Hot Money Can't be Plugged Up

Cover editorial, issue no. 375 July 7 2008
Original article: [Chinese]

The State Administration of Foreign Exchange (SAFE) announced last week that Chinese exporters receiving income in foreign currencies will have to deposit such income in a special account for clearance before it can be exchanged into the yuan. This was seen as yet another push by the Chinese government to block hot money.

Though it is unknown exactly how much hot money is coursing through the Chinese economy at any moment, regulators have devoted more attention than ever before to the issue (see The Ebbs and Flows of Liquidity in China). When hot money flows in, it drives up asset prices and leads to bubbles. In times of retreat, the banking system may suffer a serious blow, the local currency could depreciate, the asset markets could slump, all dragging down the real economy.

For regulators, international trade is the major channel for hot money inflows. Various types of capital enter China in the name of trade only to lurk in the stock market or bet on the yuan. It’s hard to assess how harmful this money can be, as it comes and goes without warning. With the lesson of Vietnam still there, China would do well to pay attention to the issue.

To replace the traditional paper-based system of tracking payments with electronic information networks will improve efficiency of supervision. However, exporters will have to present additional certificates to prove the background of goods for exporting. After collecting funds entering accounts and waiting for inspection, exporters will face capital turnover problems if documents are backed up, and fail to exchange us dollars to yuan. The documents released by supervision agencies have not clarified time limits for inspections.

Indeed, hot money is a threat. But for a country with all common services totally open, more than half of capital accounts already opened, and China's financial system fully integrated with the globe economy, plugging up all hot money channels may just be an ideal. We have never been able to confirm hot money’s true scale, which also means the effect of blockage would be limited.

In past years, while strengthening the supervision of hot money, supervisory agencies have simultaneously cranked out measures loosening controls and improving businesses’ and residents’ autonomy in foreign exchanges. Loosening control measures made trade and investment easier and reduced exporters’ costs relating to foreign exchanges. The guiding principle of balancing between foreign exchange flows also creates conditions for the gradual opening of capital accounts.

Therefore, we think that the presence of hot money does not mean that China must change its policy of entrenchment, and instead should open up capital accounts and set yuan’s exchange rate free.

It also needs to weigh pros and cons when adopting strong measures to block hot money. If we are bound to pay the cost, should we be more considerate of how to protect the export enterprises’ interests and create a looser trading environment?

We've noticed that regulators have taken into account that different industries have different characteristics and will take this into consideration when applying the new rules. This deserves high praise.

Generally speaking, it is unlikely to fundamentally solve the hot money problem by adopting prevention and blockage measures. As the saying goes, a house flie never stings an egg without a crack. This is to say that the attack of hot money is linked to  fundamental loopholes in the economic system, and that only by addressing them can you ultimately address the problem.

One the one hand, as long as China has healthy and steady investment prospects, capital flow will not reverse; on the other hand, the key to solving hot money still lies in improving the yuan’s exchange rate mechanisms and leaving more room to monetary policy.