China's FX reserves again strongly beat expectations, with regulation focused on cleaning up cross-border channels
AI summary card
China's FX reserves again strongly beat expectations, with regulation focused on cleaning up cross-border channels
J.P. Morgan believes the May increase in foreign exchange reserves was mainly supported by resilient exports, softer imports, and moderate capital outflows, while recent cross-border regulation is not a broad suppression of capital outflows but an effort to guide activities into compliant channels.
- May foreign exchange reserves increased by US$31.7bn to US$3442.2bn, above J.P. Morgan's forecast of US$3405bn and the market consensus of US$3400bn.
- Implied capital outflows are estimated to have remained at US$20bn; the report also estimates a current account surplus of US$64.0bn and valuation losses of US$12.3bn.
- PBOC gold purchases accelerated in May to +0.32 mn oz, while China's U.S. Treasury holdings fell by US$41bn in March to US$652.3bn.
- The CFETS RMB basket rose about 1.5% in May and REER rose about 1%; however, both clients' willingness to settle FX and to buy FX declined, with the net settlement rate narrowing to 0.4 percentage points.
- The report interprets recent regulatory measures as targeting illegal and gray-area cross-border activities and standardizing overseas investment governance, rather than comprehensively banning offshore investment.
Report interpretation
Overview
This report discusses how China's May foreign exchange reserves again came in significantly above expectations, and assesses the state of cross-border capital flows by combining movements in the RMB basket exchange rate, REER, banks' client FX settlement and sales behavior, PBOC gold purchases, and changes in U.S. Treasury holdings. The report further analyzes recent regulatory policies on cross-border securities, futures, funds, and overseas investment, concluding that the policy focus is on cleaning up illegal or gray channels, strengthening compliant pathways, and establishing a more complete governance framework for overseas investment, rather than imposing broad capital outflow controls.
Core views
The core views are: first, the May upside surprise in foreign exchange reserves likely came from stronger-than-expected exports, softer imports, supportive price effects, and still-moderate implied capital outflows; second, the recent strengthening in the RMB basket and REER helps ease trading partners' concerns about RMB undervaluation and is also consistent with RMB internationalization goals; third, recent cross-border regulation is aimed at channeling capital activity into supervised channels such as Stock Connect, QDII, and Wealth Management Connect, rather than comprehensively suppressing overseas investment; fourth, the State Council's overseas investment regulations are more like an institutionalized, full-process, and classified regulatory framework, with implementation details still pending.
Analysis framework
The report uses a combination of macro foreign exchange reserve decomposition, trade and price signals, banks' client FX settlement and sales behavior, RMB effective exchange rates, and policy text interpretation. It explains the reserve upside surprise using reserve changes, the current account, valuation effects, and implied capital flows, while interpreting policy implications based on regulatory targets, enforcement objects, compliant channels, and the legal framework.
Methodology notes
Current account, valuation effects, and implied capital flows
By using changes in foreign exchange reserves, the current account surplus, valuation gains and losses driven by movements in the U.S. dollar index, and the residual item representing implied capital flows, the framework identifies the funding sources behind reserve strength or weakness.
RMB basket exchange rate and real effective exchange rate
The CFETS RMB basket and REER are used to observe the RMB's strength relative to trading partners and after inflation adjustment, and to assess the implications for trade frictions, export interpretation, and RMB internationalization.
Settlement ratio, FX sales ratio, and net settlement ratio
The settlement ratio reflects clients' willingness to convert foreign currency into RMB, the FX sales ratio reflects clients' willingness to purchase foreign currency, and the net settlement ratio is used to observe marginal changes in private-sector FX supply and demand.
Channel cleanup rather than broad capital controls
By distinguishing illegal marketing, account opening, trade execution, and facilitation of fund transfers from compliant channels, the analysis determines that regulation is intended to crack down on gray activities and guide funds into supervised pathways rather than ban offshore investment.
Asset mapping & comparison
Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).
- RMB/CFETS CNYThe upside surprise in foreign exchange reserves, moderate implied capital outflows, and trade surpluses support the RMB basket.
- Strengths
- The CFETS rose about 1.5% in May and REER rose about 1%, helping ease external concerns about RMB undervaluation.
- Weaknesses
- USD/CNY is still constrained by renewed dollar strength, and both clients' willingness to settle FX and buy FX declined, indicating private-sector behavior is not unilaterally optimistic.
- Comparison
- The report argues that China's strong exports are more attributable to improved manufacturing efficiency and domestic deflation than to exchange-rate undervaluation.
- Risks
- Continued dollar strength, weaker external demand, or regulatory misinterpretation could weaken RMB performance.
- China foreign exchange reservesReserves increased by US$31.7bn in May to US$3442.2bn, the core subject of the report's analysis.
- Strengths
- Export resilience, softer imports, improved price effects, and moderate capital outflows together supported reserve performance.
- Weaknesses
- A stronger U.S. dollar index created valuation losses, and the upside surprise in reserves still needs to be validated by trade data.
- Comparison
- The actual figure was above J.P. Morgan's forecast of US$3405bn and the market consensus of US$3400bn.
