June 01,2008

Hot Money Flows Accelerate into China's Reserves

By CSC staff
RMB appreciation slowed down a bit in April, but not so the flow of hot money into China.

According to insiders, China’s foreign reserves has reached $1.756 trillion, the increase in April alone being $74.46 billion, more than January’s increase of $61.6 billion and a new record for the biggest increase in a month.

The increase in China’s foreign reserves in the first 4 months of 2008 was $228.39 billion, nearly the whole amount of the increase year between 2004 and 2006. In April, the trade surplus was $16.68 billion and FDI net inflow was $7.6 billion, leaving $50.18 billion of the increase unaccounted for. In the first third of the year the total trade surplus was $58.12 billion, FDI inflow was $35.02 billion, and the unexplained foreign inflow increase was $135.25 billion.

This number still understates the hot money inflow as it takes into account neither transfers from the central bank’s foreign reserve to China Investment Corporation nor the deposit reserve rate increase as the central bank set more foreign reserves aside as deposit reserve.

According to Logan Wright, a Stone & McCarthy Research Association analyst, in Jan and March the central bank increased the deposit reserve rate twice and commercial banks were asked to deposit dollars, meaning greater deposit reserves of $20.4 billion and $22.1 billion, respectively. Besides, the last special treasury bond of China Investment Corp of $750 billion will be converted into RMB before March, which pushes the increase of foreign reserves of up to $950 billion.

Therefore, in the first 4 months, the total amount of foreign assets inflow would reach $365.9 billion, and the unexplained foreign exchange inflow in the first 4 months would surpass $270 billion.

However, this number might not be accurate as it is still not clear whether to adjust the non-dollar capital value with the current exchange rate, and whether the gains from foreign assets investment should be recorded in the foreign reserves.

"From the current data, it is clear that the hot money flows are accelerating into China," said one economist. But the downward trend of China’s real estate and stock markets, along with the relatively small RMB appreciation in April, makes unclear the reasons for such flows. "I’d have thought that as the appreciation of RMB slowed down, the inflow of foreign reserve would also slow, but the data contradict my thought," he said.

While getting a grip on large hot money inflows, some scholars also say that China has to be alert to any sudden exodus of hot money. Tang Min, the deputy secretary of the China Development Research Foundation has emphasized this. He suggests that China should establish a financial crisis supervision and prevention group, including finance, trade and investment management departments and scholars as well, to clarify the work division, establish crisis management plans and take early measures should there be any crisis.

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