Unprecedented capital inflows test Chinese regulators
Updated: 2008-07-02 10:44

Why China and where do they invest?

Many will ask why such huge sums of "hot money" have been continuing to flood into China and where it is going.

Li Yang, head of the Financial Research Institution at the Chinese Academy of Social Sciences, said the disparity between Chinese and US interest rates, the appreciation of the Chinese currency (the yuan) since 2005 and the profits from the Chinese capital and real estate markets were the main causes of the unstoppable "hot money" inflows.

Since the start of the global financial crisis, which surfaced last summer with problems in the U.S. subprime mortgage market, the U.S. Federal Reserve has since September cut interest rates seven times to stimulate economic growth. The Fed funds target rate has fallen from 5.25 percent to the current 2 percent.

In contrast, the People's Bank of China (PBOC, the central bank), hiked interest rates six times between March and December 2007 to cool economic growth, with the one-year deposit rate rising from 2.52 percent to the 4.14 percent.

These opposing actions created a disparity that helped to lure global speculative money to into China at an accelerated pace this year.

Another major lure for "hot money" was the continuously appreciating yuan.

In July 2005, China abandoned a decade-old peg to the US dollar and allowed its currency to appreciate by 2.1 percent. Since then, the yuan has strengthened further, mostly slowly, and risen nearly 17 percent against the US dollar.

The appreciation of the yuan, coupled with the simultaneous depreciation of the U.S. dollar, has also prompted "hot money" to bet on the yuan's further appreciation.

"The combination of the interest rate disparity and the yuan's appreciation will ensure a profit rate in excess of 10 percent for 'hot money'," Li Yang said.

The other major incentive for "hot money" was the chance to profit from China's markets, mostly stock and real estate.

Many economists and analysts like Jiang said that the booming Chinese stock market between 2006 and late 2007 and soaring housing prices since late 2005 were, in part, created by global speculative money.

Stock and property returns have been poor lately: share prices have plunged since peaking late last year and the real estate market has faced uncertainties since China began to impose tight macro-economic controls.

So speculative money has sought greener pastures, with some simply being deposited into banks.

Jiang said household and business deposits had grown fast in the first five months.

According to the PBOC, as of the end of May, the balance of deposits in reminbi accounts in domestic financial institutions reached 43.11 trillion yuan, up nearly 20 percent over last year's figure.

"The consumer price index has risen more than 8 percent every month on average this year, higher than the interest rate, but deposits are soaring. It is very probable that 'hot money' is flowing into banks," Jiang said.

His judgement was echoed by investors.

Wang Chenyang, who manages a $12billion hedge fund from Wall Street, told Xinhua that the best investment choice at present was to convert money from the US dollar to the renminbi and deposit it into banks in the Chinese mainland.

Wang said his Chinese friends who work in New York had made such investments with help from their relatives in China.

Similar scenarios took place in Hong Kong, where residents traveled to neighboring Guangdong Province and converted money from the Hong Kong dollar, which has also been depreciating, into the yuan, depositing the proceeds into Chinese mainland banks.

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