May 13, 2019 / 8:04 AM / 10 days ago

China stocks fall, yuan at 4-month low as U.S. trade talks stall

* SSEC -1.2% pct, CSI300 -1.7% pct

* Yuan weakens sharply, offshore yuan crosses 6.9 to dollar

* China foreign ministry: We'll never surrender to foreign pressure

By Winni Zhou and Andrew Galbraith

SHANGHAI, May 13 (Reuters) - China's main equity indexes finished lower on Monday and the yuan weakened to a four-month low as investors' hopes for a deal to end an escalating trade war between the United States and China were dashed by signs of a stalemate in trade negotiations.

The benchmark Shanghai Composite index ended the day down 1.2% and the blue-chip CSI300 index lost 1.7%, resuming the previous week's downward slide.

For the month, the Shanghai Composite is down 5.7%, while the CSI300 has lost 6.2%.

The risk of U.S.-China talks breaking down and the two "settling down into an indefinite economic war of attrition is now uncomfortably high," Arthur Kroeber, founder of Gavekal Dragonomics, said in a note.

"The deeper that both sides entrench themselves in their political story lines, the more that risk will grow," he added.

Losses in the CSI300 on Monday were led by financial firms , which dropped 2 percent. The consumer staples sector ended down 0.06 percent, the real estate index lost 0.43 percent and the healthcare sub-index fell 0.58 percent.

While they recorded sharp losses for the whole of last week, both the Shanghai Composite and CSI300 had surged more than 3% on Friday, lifted by hopes that the continuation of talks could bring an agreement between Beijing and Washington, despite President Donald Trump hiking tariffs on $200 billion worth of Chinese goods.

But those hopes ebbed on Monday as Beijing and Washington appeared to be at an impasse, as Washington demanded promises of concrete changes to Chinese law and Beijing said it would not swallow any "bitter fruit" that harmed its interests.

With no signs of a quick solution in sight, investors continued to await Beijing's response to the higher tariffs.

On Monday, China's foreign ministry said the country will never surrender to foreign pressure, but declined to comment on what countermeasures Beijing planned in response to the tariff hike.

Investors are watching to see how Chinese policymakers plan to offset the impact of the stiffer tariffs on both the economy and financial markets, analysts at Citi said, adding that Beijing's options include support for stock markets and the yuan, as well as monetary policy measures and liquidity injections.

The smaller Shenzhen index ended 1.1% lower and the start-up board ChiNext Composite index dropped 2%.

Markets in Hong Kong were closed Monday for a public holiday.

WEAKER YUAN

Worries over the trade impasse also hit China's currency, which was dragged lower by heavy corporate demand for the greenback.

Prior to the market open, the People's Bank of China (PBOC) lowered the official midpoint of the yuan's daily trading band to 6.7954 per dollar, weaker than the previous fix, but much stronger than market expectations. The midpoint was 95 pips firmer than Reuters' estimate of 6.8049.

The PBOC had also surprised the market with a stronger-than-expected fix on Friday.

In the spot market, onshore yuan opened at 6.8459 per dollar and was changing hands at 6.8670 at 0747 GMT, 470 pips weaker than the previous late session close.

"Many market participants had hoped that Trump's tariff hike threats were just his negotiation tactics last week. But now tariffs are higher," said a trader at a Chinese bank, noting that the talks appeared stalemated.

Selling pressure on the yuan was heavy in the morning, several traders said, as many corporate clients showed rising interest to load up on dollars.

Companies that were debating whether to liquidate their long dollar positions last week were unwilling to sell dollars, awaiting better prices, they said.

In the past, major state-owned Chinese banks have usually sold dollars to prop up a falling yuan. On Monday, traders said they did not see signs of such state bank action.

Since the trade dispute blew up last week, some market watchers now believe the yuan is at risk of breaching the psychologically important 7 to the dollar mark, which it avoided last year.

But while Beijing has not yet outlined its response to higher U.S. tariffs, Tommy Xie, head of Greater China research at OCBC Bank in Singapore, said it was unlikely the country would use its currency as a trade war weapon.

"We think China is unlikely to engineer 25% depreciation to counter the impact of tariff as the cost of capital outflows amid the shrinking current account surplus may outweigh the benefit of supporting export," Xie said in a note.

"The pressure on RMB depreciation may depend on three near-term factors including the size of China's retaliation package, U.S.'s plan to impose tariff on the remaining $325 billion products and market's assessment on whether the setback is temporary or not," he added.

Offshore yuan weakened past 6.9 to the dollar to a low of 6.9048 at one point in afternoon trade, its weakest level since Dec. 24.

Reporting by Winni Zhou and Andrew Galbraith; Editing by Richard Borsuk

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