China’s Cold Eye on Hot Money

BEIJING – With China feeling the pressure from large-scale inflows of short-term capital, the State Administration of Foreign Exchange (SAFE) issued a notice in early May outlining a set of measures aimed at controlling “hot money” and reducing external risks. Indeed, the new regulations are essential to managing the renminbi’s rapid appreciation and ensuring the accuracy of trade data. But will they be enough?

A variety of data indicates the massive scale of the inflows. In the first quarter of this year, Chinese banks’ foreign-exchange purchases skyrocketed to a record ¥1.2 trillion ($195 billion) – more than double last year’s total. Such purchases increased by some ¥294.3 billion from March to April, which was the fifth consecutive month of growth.

Over the same period, China’s foreign-exchange reserves swelled by $128 billion, to $3.4 trillion – the largest quarterly increase since 2011 and equal to the total rise in 2012. Given China’s $43 billion trade surplus and $30 billion in foreign investments during this period, capital inflows must have been a contributing factor.

Furthermore, since the beginning of this year, Chinese banks’ valet foreign-exchange settlement (foreign-exchange purchases that designated banks make for their clients and themselves) has outstripped corresponding sales, resulting in a consistently large surplus – also an indication of increased capital inflows. The difference, which banks offset through transactions in the inter-bank currency market, has a significant impact on China’s foreign-exchange reserves, but is not equivalent to the net change in foreign-exchange reserves during the same period.