Yet hot money’s shadowy nature makes it statistically difficult to document, raising questions about the phenomenon’s seriousness.
By Wang Ziwu and Wen Xiu 04 September 2009
(Caijing Magazine) China’s financial regulators have once again turned attention toward so-called “hot money” inflow after cash from foreign sources reportedly poured into the country at a record rate in the second quarter.
No one is panicking, and statistical shortcomings may be exaggerating or underestimating the hard-to-define phenomenon. But the indicators have raised concerns over an apparent record surge of inflow of nearly US$ 170 billion, helping to bring China’s total foreign reserves to more than US$ 2.1 trillion by the end of the first half.
Hot money was on the agenda in late August at a Shenyang conference where Yi Gang made his first official appearance since taking over as head of the State Administration of Foreign Exchange (SAFE) in January, underscoring the phenomenon’s importance for regulators.
The latest emphasis represents a shift from attitudes that prevailed at the beginning of 2009, when the risk of foreign currency outflow outweighed official concerns over hot money, a moniker for speculative capital that seeks high returns based on fluctuating currency exchange rates and bubbly asset markets. Hot money concerns previously dogged Chinese regulators before the global financial crisis hit in 2008.
Yet officials have trouble drawing concrete conclusions about the money flow and whether it poses risks. That’s because hot money typically leaves a shadowy trail that regulators and statisticians find difficult to follow.
China’s hot money estimates are derived by subtracting factors such as trade surplus, foreign direct investment (FDI) and currency exchange gains and losses from the total sum of the nation’s foreign reserves.
The nation’s trade surplus totalled US$ 34.7 billion and FDI increased by US$ 21.2 billion in the second quarter, according to the Ministry of Commerce (MOFCOM). During the same period, SAFE said, China’s foreign currency reserves increased by US$ 177.9 billion.
Based on these figures, suspected hot money from foreign sources totalled US$ 122 billion in the quarter.
But MOFCOM figures, calculated monthly, do not always jibe with data figures published by other ministries and government agencies.
An analysis by one government source said MOFCOM sometimes carries a portion of one year’s investment to the next year, with the goal of picturing a smooth growth of FDI. Thus, in recent years, MOFCOM statistics have been consistently lower than those published by SAFE and this year it’s expected to be higher.
Numbers may be added or subtracted. Thus “a sudden bump in MOFCOM statistics doesn’t necessarily mean there is a massive inflow of hot money,” the source said.
Hot money figures are likewise difficult to gauge due to differences in estimating exchange gains and losses. The exact composition of China’s currency reserve is not disclosed to the public. Due to wide fluctuations in exchange rates between the U.S. dollar and other major currencies around the world, we know that exchange gains and losses swing widely between Chinese yuan and non-US dollar currencies. But how much that has added to the foreign reserve is not public information.
In addition to import-export trade and foreign direct investment, SAFE lists other foreign exchange transactions including services trade, securities investment and other forms of investment in its calculations of China’s international balance of payments. In this formula, all inflows other than foreign trade and FDI are classified as hot money and have, at least to a certain extent, resulted exaggerated the estimates of hot money.
An “errors and omissions” section of SAFE’s international balance of payments report for the first half 2009 cited US$ 22.8 billion, far exceeding the US$ 17.1 billion error cited in a similar report for the same period last year. “This shows that the inflow of funds we cannot explain has increased,” Stephen Green, head of China research for Standard Chartered Bank, told Caijing.
These “errors and omissions” stem from many factors, including differences in statistical standards, illegal cross-border capital flow and exchange rate fluctuations. Indeed, data crunchers have a complicated task that cannot be resolved by simply lumping figures as “unexplained capital inflow.” The source close to SAFE thinks hot money cannot be ruled out from the section of “errors and omissions”, although a precise amount can’t be determined.
Hot money estimates coming from various players in everyday trade vary widely as well. Because international rules require reports of cross-border capital flow, hot money usually flows into a country by piggybacking standard capital channels, service trade deals, and personal foreign exchange (PFE) transactions.
“It is precisely because of this that statistics on trade surplus, PFE and FDI differ greatly from the reality,” said Jiang Aiguo, director of the China Institute of International Finance.
The global financial turmoil that began last year made hidden hot money even more difficult to detect based on simple studies of normal statistical data.
Yet Morgan Stanley China’s chief economist, Wang Qing, thinks China’s unaccounted for capital influx in the second quarter was about US$ 67.5 billion, and that over the past six months the amount of foreign capital outflows – including hot money -- were in the range of US$ 182.5 billion.
Standard Charter’s Green offered another perspective. He said unexplained capital outflows in the first quarter totalled about US$ 56 billion, and a second quarter reversal of this trend led to a net inflow of about US$ 30 billion. He says the money movements prove hot money is back, with as much as $90 billion inflow in the second quarter.
The source close to SAFE said the actual amount of hot money in foreign exchange inflows in the past half year can be seen as modest once different methodologies and statistical errors are taken into account. He thinks that, based on bank settlement remittances, second quarter inflows clearly increased. But if viewed from the perspective of actual forex inflow, the amount fell slightly from the first quarter.
