Impact of “Hot Money” on China’s Economy

The main concern in China over the of “hot ” has been that it may add to China's inflationary pressures. In July 2008, the government reported that the consumer price index had risen by 7.9% over the first half of 2008 over the same period in 2007 (due largely to prices), which was much higher than the government's target ceiling of 4.8%, and the producer price index rose by 7.6%. High inflation is a serious issue for the government because of concerns that rapid inflation could produce protests and political instability. At the same time, the government needs rapid growth to help employ the 27 million new job seekers each year.

Under Chinese law, most foreign exchange entering the country must be converted into RMB. The large flow of “hot money” is causing a sharp rise in China's money supply, resulting in inflation. The Chinese government has attempted to “sterilize” the foreign exchange by selling bonds to “soak up” the RMB put into circulation, but this has resulted in higher interest rates that attract even more “hot money.” China has attempted to nullify the inflationary impact of “hot money” by other means, such as the imposition of quotas on banks, increasing the ratio of reserves commercial banks are required to maintain (it was raised to 17.5% in June 2008 compared to 9.0% in January 2007), raising interest rates, instituting government controls to limit investment in overheated sectors (such as real estate and the steel industry), and imposing price controls on certain products (mainly food and energy). A big concern by some Chinese analysts is that “hot money” may be creating bubbles in its stock and real estate markets, although recent evidence suggests that the “hot money” is being largely deposited into bank accounts.