"Hot Money" Still Flowing into China Despite Dollar Rebound

The US dollar is rebounding, and expectations are that that and the US Federal Reserve increasing interest rates will open the floodgates for international capital to gush out of China and trigger financial turmoil and ruin for the Chinese economy. 

Balance sheet data released by the People's Bank of China (PBoC), China’s central bank, in July shows that "foreign assets" increased by RMB 304.3 billion that month, about $44.6 billion according to the current exchange rate. The data show inflows in January of this year reached $83.2 billion and $76.6 billion in April. The inflow in July was less than that of May and June, $50.6 billion and $46.9 billion, respectively, and was higher only than that of February.

Moreover, according to central bank data over the same period, funds outstanding for foreign exchange in July increased by RMB 333.9 billion, or about $48.9 billion.

In July, China's trade surplus was $25.28 billion and foreign direct investment inflow was $8.34 billion, for a total of $33.62 billion dollars, which was $11 billion less than the increase of "foreign assets" to PBoC and $15.3 billion less than the inflows of funds outstanding for foreign exchange. The PBoC is still clearly facing tremendous pressure from hot money inflows.

Ding Zhijie, professor at the University of International Business and Economics, said that financial regulatory bodies�credit policies were tight until July of this year, which may have stimulated overseas financing of domestic firms and strengthened the growth of foreign exchange inflows. He believes the inflows of hot money will ease with the relaxation of domestic credit policies and other factors.

Foreign exchange reserves underestimate the inflow of foreign capital

According to the PBoC, through July of this year, total foreign currency assets increased by $394.3 billion, and the cumulative foreign capital inflow of funds outstanding for foreign exchange was $404.1 billion.

For the first half of this year, these numbers were $349.7 billion and $355.2 billion, respectively, while the current foreign exchange reserves increased only $280.6 billion, down $70 billion.

 Logan Wright, an analyst with SMRA, a research firm in Beijing, told reporters that according to integrated data, there is little evidence of any sharp slowdown in capital inflows. Although the official foreign currency reserve growth in June dropped to 11.9 billion dollars, this reflects a large part of foreign exchange reserves (about $36.4 billion) moved to commercial banks, to pay the increase of 100 basis points of the reserve requirement ratio in June.

Logan Wright said that, although in July the inflow of foreign exchange assets was around $45 billion, the official foreign currency reserve data released by the central bank in October will likely be lower than $40 billion.

"Because of the dollar's rebound against major currencies in July, it will lead to a lower value of non-dollar assets in China's foreign exchange reserves when these assets are converted into dollars, just as in the period of dollar depreciation the conversion overestimated the actual growth of foreign exchange reserves. It is estimated that in July exchange rate factors resulted in a reduction of $7 billion."

Logan Wright pointed out that because of the sharp rebound of the dollar against the euro and other major currencies in August, such adjustments will reach around $25 billion.

On the situation of China's capital outflows, which the market is most concerned about, Logan Wright said: "Under the current one-year RMB non-deliverable forwards, appreciation of RMB against dollar would be less than 1 percent, the slowest rate of appreciation since changes began in the RMB exchange rate in July, 2005. If this appreciation rate continues, it may lead to capital outflows. "

In August this year, China also revised its "Exchange Management Regulations."  The management policy on inflow and outflow of funds turned from "Lenient-in and Strict-out" to a balanced one. Analysts believe that this will also have an impact on foreign exchange inflow.

Ding Zhijie emphasized that international capital flow into emerging markets in 2006 was less than 300 billion dollars, while in 2007 it reached 620 billion dollars. But once the return of capital starts to happen, its speed may be faster than imagined. The strong dollar rebound in August may be a signal and have a decisive impact on international capital flow. In this context, the possibility of crisis in emerging markets increases.

Vietnam had a serious currency crisis in the first half. At present, South Korea, Argentina and other countries are facing problems such as foreign exchange outflow, depreciation of their currency against the U.S. dollar and forced reduction of foreign exchange reserves.