Regulation on speculative capital faces test
Updated: 2008-05-09 09:40

"Hot money", or speculative capital, is becoming an increasingly important concern for Chinese regulators as anticipation of an inflow surge strengthens along with a widening gap between interest rates in the United State and that in China.

The exact amount of "hot money" into the country would be difficult to discern, however, there is indeed an acceleration of capital influx into the Chinese market as investors bet on a stronger yuan and rising domestic interest rates.

The influx of international capital was accelerating with investors seeking profits from the interest rate gap and a stronger yuan via arbitrage transactions, said Li Yang, director of the Institute of Finance and Banking under the Chinese Academy of Social Sciences.

The US Federal Reserve has cut the country's interest rates seven times since September, down from 5.25 percent to 2 percent, to shore up the economy threatened by the still unfolding credit crisis.

In the opposite direction, China's central bank last year raised the domestic benchmark interest rate six times to offset inflationary pressure, up from 2.52 percent to 4.14 percent.

Chinese currency gained more than 4 percent against the weakening US dollar in the first quarter, the biggest quarterly gain since China depegged yuan with the greenback in 2005.

"Arbitrage transactions will render investors at least a 10-percent return on investment," Li said.

The world's speculative capital is anxiously turning to emerging markets to seek shelter from the international financial market turmoil.

Zhang Ming, a financial researcher with the Chinese Academy of Social Sciences, said the rapidly rising asset prices on China's capital and real estate markets also arrested some speculative funds.

Recently published statistics showed the country's foreign exchange reserve in the first quarter stood at $153.9 billion, compared with a combined $70 billion in trade surplus and actual use of foreign investment in the same period.

Some analysts said the gap between the two numbers indicated the influx of "hot money" into China could be tens of billions of US dollars in the first quarter.

Zhu Baoliang, the chief economic analyst of the prediction department of the State Information Center (SIC), told an industryseminar last month the first-quarter speculative inflow exceeded $80 billion, compared with $120 billion for all of 2007.

Yet, Zhao Qingming, a senior manager of the research department with the China Construction Bank, said the increase in first-quarter forex reserve was also contributed to by earnings from earlier investment of forex reserve as well as by the sharp appreciation of currencies other than the US dollar.

He also said it was not accurate to analyze the scale of "hot money" simply from the gap between forex reserve and trade surplusplus the use of foreign investment.

Speculative capital inflows into China may climb to $650 billion by the end of this year, or $800 billion by the end of 2009, Zhong Wei, director of the financial research department under the Beijing Normal University, said in a recent report without elaborating on his calculation method.

He put the amount of hot money at $320 billion at the end of 2005, 400 billion at the end of 2006, and $500 billion at the end of last year.

"The excessive inflows of hot money would increase the country's liquidity, and add to the country's existing inflationary pressure," said Zhao.

"The speculative capital, if invested in stocks or housing, could push the country's asset prices up to an irrationally high level," said Mei Xinyu, a trade and foreign investment expert with the research institute of the Ministry of Commerce.

"If a massive amount of speculative funds withdrew from China, the normal operation of the country's financial system could be disturbed," Mei warned.

Zhao said the country needed to contain the anticipation of the yuan's further appreciation and keep asset prices within the range of their true value.

The interest rate gap between the US and China should also be kept within a certain range to curb arbitrage transactions, Zhang Ming added.

China's central bank governor Zhou Xiaochuan said in Brussels on Monday the central bank has always been closely monitoring the possible inflows of "hot money" into the country.

There could be new circumstances as more investors considered short-term investment in China after recent repeated interest ratecuts in the United States, he said.

However, the abnormal capital flows in a relatively small amount would not affect the country's monetary policy, given the large size of the national economy.

China had the option of raising interest rates to control inflation, but there was a range of instruments available for that purpose, Zhou added.

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