Hot money needs cooling

Mainland and HK monetary authorities must make joint efforts to reduce risks from inflows of speculative capital

A series of monetary easing measures by the United States and some European countries since August, aimed at curbing their debt crises and stimulating economic growth, has added huge liquidity to the international financial market and complicated the economic and financial environment facing emerging countries.

A recent Citigroup report indicates that the flow of global capital from developed countries to emerging markets has accelerated following the adoption of the third round of quantitative easing by the US Federal Reserve. More than 80 percent of it flowed to the Hong Kong Special Administrative Region and the Chinese mainland from late September to the end of October. Besides preying on the yuan's exchange traded fund, Hong Kong H shares and yuan-denominated financial products are also the targets for international hot money.

Given that the US dollar is expected to maintain a near-zero interest rate for a long time to come, a large portion of China-bound capital is seeking to profit from the interest rate gap between the yuan and the dollar. The multi-channel entry of hot money makes it difficult for the mainland's monetary authorities to exert effective control over it. But a continuous inrush of speculative international capital, if not effectively curbed, will push up China's inflation, add pressures to the yuan's appreciation, produce serious negative influences on the country's financial stability, and weaken its efforts to tame inflation and pursue sustainable and healthy development of the national economy.

Despite an emerging economic recovery, Asian economies are still likely to face inflation pressures next year under the influence of this huge external liquidity. Indonesia and the Philippines are expected to join Singapore in fighting inflation.

To reduce the risks arising from the inflows of hot money, joint efforts are needed from Asian governments to strengthen monitoring to fend off the excessive inflows of speculative international capital. In response to the large-scale inflows of international hot money to their capital markets, the Hong Kong Monetary Authority and the monetary authorities in the Republic of Korea and Thailand started taking some forcible precautions in October, which have helped avoid further inflation of their asset bubbles.

As a leading economy in Asia, China should adopt a timely, flexible, well-tailored and more forward-looking macroeconomic policy. Amid signs of its economic deceleration and the increased risk of imported inflation following the adoption of QE3 in the US, China will face an uphill task in effectively implementing its fiscal and monetary policies aimed at maintaining stable growth.

China needs a flexible regulatory policy, and quantity-dominant regulatory means should be employed as much as possible to hedge against liquidity and prevent a rapid appreciation of local currencies. They should also maintain measures to curb inflation and real estate bubbles. Effective measures should also be taken to stabilize the yuan's exchange rate and reduce appreciation expectations. Reform of the yuan's exchange rate regime should be carried out in an active but controlled manner, and monitoring should be strengthened over the inflow and outflow of international capital. Harsh penalties should be enforced against unregulated flows of transnational capital in a bid to prevent their large-scale inflow and outflow, especially to prevent them from flowing to the housing and stock markets.

The mainland and Hong Kong monetary authorities should strengthen cooperation in financial monitoring. Under the current financial framework, Hong Kong is usually regarded by international hot money as a transfer center for movement to the mainland. The recent depreciation of the Hong Kong dollar and the rise of its asset prices are a result of the increased inflow of international hot money to the region. Maintaining stable exchange rates and avoiding a rapid rise in asset prices will help the Chinese mainland and the SAR forestall the speculative inrush of international capital.

As a fundamental way of stopping the excessive inflow of international hot money, China should accelerate the pace of the yuan's internationalization to reduce the negative effects brought about by the US dollar's hegemony and unrestrained liquidity. At the same time, China should make adjustments and perfections to its monetary and exchange rate policies.

China's continuous and large-scale purchases of the US dollar over the past decade in a bid to maintain the stability of the yuan's exchange rate has added pressures to domestic inflation. This has caused doubts about the necessity of China continuing to peg the yuan to the dollar. The dollar-pegging exchange rate policy will plunge China into a particularly passive position if the US continues to loosen the screws on dollar issuance.