Monday 30 November 2009
The threat of ‘hot money’ in the region
Emerging countries the world over are growing increasingly concerned about strong inflows of ‘hot money’ into their respective countries. ‘Hot money’, also known as mobile capital, refers to short-term private capital that flows across borders into different markets in search of higher returns.
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The threat of ‘hot money’ in the region
Emerging countries the world over are growing increasingly concerned about strong inflows of ‘hot money’ into their respective countries. ‘Hot money’, also known as mobile capital, refers to short-term private capital that flows across borders into different markets in search of higher returns.
The head of the International Monetary Fund, Dominique Strauss-Kahn, said in Singapore recently that the flow of funds to emerging countries is a sign of renewed investor appetite for higher-risk assets as financial conditions normalise after the height of the financial crisis. While capital inflows are generally beneficial, they can raise risks of rapid and potentially destabilising movements of currencies and asset prices. Indeed, a few emerging markets have implemented or are contemplating measures to combat the threat of speculative ‘hot money’ flows. Earlier this week, Noritaka Akamatsu, senior adviser at the Asian Development Bank’s Office of Regional Economic Integration, said that some regional governments are thinking of limiting capital inflows in the ‘short-term, liquid side of the market’. For example, Indonesia’s central bank deputy governor said the country may impose immediate curbs on foreign ownership of short-term debts. Meanwhile, policymakers in Taiwan, Brazil and Peru have acted to restrict short-term foreign fund inflows.
Many of these emerging countries know from experience how painful it is when the money flow stops or reverses. In the past 15 years, such ‘sudden stops’ or abrupt cessation in foreign capital inflows and/or sharp capital outflows from emerging markets had precipitated many a currency or balance-of-payment crisis. More than 120 sudden stops in capital inflows have been identified since the early 1980s, with an average output loss of almost 10 per cent of GDP. Notable episodes of sudden-stop crisis are the financial crisis that hit Mexico in 1994, Thailand and Korea in 1997, Indonesia, Malaysia and Russia in 1998 and Argentina in 2001. But there is a difference between the 1990s and now. Then, the sudden stops resulted in a situation in which a country’s consolidated financial system has potential short-term obligations in foreign currencies that exceed the amount of foreign currency it can have access to on short notice. Today, the corporate and sovereign balance sheets in emerging markets are much stronger. And the ‘hot money’ does not come in the form of debts.
Still, the unfettered flow of such ‘hot money’ into the assets of small economies will definitely create bubbles and its subsequent departure can wreak havoc on the market. Academic papers of past ‘sudden-stop’ crises have identified short-term debt as a potential cause of liquidity problems. As such, policies to lengthen the maturity of debts are recommended and one solution may be to tax short-term capital inflows. A variation for today’s emerging markets could be tax on capital gains made within, say, a one or two-year period. This may well have the effect of forcing investors think a bit more long term.
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