Defending Against Hot Money Risks
As is reported, a lot of “hot money” has frantically flown into Asian Capital Market since QE3, yet the Greater China has attracted the lion’s share of it. As a result, RMB begins re-appreciating after a period of depreciation, and such drastic changes have drawn wide attention in the capital market.
The so-called “Hot Money” does have its sources. Let’s put it simply, Hot money means the huge short-term capital flow due to the difference of the interest rates in different countries and the expectation of further appreciation of a certain currency. The formation of the hot money represents the outcome caused by the international financial market integration and the rapid expansion of the global investment institutions. Once the favorable investment opportunities crop up within a short period of time, these investment institutions will surge up, thus exerting a strong effect on the exchange rates and interest rates of the corresponding countries.
As for China, Hot money has been something of great interest in the recent decade. With the fast growth of China’s economy, particularly the rapid expansion of the export sectors, the Chinese government has to repeatedly tighten the credit in response to the domestic inflation, thus having bred the soil to attract the hot money due to the fluctuation of interest rate and exchange rate. Thus, when the US currency policy is adjusted, the foreign market will cause a stir and hot money will flow back and forth between China (including the emerging market countries in a broader sense) and the US.
Hot money is highly featured as short-term, speculative, virtual and profit-driven, so they will bring the greater negative impact than its positive impact either in terms of the efficiency of the financial system or from the perspective of the social equality. So the macro-economic administrative authorities should regulate and control over hot money.
However, while China’s currency policy targets on containing inflation, there are only two major ways to deal with hot money in short term: One is to intervene the foreign exchange market to curb the appreciation of the RMB; the other is to strengthen the regulation of capital flows. In the current China where the capital account is not open yet, these initiatives can exert the short-term effect and contribute to the stabilization of the foreign exchange market.
Yet, we still need to tackle the hot money issues from the longer and more profound perspective. So in this regard, we have to answer two questions: First, the Capital Account Openness and the RMB internationalization will not be the long-range policy target, yet how can we do when the day really comes? Second, it is quite normal that the interest rates and exchange rates among all countries will be greatly different as the domestic economic situations and the policies are out of sync, yet why do we seldom hear that the US is negatively affected by the “Hot money”?
Of course, we hope that China can achieve the same goal in the near future: the capital account will be totally open and at the same time the inflow and outflow of the hot money will not exert the tremendous impact on our financial market. To achieve this goal, or to mitigate the negative impact wrought by hot money (of course we can not expect to totally eliminate the hot money), it seems to me that we need to iron out two core issues: the first one is to strongly boost the domestic demand and reduce the excessive reliance of the entire national economic growth on the export sectors. In the past decade, the export trade has played a tremendous contribution to the national economic growth. However, the “excessive foreign trade dependence” has considerably kidnapped the RMB exchange rate. So under such a situation, once RMB is appreciated, it is sure to impose the huge pressure on the export and the economic growth. As China currently has a large population and the huge market, the excessive dependence on the economic growth as the major engine is just a makeshift in the short run, but it is unimaginable in the long run. So we should give it more serious consideration as to how to “transform the export into the domestic demand”, which will considerably benefit us and also will be a blessing to all other countries in the world.
Second, it is necessary to improve the depth of our financial market. Though being the second largest economy in the world, China’s financial market is not yet mature in terms of its stock market, bond market, foreign exchange market, etc. If the capital account is opened against the current situation, the rampant flow of the hot money will shock the domestic financial market, thus cause the rapid rise or immediate drop of the prices of stocks and real properties and the prices of other assets within a short period of time and negatively affecting the stabilization of the financial system. Why does hot money not exert the similar damage in the US? The key lies in that the US has the largest capital market in the world which has become the “big absorber” of huge hot money. So from this perspective, it is very important to accelerate the development of domestic financial market, especially the direct capital markets.
Originally published on Time Weekly | 2012-11-1
