From Money and Investment, Page 17, Issue 381, August 18, 2008
Translated by Liu Peng
Original article: [Chinese]

The growth rate for China's foreign exchange reserves has slowed, a sign some market observers thought to indicate hot money was retreating from the country.

In June this year, China's foreign reserves grew by 11.9 billion dollars but in July, the growth had halved and only upped by 5.6 billion dollars, according to the latest statistics released by its central bank, People's Bank of China, on August 13.

For the first half of this year, the country's total foreign reserves amounted to over 1.8 trillion dollars. The reserves had surged within four years since 2004 by more than one trillion dollars, and market observers suspected that hot money contributed to the impressive growth.

Hot money ferers to capital that is transferred from one financial market to another seeking the best opportunity for short-term gain.

Hot Money Outflow Factors
"Though it may not be large scale, but capital is retreating from China, while incoming capital has also reduced," said Zuo Xiaolei, chief economist of China Galaxy Securities Company.

Zuo believed a rebounded US dollar was a main reason in attracting hot money that once flooded into China - when the Chinese yuan was rising against dollars - to flowing back to the US, as the latter regained investors' confidence.

Just two months ago, Bank of China released a research finding saying that the inflow of hot money had accelerated, mainly flowing into Chinese capital market. The report said that sub-prime mortgage crisis in the US and high expectation for Chinese currency, the yuan, to appreciate were the major driving forces behind the inflow.

The yuan's rising trend, however, was reversed and it had been falling against the dollar continuously since August 1. By August 15, the central parity had dropped 226 basic points to 6.8649 yuan per dollar, according to the latest data from China foreign exchange trading center.

Meanwhile, the international crude oil prices slumped to 116 from 150 dollars per barrel. Consequently, the above factors brought about optimistic sentiments over the US stock markets.

One latest survey revealed that increasing number of investors were expecting the US markets to go bullish. The US stock market index Dow Jones had also in mid-July bounced up to around 11,500 points, about 10% higher than its lowest point in recent time.

Across the shore in China, however, the trading volume in its Shanghai Stock Exchange had been contracting. In the first two weeks of August, the daily trading volume remained around 30 to 40 billion yuan, almost a two-thirds reduction if compared with the average volume for the first half of this year.

According to Everbright Securities’ TopView data, securities companies made up most of the top 40 institutions that executed net outflow of capital. On last Monday alone, securities houses pulled out over 6 billion yuan of capital.

In addition, the Chinese central bank's latest data revealed that the broadest type of money supply - M2, which include currencies in circulation, demand deposits, savings, mutual funds shares and more, had been recording downwards trend. In July, the M2 growth rate was 16.3%, which was 1% lower than the previous month.

Market analyst Jiang Chao, from Guotai Jun'an Securities, suspected the two-month-straight drop of M2 growth rate and a dip in securities margin deposits were related to hot money pulling out of the Chinese market.

Potential Shock Waves
Beyond the stock market, the retreating of hot money could have strong impacts on other Chinese assets sectors, such as the real estate, bond, entrusted loan and private loan services markets.

Professor Zhang Ming from Institute of World Economics and Politics, Chinese Academy of Social Sciences, outlined the possible shock waves resulting from hot money outflow and liken them to a chain reaction.

"If hot money retreats, the stock and real estate markets would dive further, affecting both enterprises and individual investors.

"When real estate values plunge, developers would be affected, so would the enterprises and individuals holding shares of the affected real estate companies.

"Consequently, the banking system would be impaired as mortgage assets shrinking; and finally, the insurance industry would also be dragged into the crisis," he said, adding the potential damages would be hard to estimate.

The outlook was not altogether gloomy though, as some market observers pointed out that there appeared to be counter-forces coming into play as hot money retreating and stock markets tumbling.

"For the first week of August for example, funds institutions executed net inflow of capital, amounting to over 10 billion yuan, into the stock markets," said one manager from a Shanghai-based market data tracking company.

In addition, industry players believed there were "invisible hands" or "secret capital" entering the markets.

For instance, on July 18, the share prices of China's state-owned oil giant Sinopec and telecommunication company China Unicom registered sudden surge around the same time, contributing to that day's Shanghai Composite Index to go up by nearly 100 points.

On Aug 20, the drooping Shanghai market again registered a surge of 7.6%, the biggest jump in a day since April 24, following rumours that the Chinese government might intervene with market relief policy. It was not the first time such rumours were circulated and led to temporarily market surges.