Guan Tao: On the Economic and Policy Implications of 'Trade Surplus and Capital Outflow'

At present, China's economy continues to operate in a generally stable manner, moving toward new growth and improvement, but the prominent contradiction of strong supply and weak demand remains, and the foundation for stabilizing and improving the economy still needs to be consolidated.

Some argue that Chinese companies now run a trade surplus of over one trillion US dollars, yet the goods go out while the money does not come back, and the country's foreign exchange reserves have not increased accordingly. This, they say, shows a lack of confidence among market participants and is an important reason for weak domestic investment and consumption demand and low inflation. Some suggest either restoring the mandatory foreign exchange settlement system, requiring companies to repatriate export earnings and convert them into RMB, or restricting outward investment so that companies invest more domestically. The author disagrees.

The "mandatory settlement of foreign exchange" back then embodied the reform approach of "concentrating foreign exchange supply and safeguarding foreign exchange demand." In early 1994, the exchange rates were unified and a bank settlement and sale of foreign exchange system was introduced, achieving conditional convertibility of the current account. Against the backdrop of foreign exchange scarcity at the time, the foreign exchange retention and remittance system for Chinese enterprises was abolished, requiring 100% settlement of their current account foreign exchange receipts, while allowing them to purchase foreign exchange at bank counters with valid documents for trade and trade-related services such as transport, insurance and commissions. This reflected the reform art of "retreating in order to advance."

Marked by "exchange rate stability and rising reserves," the old and new foreign exchange management systems achieved a smooth transition. After incorporating foreign-invested enterprises into the bank settlement and sale system in the second half of 1996 and abolishing the remaining current account exchange restrictions at the end of that year to achieve full current account convertibility, China gradually relaxed mandatory settlement requirements and implemented voluntary settlement from August 2007. This had nothing to do with current account convertibility; it was an important measure to advance trade and investment facilitation.

For most of the period before the "August 11" exchange rate reform in 2015, China's domestic foreign exchange market was persistently oversupplied. To prevent the RMB exchange rate from appreciating too quickly, the central bank stepped in to buy the excess foreign exchange sold on the market. From 1994 to 2014, except for six years, China's balance of payments showed a "twin surplus" in the current and capital accounts, with transaction-driven foreign exchange reserve assets rising substantially and continuously. At that time, the foreign exchange position purchased by the central bank was the main channel for base money injection, resulting in imported excess liquidity. To avoid breeding risks of credit expansion, inflation and asset bubbles, the central bank was forced to drain base money by raising the statutory deposit reserve ratio and issuing central bank bills.

In the early period of the "August 11" reform, China suffered a high-intensity cross-border capital flow shock and the RMB exchange rate trend reversed. In 2015 and 2016, the balance of payments showed "a current account surplus, a capital account deficit and a sharp decline in foreign exchange reserve assets." The reform was successfully reversed in 2017; in early 2018 China announced a return to a neutral exchange rate policy, and the central bank basically withdrew from routine intervention in the foreign exchange market; in August 2019, the RMB exchange rate broke through 7. As exchange rate marketization deepened and two-way volatility gained elasticity, China's balance of payments gradually formed a self-balancing pattern of "a current account surplus, a capital account deficit and small fluctuations in foreign exchange reserve assets." This expanded the central bank's autonomy in monetary policy and laid an important foundation for China's modern central banking system.

The People's Bank of China's base money injection has shifted from foreign exchange holdings to domestic credit channels. At the end of August 2026, foreign exchange holdings accounted for 43.6% of the central bank's total assets, down markedly from the peak of 83.3% at the end of 2013. Improving the base money injection mechanism on this basis, such as strengthening fiscal and monetary policy coordination and improving open market purchases and sales of government bonds, is an important part of building a scientific and sound monetary policy system. Restoring the mandatory foreign exchange settlement system would run counter to the reform direction of trade and investment facilitation and could also drag monetary policy back into being held hostage by exchange rate policy.

More critically, the self-balancing pattern of the balance of payments means that the current account and capital account balances are mirror images of each other, and the larger the current account (or goods trade) surplus, the greater the net capital account outflow. Last year, for example, the trade surplus was $1.2 trillion, the current account recorded a record surplus of $735 billion, the non-reserve financial account recorded a record deficit of $820.1 billion, and foreign exchange reserve assets declined only slightly by $51.3 billion.

Such capital outflows are not necessarily related to investor confidence, but are the balancing item of the current account surplus in a statistical sense. In the past, the trade surplus became the central bank's accumulation of foreign exchange reserves, a use of official external assets; now the trade surplus directly becomes the use of private external assets. Within the private sector, if enterprises, households and non-bank financial institutions invest more abroad (that is, the banking sector's settlement and sale surplus is smaller or even in deficit), the banking sector can use less or even repatriate overseas positions (reflected as smaller or even negative net increases in portfolio investment and/or other investment assets in the balance of payments); if the non-bank sector invests less abroad (that is, the banking sector's settlement and sale surplus is larger), the banking sector must use more, turning more of its settlement and sale surplus into its own foreign exchange positions, outward portfolio investment, or outward lending and deposits abroad.

Pursuing a "twin surplus" in the balance of payments in which "not one item can be missing" is in essence the inertial thinking of "easy in, strict out" from the era of foreign exchange scarcity, making moral judgments about cross-border capital flows and subjectively assuming that capital inflows are good and outflows are bad. This not only runs counter to the policy orientation of the 15th Five-Year Plan regarding "raising the level of capital account opening" and "expanding space for two-way investment cooperation," but may also affect the efficiency of foreign exchange resource use.

According to international investment position statistics, by the end of 2025, among China's four major categories of external financial assets, in descending order: reserve assets fell from a peak of over 70% to 31.8%; outward direct investment assets accounted for 30.4%, up 24.0 percentage points since data began in 2004 and only 1.4 percentage points lower than the share of reserve assets in the same period; other outward investment assets accounted for 20.8%, up 3.1 percentage points from 2004; and outward portfolio investment assets accounted for 16.9%, up 7.0 percentage points from 2004. Based on balance of payments data, China's return on outward direct investment in 2025 was 4.41%, 2.33 percentage points higher than the return on outward non-direct investment (including outward portfolio investment, other investment and reserve asset investment) in the same period.

Back then, Japan encouraged private outward investment during a period of large goods trade surpluses. Today, Japan's goods trade has long turned to a deficit, but investment income surpluses earned through private outward investment support the large current account surplus Japan still maintains. This is precisely the goal China should pursue: looking at both gross domestic product (GDP) and gross national income (GNI), and valuing both "China's economy" and "the Chinese people's economy."

Moreover, interpreting capital outflows as depreciation pressure on the RMB is also biased. China structurally has "a trade surplus and capital outflows," so a trade surplus does not necessarily mean the RMB must appreciate, nor do capital outflows necessarily mean the RMB must depreciate. Just as the United States structurally has "a trade deficit and capital inflows," one cannot simply use the trade deficit to explain and forecast dollar index depreciation, or capital inflows to explain and predict dollar index appreciation.

Note: This article was published in Yicai (First Financial Daily).

(Source: Dahe Caicube)