News, Cover Story
Issue 431, August 10, 2009
Translated by Liu Peng
Original article: [Chinese]

Short-term speculative funds, also known as hot money, have started flowing into China at an unprecedented rate as the country's economy appears to slowly emerge from the global downturn.

Academics estimate that the total amount of hot money in mainland China is in the vicinity of 200 billion to 300 billion US dollars, accounting for some where between 10 and 15% of the country's foreign exchange reserves.

In the wake of the US financial crisis, hot money rapidly exited China's markets last September, but as property market began to heat up, speculative funds have returned.

Although these funds at first entered the real estate market, they are now moving towards the stock market. Analysts predict that the speculative funds will later switch to the commodity markets.

How Much Hot Money has Flowed into China?

There's been a surge in the amount of hot money flowing into China over the past two months, according to Li Youhuan, a researcher in Guangdong Academy of Social Sciences, who has been researching speculative funds since 2002.

Wang Tao, chief economist at UBS Securities, estimated that nearly 56 billion US dollars, or about one third of the total 170 billion US dollar second quarter increase in China's foreign exchange reserves, could not be explained by reference to either money inflows from the trade surplus or fluctuations in the foreign exchange rate. The foreign exchange reserves growth figures for the second quarter were significantly higher than that registered in the several preceding quarters.

The central bank's foreign exchange accounts provide further evidence that hot money is back. Data released by the People's Bank of China revealed that in the first quarter, the central bank purchased an average of 100 billion US dollars worth of foreign currency every month. However, from April, this figure began to increase dramatically and climbed to nearly 290 billion US dollars in May.

Wu Nianlu, a professor from the Graduate School of the People's Bank of China, said that while it was possible that the surge in the amount of foreign currency purchased by the central bank could be due to inflows of hot money, he also noted that this growth may also have been affected by the foreign currency deposits of domestic Chinese individuals and foreign currency loans extended to domestic firms.

Ma Zihui, a macro-analyst at the Samsung Economic Research Institute China, estimated that the amount of hot money that had flowed into China in the first half of this year reached between 30 and 40 billion US dollars. He also noted that the country's economic recovery and bullish capital market instead of expectations that the yuan might appreciate, were the main factors that attracted speculative capital. 

Where Does Hot Money Come From and How Does it Enter China?

What remains a mystery is, given the formal tight controls of foreign currency flows in and out of China, how do tens of billions of dollars of hot money enter domestic markets and where does it come from?

Lou Gang, a strategist at Morgan Stanley China, noted that not all hot money was necessarily foreign funds, it was possible that at least a portion of the funds were overseas assets held by Chinese financial institutions.

Wu Nianlu also pointed out that the foreign exchange deposits of domestic citizens and institutions were also capable of becoming hot money.

Li Youhuan said his monitoring of underground banks revealed that most of the hot money that began flowing into the mainland from April, came from savings and investment funds in Hong Kong, Macao and Taiwan. In addition, his investigations also detected that funds from overseas Chinese and a small number of overseas investment funds had also begun to enter the mainland. But he went on to add that there was no indication that international hedge funds were diverting hot money into China.

Li also uncovered several channels by which overseas hot money entered the mainland. These included companies exaggerating the price they paid or received for traded goods, individuals or companies falsifying capital contributions to foreign-funded companies, foreign-funded companies releasing falsified profit performance reports or of individuals transferring funds via foreign-funded institutions.

A source from a real estate company in Guangzhou told the EO that as long as overseas funds wanted to find a channel to enter the mainland, they could. Even if they couldn't go through more "professional" agencies, they could always turn to underground banks.

From Real Estate to the Stock Market to Commodities

A report from Samsung Economic Research Institute China showed that nearly 14% of the 1.66 trillion yuan increase in narrow money supply (M1) in the second quarter was caused by the inflow of hot money, much of which seems to have ended up in the country's stock market.

Li Youhuan predicted that the real estate market would soon witness a downturn and believed that from June onwards, hot money began to retreat from real estate market and began to flow into China's surging stock market. However, Li warned that A shares were already over-priced and that once the stock market peaked, hot money would speculate on the prices of certain commodities whose prices are open to rapid fluctuation.

He also noted that moves by regulatory authorities to crackdown on illegal currency flows were unlikely to have much of an impact on the hot money.

Morgan Stanley analyst Lou Gang noted that given the current global economic situation, particularly China's position as one of the few economic regions achieving of positive growth, hot money was likely to flow into China at an accelerated rate in the second half of the year.