Neither does Shi Lei, a Bank of China market analyst, agree with talk about a massive inflow of hot money over the past six months. Some money parked in Hong Kong equity is still profitable, he said, and for the time being there is no reason for these investors to take risks by trying to “launder” money on the mainland.
Transactions on the non-deliverable forward market (NDF) indicate that the yuan’s appreciation will remain slow, Shi said. NDF data shows the near-term yuan trading price against the U.S. dollar is expected to average 0.3 percent, down from the current range of 0.5 to 0.7 percent.
“Between 2006 and 2007, the yuan was expected to appreciate more than 3 percent,” Shi said. But it did not. The current expectation of yuan appreciation is not as high, and China shouldn’t be as attractive to speculators as it was three years ago.
The source close to SAFE said estimating the scope of the hot money phenomenon is also difficult because its definition is unclear.
“For instance, what if someone here had a relative abroad wire them a chunk of money, and then took it to buy property and stock?” he asked. “Would you call that hot money? How would you even regulate that?”
“Both legitimate and illegitimate financial channels exist alongside each other,” an expert connected to SAFE told Caijing. “This is one of the major aspects of China’s financial revolution.
“Hot money is not necessarily bad money. Massive inflows of cash are snatched up by enterprises for productive reasons,” the source said. “We are not talking about a tsunami of cash eroding other economic sectors; it’s not necessarily a reason to panic.”
The source thinks any open economic system will have administrative problems with cross-regional and cross-border monetary exchanges, and that trying to implement rules for every possible scenario is never better than identifying and resolving problems as they arise.
“If you think there’s an economic bubble, then you should work to solve the bubble problem. If you still try to control things by blocking inflows of foreign capital, I’m afraid you’ll just have a mess on your hands, because ‘hot money’ will always find a way,” he said.
So although the scale of China’s latest hot money influx is unclear, regulators say a trend has become apparent.
One expert said SAFE’s earlier fears about a reversal of capital flow have essentially been resolved. But he also said SAFE needs to make its statistics more transparent, a step that would let the market better control risk on its own and guide expectations. This kind of improvement could be coupled with a policy of short-term flexibility with regard to these fluctuations.
There are encouraging signs. Usually it will take until October for SAFE to release the report of last half year, yet this year the data’s been available since mid August.
For the time being, capital flow is not expected to reach serious levels. Furthermore, some scholars think China should now introduce an effective exchange rate policy and define an exit for loose monetary policy to avoid a lag in exchange rate adjustments.
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Hot Money Back on China’s Front Burner
Yet hot money’s shadowy nature makes it statistically difficult to document, raising questions about the phenomenon’s seriousness.
By Wang Ziwu and Wen Xiu
04 September 2009
(Caijing Magazine) China’s financial regulators have once again turned attention toward so-called “hot money” inflow after cash from foreign sources reportedly poured into the country at a record rate in the second quarter.
No one is panicking, and statistical shortcomings may be exaggerating or underestimating the hard-to-define phenomenon. But the indicators have raised concerns over an apparent record surge of inflow of nearly US$ 170 billion, helping to bring China’s total foreign reserves to more than US$ 2.1 trillion by the end of the first half.
Hot money was on the agenda in late August at a Shenyang conference where Yi Gang made his first official appearance since taking over as head of the State Administration of Foreign Exchange (SAFE) in January, underscoring the phenomenon’s importance for regulators.
The latest emphasis represents a shift from attitudes that prevailed at the beginning of 2009, when the risk of foreign currency outflow outweighed official concerns over hot money, a moniker for speculative capital that seeks high returns based on fluctuating currency exchange rates and bubbly asset markets. Hot money concerns previously dogged Chinese regulators before the global financial crisis hit in 2008.
Yet officials have trouble drawing concrete conclusions about the money flow and whether it poses risks. That’s because hot money typically leaves a shadowy trail that regulators and statisticians find difficult to follow.
Numbers Game
China’s hot money estimates are derived by subtracting factors such as trade surplus, foreign direct investment (FDI) and currency exchange gains and losses from the total sum of the nation’s foreign reserves.
The nation’s trade surplus totalled US$ 34.7 billion and FDI increased by US$ 21.2 billion in the second quarter, according to the Ministry of Commerce (MOFCOM). During the same period, SAFE said, China’s foreign currency reserves increased by US$ 177.9 billion.
Based on these figures, suspected hot money from foreign sources totalled US$ 122 billion in the quarter.
But MOFCOM figures, calculated monthly, do not always jibe with data figures published by other ministries and government agencies.
An analysis by one government source said MOFCOM sometimes carries a portion of one year’s investment to the next year, with the goal of picturing a smooth growth of FDI. Thus, in recent years, MOFCOM statistics have been consistently lower than those published by SAFE and this year it’s expected to be higher.
Numbers may be added or subtracted. Thus “a sudden bump in MOFCOM statistics doesn’t necessarily mean there is a massive inflow of hot money,” the source said.