- Risks
- If the trade surplus underperforms expectations or capital outflows widen again, reserve strength may prove unsustainable.
- GoldThe PBOC further accelerated gold purchases in May.
- Strengths
- Higher official gold purchases help diversify reserve assets.
- Weaknesses
- The report does not provide a target allocation for gold or a long-term purchase path.
- Comparison
- May's +0.32 mn oz was significantly above the 2H2025 monthly average of 0.03 mn oz.
- Risks
- Gold price volatility and changes in the pace of reserve allocation may affect market interpretation.
- U.S. TreasuriesChina's U.S. Treasury holdings declined noticeably in March.
- Strengths
- This reduces exposure to a single dollar bond asset and is consistent with reserve diversification.
- Weaknesses
- The decline in holdings may also reflect valuation, maturities, or reallocation factors, and the report does not break down the specific sources.
- Comparison
- Holdings fell by US$41bn in March to US$652.3bn.
- Risks
- U.S. Treasury yields, dollar trends, and changes in China-U.S. financial relations could affect subsequent holdings.
- Cross-border securities, funds, futures, and overseas investmentThe regulatory focus is on cleaning up illegal and gray cross-border activities and channeling funds into compliant routes.
- Strengths
- Supervised channels such as Stock Connect, QDII, and Wealth Management Connect may receive clearer policy support.
- Weaknesses
- Stricter KYC, source-of-funds, and document reviews for new mainland visitor accounts in Hong Kong may reduce the convenience of account opening and trading.
- Comparison
- The report emphasizes that this is not a new broad tightening of rules, but stricter enforcement against gray practices under existing rules.
- Risks
- Implementation rules for the overseas investment regulations, national security reviews, export controls, and data and technology restrictions may impose stronger constraints.
Key data
- May foreign exchange reservesUS$3442.2bnUp US$31.7bn from the previous month, above J.P. Morgan's forecast of US$3405bn and the consensus expectation of US$3400bn.
- Estimated current account surplusUS$64.0bnOne of the key components used in the report to explain why foreign exchange reserves exceeded expectations.
- Estimated valuation lossUS$12.3bnThe U.S. dollar index rose from 98.1 to 98.9, creating a negative impact on reserve valuation.
- Implied capital outflowUS$20bnThe report believes implied outflows remained moderate.
- PBOC gold purchases+0.32 mn ozPurchases accelerated in May, above the 2H2025 monthly average of 0.03 mn oz.
- China's U.S. Treasury holdingsUS$652.3bnDown US$41bn in March.
- CFETS RMB basket+1.5%Increase in May; the report says it has basically recovered the 2025 depreciation.
- REER+1%Rose in May, returning to around early-2025 levels.
- Banks' client FX settlement ratio50.2%In April it fell from 58.2% in March, weaker than typical seasonality.
- Banks' client FX sales ratio49.8%In April it fell from 55.0% in March.
- Net settlement ratio0.4 percentage pointsNarrowed from 3.1 percentage points in March.
- Effective date of overseas investment regulations2026-07-01The State Council's overseas investment regulations establish a more comprehensive governance framework, but detailed implementation measures have not yet been released.
Impact & implications
The implications for assets and the macro environment are that short-term pressure on the RMB and foreign exchange reserves has eased relative to before, and the policy focus may shift from preventing capital outflows to avoiding excessively rapid RMB appreciation. Accelerating gold purchases indicate continued diversification of official reserve asset allocation, while declining U.S. Treasury holdings extend the adjustment in exposure to dollar assets. In cross-border business, the importance of compliant channels is rising, while illegal or gray cross-border marketing, account opening, trade execution, and facilitation of fund transfers face stricter enforcement.
Risks
- The upcoming May trade data may not fully validate the explanation of stronger-than-expected exports or softer imports.
- Renewed dollar strength may constrain USD/CNY movements and continue to pressure foreign exchange reserve valuations.
- The simultaneous decline in banks' client FX settlement and sales ratios may reflect more cautious client FX behavior.
- If the market interprets channel cleanup as capital controls, it could affect cross-border investor sentiment and liquidity.
- Detailed implementation rules for the overseas investment regulations have not yet been released, leaving uncertainty around classified regulation, national security review, export controls, and technology and data requirements.
- If Chinese companies face discriminatory restrictions overseas, policy retaliation may increase geopolitical and compliance risks.
What to watch
- Details on exports, imports, and price effects in the May trade report.
- Subsequent breakdowns of foreign exchange reserves, the current account, valuation gains and losses, and implied capital flows.
- The pace of PBOC gold purchases and changes in China's U.S. Treasury holdings.
- The relative movements of the CFETS RMB basket, REER, and USD/CNY.
- Whether banks' client FX settlement ratio, FX sales ratio, and net settlement ratio continue to weaken.
- The enforcement intensity by the CSRC and Hong Kong markets on cross-border account opening, KYC, source of funds, and document review.
- Implementation rules and actual approval/filing requirements for the overseas investment regulations after they take effect on July 1, 2026.