Emerging economies face hot money risk
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In the post-crisis era, the flow of international capital has taken on new features. FDI has decreased from 80 percent to 50 percent of net international capital flows. The gap is being filled by short term capital flows to emerging economies.
International hot money
Since the U.S., EU and Japan slashed interest rates, higher rates in emerging economies have become a magnet for arbitrageurs. Net capital inflows to Asia reached $35 billion in 2009, and the 2010 figure will be higher. Emerging markets have become the target of international hot money, causing asset bubbles in real estate and stock markets. In 2009, India's Sensex Index increased by 81 percent, the Brazilian BOVESPA index surged by 82.7 percent, and the Russian RTS Index rose by an astonishing 128.8 percent. In Indonesia, Philippines, Thailand, Vietnam and Argentina stock market indexes rose more than 60 percent, while the Dow Jones only managed 18.8 percent.
Stimulus packages, economic recovery and the the inflow of foreign capital have caused a real estate boom in emerging economies. Brazil began to surge in 2009; real estate in Brasilia is now $6600 per square meter on average; in Moscow the average is $5320; in New Delhi it is $1400.
Vietnam and India are facing inflationary pressures. The forecast growth rate for the Vietnamese economy this year is 8.2 percent, while the CPI is expected to reach 10.8 percent. The wholesale price index in India has reached an 11-year high.
Why is hot money flowing into emerging countries?
Loose monetary policy is the financial platform for international hot money. Interest rates in major Western countries are almost zero, and capital is flowing into stock markets and real estate. The capital markets of emerging countries have become the destination of choice for excess liquidity.
Industrialization and urbanization in the emerging economies have contributed to the surge in asset values, providing a further spur to international arbitrageurs.
Exchange rate mechanisms in emerging economies lack the flexibility to react to the excessive hot money inflows. Most emerging countries still have exchange controls and lack the auto-adjustment function of free-floating exchange rates.
Negative impact
Hot money has several negative impacts. The inflow of foreign capital increases pressure on the domestic currency to appreciate. In countries with floating exchange rates, this can have a huge impact on the national economy. Countries with fixed exchange rates, on the other hand, have to make costly interventions in the currency markets. Inflows and outflows of hot money disrupt macroeconomic policies and make an independent monetary policy virtually impossible.
By early 2009, the international hot money was already active and predatory in the commodity markets, even before the economic recovery began. Hot money in commodities drives up prices, causing bubbles and cost-push inflation in emerging economies. Hot money flowing into capital and real estate markets causes property bubbles and distorts investment and consumption patterns. Finally after realizing its profits, hot money rapidly withdraws and the flow of capital reverses direction, inflicting even more serious damage on emerging countries.
The author is a researcher at the China Institute of International Studies.
(This article was translated by Lin Liyao.)
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