User:Kurshat

Hot Money

Definition

There is no formal definition of “hot money,” but the term is most commonly used in financial markets to refer to the flow of funds (or capital) from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts. These speculative capital flows are called “hot money” because they can move very quickly in and out of markets, potentially leading to market instability

In his paper titled Hot Money and Serial Financial Crises, economist Dr. Anton Korinek vividly described the hot money as following: one country or sector in the world economy experiences a financial crises; capital flows out in a panic; investors seek more attractive destination for their money. In the next destination, capital inflows create a boom that is accompanied by rising indebtness, rising asset prices and booming consumption-for a time. But all too often, these capital inflows are followed by another crisis. Some commentators describe these pattern of capital flow as “hot money” that flows from one sector or country to the next and leaves behind a trail of destruction.

Estimating the Hot Money

There is no well-defined method for estimating the amount of “hot money” flowing into a country during a period of time, because “hot money” flows quickly and is poorly monitored. In addition, once an estimate is made, the amount of “hot money” may suddenly rise or fall, depending on the economic conditions driving the flow of funds. One common way of approximating the flow of “hot money” is to subtract a nation’s trade surplus (or deficit) and its net flow of foreign direct investment (FDI) from the change in the nation’s foreign reserves.

Sources of Hot Money

It is generally believed that hedge funds and other portfolio investment funds are major source of hot money. However, in the 1997 East Asian Financial Crises and 1998 Russian Financial Crises, the “hot money” chiefly came from banks, not portfolio investors. Attitudes Toward Hot Money

Generally, countries around the world welcome capital inflows such as Foreign Direct Investment. However, on the contrary, government’s try to stop the Hot Money coming into their country. This is because “hot money” inflows present two dangers to the receiving country’s economy. One is that capital could suddenly flow out, which either help cause financial crises as in the case of East Asian Financial crises in 1997 or could hurt the bank system. The other danger is that the massive short term capital (hot money) inflow could fuel inflation or exchange rate appreciation creating short term macroeconomic instability.

Different countries are using different method to prevent massive influx of hot money. The following are specific examples of several countries approach to the hot money.

In Turkey: on December 16, 2010, the Turkish Central Bank surprised markets by cutting interest rates at the time of rising inflation and relatively high economic growth. Erdem Basci, deputy bank governor of Turkish Central Bank argued that gradual rate cuts were the best way to prevent excessive capital inflows fuelling asset bubbles and currency appreciation. On February 14, 2011, Mehmet Simsek, the Turkish Finance Minister said: “more than $8 billion in short-term investment had exited country after the central bank cut rates and took steps to slow credit growth. The markets have got the message that Turkey does not want hot money inflows” In China: the government does not allow foreign funds directly invest in its capital market. Also, China set quotas for its domestic financial institutions for the use of short-term foreign debt and prevent banks from overusing their quotas.