Brexit And China: Xi Is Not Amused

| About: iShares MSCI (EWU)

Brexit will undermine the UK's relations with China, as Beijing looks elsewhere to stay plugged into Europe.

Most post-Brexit coverage has focused on the ramifications for Europe and the impact for British business interests on the Continent; yet one should not overlook the consequences of Brexit on London's ties with China. Under the so-called "Osborne Doctrine," the UK has sought to establish close relations with China, yet Brexit has seriously weakened the UK's position vis-a-vis Beijing.

With London as a major financial hub, and English offering easy access into Europe as the region's lingua franca for business, the UK styled itself as China's gateway to the EU. This strategy paid off; since 2000, the UK has garnered tens of billions of Beijing's business, making Britain China's largest European investment destination. The UK also acted as an advocate for Chinese interests in Europe, pushing for greater trade ties and leading the way in bilateral cooperation efforts with Beijing.

After Brexit, UK brand tarnished in China

Brexit has put years of bridge-building in jeopardy, as the UK has catapulted itself from a leading voice in Europe to uncertain outsider. As one Western diplomat in Beijing noted:

"The UK leadership always said they would be the guy pushing for China's interests in the West and the European Union. [Brexit then] is quite bad news for China."

Beijing is no fan of uncertainty, with Brexit threatening Chinese efforts to encourage European integration, as this in turn simplifies Chinese trade and investment in Europe. Brexit has left a bad taste in China's mouth, and "in the future, Chinese investors will have a negative sentiment toward the British market. This will be a blow to Britain as an investment destination," notes Zheng Chaoyu of Renmin University.

The UK is likely to lose a substantial amount of Chinese money and attention, as China realigns its European contacts to remain plugged into the EU market. There is already talk of China paying greater attention to Frankfurt for financial services in the wake of Brexit. Moreover, instability in the UK will not engender much confidence in London as a non-EU European finance hub, especially given the fact that Zurich - Europe's second highest ranked financial hub for competitiveness according to the Global Financial Centres Index - already deftly fills that role.

Such a move would be a severe blow in any case, even more so given the UK's over-reliance on financial services. Philippe Le Corre of Brookings Institution sums up the post-Brexit landscape:

"China will probably not give up on the UK, but it will treat it as what is will be: a medium-sized economy with a strong financial focus, and not much of an industry left."

Recently, President Xi Jinping has reaffirmed that China will not change its support for European integration, as talks with the EU took place in Beijing on July 12th. China has expressed its hopes that the EU will adopt a business-as-usual stance, and carry out its obligations on Article 15 of China's ascension to the WTO as scheduled. To add to the UK's woes, Premier Li Keqiang announced he wants a high-level investment agreement at an early date, as well as a feasibility study on a China-EU free trade agreement.

If the UK has managed to exit the EU only to see the implementation of a China-EU FTA, London will be left out in the cold, losing out on potential billions: UK businesses have already lost access to the influential EU chamber of commerce facilities in Beijing. Without being able to draw on the clout of a $16 trillion trading bloc, the UK - while still a major economy - will be at the back of queue, as it disentangles itself from EU trade mechanisms.

Brexit is also affecting China at home, as a weak pound and resulting strong dollar have put pressure on the renminbi: indeed the yuan is down 1.6% on the dollar since Brexit. The yuan is also down 1% against a weighted basket of currencies, leading the central bank to make assurances to markets that it will intervene if needed to maintain the symbolic 6.7-6.8 yuan to dollar exchange rate. This in turn has raised the spectre of increased capital flight, with some characterizing signs of Brexit-related capital outflows in China as "not weak."

Some bright spots remain

The uncertainties surrounding Brexit make it easy to assume all sectors are on the back-foot, yet there are some industries that will weather the storm better than others. Firstly, the fact that a lot of Chinese investment in the UK is in the housing market could lead to several outcomes. Firstly, the weak pound has reduced the value of these investments, yet that also aids domestic homeowners, as well as offers opportunities for savvy investors.

Furthermore, the weak pound will likely lure more Chinese tourists, for whom the allure of the UK's history and culture remains intact. Despite Brexit, the UK remains a major international travel hub, with aviation infrastructure in Heathrow and beyond ensuring that tourism and travel firms will continue to benefit, although questions concerning travel documentation when entering Europe going forward will cause confusion.

Lastly, one the UK's major exports to China is its systems of satellite campuses and dual-study programs with local universities. Capitalizing on world-class brands such as Oxford, Cambridge, and LSE, UK universities will continue to do well. The "Harry Potter Effect" has led to a boom for English boarding schools, universities and other educational institutions, which have in turn set up facilities in Chinese cities such as Hong Kong. The desire for a Western education, acquiring English skills, and brand name prestige will insulate these ventures.

Zhou Enlai once famously, albeit apocryphally, quipped that it was too soon to tell if the French Revolution was a success, so too Brexit's true damage to Sino-UK ties remains to be seen.