU would drop by 5 to 6 percentage points and China’s overall export growth would fall by 1 percentage point, CICC said, on the assumption that the European economy would lose 1 percentage point of potential GDP growth because of the shockwaves created by Britain’s stunning exit decision.

That will drag China’s economic growth this year down 0.2 percentage points, as exports account for 20 per cent of total GDP.

In a worst case scenario, the EU’s growth would slow 2 percentage points, which will translate to a more than 5 percentage point impact to China’s exports and GDP, CICC said.

In addition, the sharp appreciation of the yuan against the British pound and the euro since the Brexit result was known on June 24 will add to the downside risks to China’s exports.

In the medium and long term, a reverse in the direction of globalisation will bring more headwinds to China, a beneficiary of globalisation over the last 30 years, especially after it became a member of the World Trade Organization in December 2001, CICC said.

Looking back to the European sovereign debt crisis in 2011 and 2012, the EU’s economic growth fell 2.3 percentage points in 2012 year on year, causing a 6.2 per cent decline of China’s exports to the EU in 2012.

However, the impact of Brexit may be milder when compared to events four years ago, depending on the response from central banks, the CICC report said.

Still, the research report noted that Brexit will “significantly” dampen investment flows between China and Britain or the EU.

“China’s capital may become more cautious towards investment in Europe. Should Brexit undermine London’s status as an international financial centre, China’s investment in the UK could also be affected,” the report said.

To counter the slowdown, China’s policymakers are likely to inject fresh stimulus into the economy, either by cutting bank’s reserve requirement ratio (RRR) several times or lowering interest rates, CICC said.

Earlier CICC had forecast a one time RRR cut and no interest rate cuts for the rest of this year, based on the assumption that most Britons would vote to stay in the EU.

Major central banks, such as the Bank of England, may jointly implement monetary easing and inject liquidity into the market, which would provide the People’s Bank of China with more room to loosen monetary policy, the report said.

Brexit will also make it more difficult for the United States to raises interest rates, CICC said, which may help the yuan stabilise in the medium term.

But Chinese companies may find Brexit an opportunity for overseas acquisitions, particularly as the British pound falls, Macquarie Research said.

Outbound mergers and acquisitions has been a major theme for Chinese companies in recent times. Traditionally, compared with the US and Japan, European companies are more friendly to Chinese money, Macquarie said.

The yuan fell to a five-year low against the greenback, dropping over 1 per cent in three trading days following the Brexit result. The British pound, meanwhile, has lost over 11 per cent since Friday. That led to a comparative appreciation of the yuan, up from 9.6 yuan per pound to 8.7 yuan per pound.

“If Brexit could lower the prices for acquisition in UK and EU, it could benefit Chinese companies on this front,” Macquarie analysts Larry Hu and Jerry Peng wrote in a note.

Chinese companies have been actively enlarging their overseas assets, with Europe as the second most popular destination behind the US, Macquarie research showed. Among recent deals, home appliance maker Midea was bidding for a controlling stake in German robot maker Kuka, while Luye Pharm was bidding for French drug maker Ethyphram.