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)