(Yicai) April 27 -- From the perspective of market expectations around the exchange rate, the recent decline in China’s trade surplus has both positive and negative implications for the yuan.

If the market interprets the decline in the trade surplus as a sign of strong domestic demand and the successful transformation of the Chinese economy, the yuan could strengthen. But if the decline deepens, it may lead to a weakening or even a reversal of the positive impact of overseas demand on China’s economic growth. In this scenario, the yuan could come under renewed pressure, the global chief economist at BOC International Securities wrote in a recent article.

Can the positive feedback loop between future trade surpluses and appreciation expectations continue? Looking back, the market’s logic was that if China’s trade surplus expanded, it meant the yuan was undervalued in foreign exchange markets, and appreciation would follow. The goods trade surplus, measured in yuan by China’s customs, jumped 19.4 percent last year after a 20.7 percent year-on-year increase in the previous year, rising for two straight years.

The market thought that China’s exports would remain resilient, the trade surplus would further expand, and yuan appreciation would continue this year. However, in the first quarter of 2026, China’s exports rose 11.9 percent from a year ago, while imports surged much more at 19.6 percent. The cumulative goods trade surplus reversed from a 23.4 percent year-on-year increase in the first two months to a 4.7 percent decrease. Since customs import and export data for March and the first quarter were released on April 14, the foreign exchange market likely had not yet priced in this unexpected event last month.

The slower export growth in the first quarter was partly due to the timing of the Chinese New Year holiday and the high base effect from the same of period last year, but there are other factors at play too.

Firstly, the policy of expanding domestic demand has continued to yield positive results. In the first quarter, the combined effect of policies to boost consumption and the longer Chinese New Year break led to a 5.4 percent increase in consumer goods imports. The manufacturing sector also showed strong demand for intermediate products, and there was rapid progress in artificial intelligence and data centers, which drove import demand for key components such as chips, memory devices, servers, and semiconductor equipment.

Secondly, the policy of expanding imports has continued to exert an influence. At the end of 2006, the Central Economic Work Conference judged that the main contradiction in China’s international balance of payments had shifted from a shortage of foreign exchange to an excessive trade surplus and overheated growth of foreign exchange reserves. The conference set maintaining a balance in international payments as the main goal of macroeconomic control, and this year’s Government Work Report proposed to “actively expand imports and promote balanced trade development.”

Thirdly, war in the Middle East is hindering global trade. The World Trade Organization recently predicted that in a baseline scenario without considering the impact of energy prices, global commodity trade growth would slow to 1.9 percent in 2026 from 4.6 percent last year. It could drop by a further 0.5 percentage point to 1.4 percent if crude oil and gas prices remain at high levels throughout 2026. Persistently high energy prices will hit the growth of imports by Europe and Asia, which are highly dependent on Middle Eastern energy resources -- the rate could fall from 2.1 percent and 6.0 percent in the previous year, respectively, to 0.3 percent and 2.6 percent, down 1.0 and 0.7 percentage point from the baseline prediction without considering the impact of energy prices. Europe and Asia together account for about 70 percent of China’s total exports, and the longer the war lasts, the greater the probability that global trade will head in an unfavorable direction.

Fourthly, there are concerns about trade friction. On Feb. 20, due to a ruling by the US Supreme Court that the Trump Administration’s tariff policy was unconstitutional, the US withdrew the 10 percent reciprocal tariffs and fentanyl tariffs imposed on China, and instead imposed a 10 percent tariff on a temporary basis according to Section 122. Given that the US government is still actively seeking to replace the reciprocal tariffs with Section 301 and Section 232 tariffs, and that it launched two Section 301 investigations against countries including China on March 11 and 12, we need to be vigilant about the US imposing tariffs on goods imported from China.

Finally, deterioration of trade conditions also decreases the trade surplus. The turmoil in the Middle East will worsen global economic and trade growth prospects, and intensify the contradiction of strong supply and weak demand in China. In the domestic market, this may manifest as suppressing the transmission of producer price index inflation to the consumer price index. In the export sector, it will manifest as growth in the export price index that is smaller than growth in the import price index, which will lead to a further deterioration of China’s trade conditions, meaning a further decline in the trade surplus.

The high growth in imports and the decline in the trade surplus help demonstrate China’s open stance of transforming from a “world factory” to a “world market,” as well as its proactive efforts to rebalance the economy, injecting stability and certainty into global economic and trade development. But the decline in the trade surplus may also affect the yuan’s future exchange rate through two channels: foreign exchange supply and demand as well as market expectations.

From the perspective of foreign exchange supply and demand, banks’ foreign exchange settlement and sale balance was in surplus for 13 consecutive months from March 2025 to March 2026, with a cumulative surplus of USD597.4 billion. The cumulative surplus of banks’ foreign exchange settlement and sale for goods trade was USD686.7 billion, equivalent to 54 percent of the customs import and export surplus in the same period, and contributing 115 percent of the banks’ foreign exchange settlement and sale surplus. If the trade surplus drops, it will affect the ability of the goods trade foreign exchange settlement and sales surplus to offset the pressure of capital outflow.

(The author of this article is Guan Tao, chief global economist at BOC International China.)

Editor: Tom Litting