My Blog

November 23, 2007

How much money has been flowing illegally from the mainland to Hong Kong?  No one really knows, of course, but there has been an awful lot of noise about the subject recently, culminating in the decision last week by the Shenzhen branch of the PBoC (and Wen Jiabao’s subsequent reversing of the decision) to limit bank withdrawals, in an effort to slow down money flows out of Shenzhen and into Hong Kong.  

Prime Minister Wen did say that the amount of money illegally flowing out of China is “huge”, and several people who know a lot more about this than I do say that roughly half of this is going to Hong Kong to take advantage of relatively cheap share prices of Chinese companies that trade there (the so-called “H-shares”).  HSBC’s Steven Sun even says that there have been suggestions that as much as RMB 120 billion ($16 billion) flowed into Hong Kong just in September, although he dismisses the number as being way too high.

At the same time there has been an increasing debate during the past few months about hot money inflows into China.  Some analysts still argue that this is not a serious problem for monetary policy, and so will not act as a constraint on the ability of the PBoC to manage domestic interest rates and the rate of RMB appreciation. 

I disagree.  At any rate I think these arguments are a lot weaker than they were even three months ago, and I don’t think they were very strong back then either.  Research group CEBM argues in their November 19 report that hot money inflows are becoming once again a real PBoC concern and declining US-China interest rate differentials are making things worse.  Based largely on educated guesses about the balance of payments figures, anecdotal evidence, and statements from financial authorities that seem to indicate real worry, my working assumption for a long time has been that net hot money inflows are high enough severely to limit the ability of the PBoC to manage monetary policy.  Nearly all domestic tightening measures will simply have the perverse effect of increasing money inflow and so reversing the intended impact of the tightening. 

So it seems that absolute flows out of China are high enough to cause a lot of concern among authorities, even to the extent of causing them to take the anxiety-inducing step of limiting bank withdrawals.  Net inflows are also high enough to cause significant concern.  This suggests that gross flows coming from and going into mainland China are probably very high – and certainly high enough to suggest that we shouldn’t place too much confidence in the ability of capital controls to protect the integrity of domestic Chinese monetary policy. 

In and of itself this shouldn’t be surprising.  Capital controls for such a big and rapidly changing country like China were never going to be easy, and of course the longer they are in place the more easily subverted they tend to be.  Tomorrow I will try to say a little more on the subject based on as-usual invaluable sleuthing by Logan Wright of Stone & McCarthy.

Comments (3) for "Hot money coming and going"

the upcoming policy that allows onshore investors to directly invest in hk stock exchange has been boosting the hkd/cny blackmarket for the past few months. there are many people i know who have been exchanging hkd with cny they have from ppl living in hk wishing to invest in the mainland. btw, here is an article from today's bloomberg. maybe its time to buy nikkei: Yen Pares Losses on Speculation China to Invest in Japan Stocks By Stanley White Nov. 26 (Bloomberg) -- The yen pared losses against the dollar and the euro on speculation China will invest some of its foreign exchange reserves in Japanese stocks. The yen gained against 11 of the 16 most-active currencies after the Nikkei news agency reported that China Investment Corp., a fund that will invest $200 billion of the country's reserves, will buy Japanese equities. The company said last month it will use about $67 billion to invest in financial assets around the world. ``This report could push up the yen this afternoon,'' said Tokichi Ito, deputy general manager of foreign exchange in Tokyo at Trust & Custody Services Bank Ltd., a unit of Japan's second-largest publicly traded lender. ``Questions about what China will do with its reserves suggest that other investors may also favor Japanese assets.'' The yen traded at 108.29 per dollar at 12:35 p.m. in Tokyo up from an earlier low of 108.78 and little changed from 108.29 late in New York Nov. 23. It was at 160.56 against the euro after falling to a low of 161.43. The yen may rise to 107.80 against the dollar and 159.50 per euro today, Ito forecast. By megatone - 11/25/2007 12:49 PM

I'm curious as to why a limit on bank withdrawals is necessarily aimed at reducing (current) outflows from China. Might such a measure not also be aimed at reducing (current) inflows by making explicit the possibility that (later) outflow of a speculator's funds may be restricted? By Estragon - 11/26/2007 3:52 AM

Estragon, I suppose it might, but I think the Shenzhen authorities (and Wen's subsequent comments) made it pretty clear that it was the former they were considering and not the latter. I think you might be implicitly wondering why should authorities care about illegal outflows when inflows are their biggest headache. There I am not sure what the answer is. I would have thought that their reaction to illegal outflows would have been : Good riddance! Perhaps they were concerned about destabilizing the HK markets, or perhaps this boils down to a lower level bureaucratic thing. By Michael Pettis - 11/27/2007 5:24 PM