Hot money figures are likewise difficult to gauge due to differences in estimating exchange gains and losses. The exact composition of China’s currency reserve is not disclosed to the public. Due to wide fluctuations in exchange rates between the U.S. dollar and other major currencies around the world, we know that exchange gains and losses swing widely between Chinese yuan and non-US dollar currencies. But how much that has added to the foreign reserve is not public information.
In addition to import-export trade and foreign direct investment, SAFE lists other foreign exchange transactions including services trade, securities investment and other forms of investment in its calculations of China’s international balance of payments. In this formula, all inflows other than foreign trade and FDI are classified as hot money and have, at least to a certain extent, resulted exaggerated the estimates of hot money.
An “errors and omissions” section of SAFE’s international balance of payments report for the first half 2009 cited US$ 22.8 billion, far exceeding the US$ 17.1 billion error cited in a similar report for the same period last year. “This shows that the inflow of funds we cannot explain has increased,” Stephen Green, head of China research for Standard Chartered Bank, told Caijing.
These “errors and omissions” stem from many factors, including differences in statistical standards, illegal cross-border capital flow and exchange rate fluctuations. Indeed, data crunchers have a complicated task that cannot be resolved by simply lumping figures as “unexplained capital inflow.” The source close to SAFE thinks hot money cannot be ruled out from the section of “errors and omissions”, although a precise amount can’t be determined.
Hard to Quantify
Hot money estimates coming from various players in everyday trade vary widely as well. Because international rules require reports of cross-border capital flow, hot money usually flows into a country by piggybacking standard capital channels, service trade deals, and personal foreign exchange (PFE) transactions.
“It is precisely because of this that statistics on trade surplus, PFE and FDI differ greatly from the reality,” said Jiang Aiguo, director of the China Institute of International Finance.
The global financial turmoil that began last year made hidden hot money even more difficult to detect based on simple studies of normal statistical data.
Yet Morgan Stanley China’s chief economist, Wang Qing, thinks China’s unaccounted for capital influx in the second quarter was about US$ 67.5 billion, and that over the past six months the amount of foreign capital outflows – including hot money -- were in the range of US$ 182.5 billion.
Standard Charter’s Green offered another perspective. He said unexplained capital outflows in the first quarter totalled about US$ 56 billion, and a second quarter reversal of this trend led to a net inflow of about US$ 30 billion. He says the money movements prove hot money is back, with as much as $90 billion inflow in the second quarter.
The source close to SAFE said the actual amount of hot money in foreign exchange inflows in the past half year can be seen as modest once different methodologies and statistical errors are taken into account. He thinks that, based on bank settlement remittances, second quarter inflows clearly increased. But if viewed from the perspective of actual forex inflow, the amount fell slightly from the first quarter.
Neither does Shi Lei, a Bank of China market analyst, agree with talk about a massive inflow of hot money over the past six months. Some money parked in Hong Kong equity is still profitable, he said, and for the time being there is no reason for these investors to take risks by trying to “launder” money on the mainland.
Transactions on the non-deliverable forward market (NDF) indicate that the yuan’s appreciation will remain slow, Shi said. NDF data shows the near-term yuan trading price against the U.S. dollar is expected to average 0.3 percent, down from the current range of 0.5 to 0.7 percent.
“Between 2006 and 2007, the yuan was expected to appreciate more than 3 percent,” Shi said. But it did not. The current expectation of yuan appreciation is not as high, and China shouldn’t be as attractive to speculators as it was three years ago.
The source close to SAFE said estimating the scope of the hot money phenomenon is also difficult because its definition is unclear.
“For instance, what if someone here had a relative abroad wire them a chunk of money, and then took it to buy property and stock?” he asked. “Would you call that hot money? How would you even regulate that?”
Policy Reaction
“Both legitimate and illegitimate financial channels exist alongside each other,” an expert connected to SAFE told Caijing. “This is one of the major aspects of China’s financial revolution.
“Hot money is not necessarily bad money. Massive inflows of cash are snatched up by enterprises for productive reasons,” the source said. “We are not talking about a tsunami of cash eroding other economic sectors; it’s not necessarily a reason to panic.”
The source thinks any open economic system will have administrative problems with cross-regional and cross-border monetary exchanges, and that trying to implement rules for every possible scenario is never better than identifying and resolving problems as they arise.
“If you think there’s an economic bubble, then you should work to solve the bubble problem. If you still try to control things by blocking inflows of foreign capital, I’m afraid you’ll just have a mess on your hands, because ‘hot money’ will always find a way,” he said.
So although the scale of China’s latest hot money influx is unclear, regulators say a trend has become apparent.
One expert said SAFE’s earlier fears about a reversal of capital flow have essentially been resolved. But he also said SAFE needs to make its statistics more transparent, a step that would let the market better control risk on its own and guide expectations. This kind of improvement could be coupled with a policy of short-term flexibility with regard to these fluctuations.
There are encouraging signs. Usually it will take until October for SAFE to release the report of last half year, yet this year the data’s been available since mid August.
For the time being, capital flow is not expected to reach serious levels. Furthermore, some scholars think China should now introduce an effective exchange rate policy and define an exit for loose monetary policy to avoid a lag in exchange rate adjustments.
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