China's currency could plunge by 25 per cent by the end of next year, with the Australian economy hit by falling Chinese demand for -resources and property, Hong Kong-based research company CLSA has warned.
CLSA economist Eric Fishwick yesterday said continued flight of capital from China would force a major devaluation of the yuan at the end of next year, putting downward pressure on the dollar.
In a strongly worded report, CLSA said there was a "looming spectre" of a big fall in the Chinese currency as capital outflows put pressure on foreign exchange -reserves that have already fallen $US800 billion ($1 trillion) from a peak of $US3.99 trillion in mid 2014. 
The report predicted a "short, sharp shock" in world financial markets next year as China was forced to let the yuan to find its true market level.
"We expect greater stress for Australia, Korea and Taiwan, which send more than a quarter of their exports to China," Mr Fishwick said. "Currencies across the region will fall." "Our economics team predicts greater depreciation for the Aussie dollar, the Taiwan dollar and the Korean won." "A yuan depreciation, which results in a softer Aussie dollar, should be initially negative across the Australian market," it said.
"A weaker yuan would likely be bad for US dollar commodity prices, which would not bode well for China's second derivative economies and premium-priced Australian banks." The report also warned property prices in Australia could be hit by the falling Chinese currency.
"Property will be negatively hit by capital flight from China and deflation in Hong Kong.
"Mainlanders' reduced buying power will be felt further away in Singapore and Australia." The report predicted financial volatility and increasing concern about investment risks and the ongoing flight of capital from China would be "extremely negative for banks".
"Overall, it will not be pretty," it warned.
CLSA predicted the dollar would fall from levels of about US77c now to about US65c by the end of next year.
The report said capital outflows would continue, with the prospect of falling Chinese interest rates, falling expectations of -investment returns in China and President Xi Jinping's anti--corruption drive.
While Chinese leaders have been publicly insisting they will defend the currency, CLSA's head of Asia research, Amar Gill, said in a press briefing yesterday the government's policy of defending the exchange rate was running down foreign currency reserves, particularly in recent months.
Mr Gill estimated China had been spending more than $US50bn a month -defending the currency since the end of last year.
"It can't go on forever." He said continued capital outflows from China were in danger of pushing down the country's -foreign exchange reserves to about $US2.75 trillion.
"If it gets to that level, it is getting very close to the minimum threshold that the IMF would -recommend. China should have at least $US2.5 trillion in foreign -currency." Mr Gill said the risks on the Chinese currency were all on the downside. "The risk is asymmetric. The currency is not going to appreciate against the US dollar. It can only go down." He rejected suggestions Chinese authorities could head off the devaluation with tighter capital market controls, arguing over time they could not fight the impact of continued capital outflows.
He said the pressure for authorities to deliver their announced growth rate of 6.5 per cent would also hold down Chinese interest rates, as both monetary and fiscal policy would be needed to hold up the economy.
Mr Gill said the currency devaluation, or even de-pegging from the US dollar, could have a strong impact on the Australian economy during its fall.
Mr Gill said Chinese tourist spending in Australia would also be hit by the lower currency, although its impact could be cushioned by the wealth of China's middle class.
The report said Australia was the region with the second-biggest exposure to the Chinese economy after Hong Kong, with more than 20 per cent of imports and more than 30 per cent of exports with China.
It says countries with the highest exposure to China, including Australia and others in north Asia such as Korea, Taiwan and Japan would have the most exposure to the fall in the Chinese currency.
The report said the yuan would rebound in 2018 once it had found a market level.Mr Gill said the prospect of a big fall in the currency, which would increase the price of US dollar borrowing, was already being considered by major Chinese companies. He said this might have been behind the decision by Chinese insurance company Anbang to withdraw from its proposed $14bn bid for the Starwood Hotels & Resorts group.