KYOTO — China’s export machine continues to impress with its strength. The country ended last year with the largest merchandise trade surplus in world history ($1.2 trillion), underscoring the continued competitiveness of its manufacturing sector. But the money earned is no longer going to the same places as before.
The $1.2 trillion figure, derived from customs statistics, is somewhat misleading. The balance of payments, which reflects transactions between residents and non-residents of the country, shows a slightly smaller surplus—about $1.1 trillion.
The amount available for use is even smaller. Although China boasts a massive surplus in goods trade, it has a significant deficit in services trade: $238 billion in 2025, including nearly $199 billion in outbound tourism spending.
In addition, the country has a primary income deficit of $110 billion, which is due to profits and dividends paid to foreign investors in China.
As a result, the current account surplus in 2025 amounted to $735 billion. This is, of course, a record figure, but it is much smaller than the trade surplus that attracts media attention.
The surplus does not go into reserves
However, the ways in which this capital is utilized say more about the trajectory of China’s economic development.
In the early 2000s, the procedure was simple. The People’s Bank of China (PBC) intervened in the market by buying up foreign currency, which it added to its foreign exchange reserves for investment in U.S. Treasury bonds and other sovereign assets. Between 2002 and 2011, China’s foreign exchange reserves grew by nearly $300 billion annually.
The situation changed around 2012—following the abolition of the “Foreign Exchange Mandatory Settlement and Sale System,” which required domestic institutions and residents to sell all foreign exchange earnings to authorized state banks.
Since Chinese companies gained the right to retain foreign exchange earnings, the link between the trade surplus and reserve growth weakened, although the PBOC maintained massive foreign exchange reserves.
Around 2015, due to expectations of a yuan devaluation, firms and investors began to adjust their foreign exchange positions: companies increased their dollar deposits, settled foreign currency liabilities, and transferred funds abroad.
In other words, instead of being converted into domestic currency inflows, the trade surplus was increasingly held in foreign currency assets.
But following the Covid-19 pandemic, another shift occurred, signaling the continued opening of China’s financial market. The private sector continues to play a leading role in utilizing the trade surplus, but it has ceased to act out of fear.
The yuan is stable today and has even strengthened against the dollar. Now investors and firms are focused on seeking returns, primarily through portfolio investments in bonds and stocks.
Portfolio investments are flowing into Hong Kong
The sum of a country’s international transactions, known as the balance of payments identity, must equal zero. This means that if the People’s Bank of China no longer appropriates the current account surplus to build reserves, then this surplus must be offset by an increase in foreign assets or a decrease in foreign liabilities, net of errors and omissions.
China’s financial account deficit, excluding reserves, amounted to approximately $820 billion last year, which roughly corresponds to the current account surplus.
Portfolio investments—particularly under the Qualified Domestic Institutional Investor (QDII) and Stock Connect programs—have become the largest component of the financial account, accounting for more than half of the deficit.
Net outflows through this channel reached $426 billion in 2025: investors from mainland China increased their foreign equity portfolios by approximately $208 billion and their foreign debt portfolios by $153 billion.
Although some portfolio investments are made within China, a much larger portion of this flow goes to Hong Kong. Southbound flows through the Stock Connect program reached 1.4 trillion Hong Kong dollars ($178.6 billion) last year, an increase of 74%. Overall, this corresponds to the capital outflow recorded in China’s balance of payments.
Chinese companies are also increasing their direct investments abroad, which grew by $140 billion last year. Although the net outflow in this category amounted to only $77 billion in 2025, direct investment remains an important channel for excess capital as Chinese firms expand their operations abroad.
Through investment, China is promoting the yuan
What do all these figures tell us about China’s economic trajectory? The portion of the country’s trade surplus in the form of foreign exchange earnings has increased, and these earnings are now being channeled through market channels rather than official reserves.
As the competitiveness of China’s manufacturing sector grows and it generates a rising external surplus, the amount of capital seeking overseas assets is also increasing.
Hong Kong—with its deep stock market, strong financial infrastructure, and the Stock Connect program linking it to investors from mainland China—is well-positioned to absorb a significant portion of these flows. And it is already playing a more constructive intermediary role than it did in the past.
All of this will contribute to achieving China’s strategic goal of developing offshore yuan markets and deepening international financial integration.
This development is prompting new approaches among market participants. Flows driven by the decisions of private portfolio investors can respond more quickly to market conditions (including yield differentials, exchange rate expectations, global risk appetite) more quickly than flows driven by the management of official reserves.
Previously, the question was: what would China’s surplus turn into—foreign exchange reserves, traditional U.S. assets, or bank deposits?
Today, the answer is clear. China’s surplus is used primarily for portfolio investments, cross-border banking flows, and in Hong Kong’s capital markets.
This reflects China’s progress in deepening its financial sector and underscores that markets are increasingly playing a central role in shaping the economy.
©: Project Syndicate, 2026.
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