The 2008 China Financial Market Development Report, issued by the People's Bank of China on May 4, pointed out that various stimulus packages launched by respective countries would influence supply and demand relation in international financial market. This may probably lead to a large scale withdrawal of capital from emerging markets.

"If the inflowing offshore funds in China begin to outflow, it may probably result in a drastic adjustment in the stock market and bond market of China," said the report.

The warning of the Chinese central bank is based on the financial crises as it occurred in different countries as well as the appreciation of the US dollar since the later half of 2008. The dollar value moving up resulted from the flowback of large sums of money from international markets to the US after subprime mortgage crisis.

After the financial tsunami broke out in the US in 2008, it is not only the US financial institutions that brought back the capital invested overseas to make up the shortage of liquidity but capital in the global market also sought a safer place--the US market. Therefore, it is no surprise that foreign capital withdrew from emerging markets considering that capital from other parts of the world also flowed to the US.

Various recovery measures and economic stimulus packages, which are announced by the affected countries with the aim of saving a depressed economy, will also change the trend of capital flows in the international financial market.

On May 5, State Administration of Foreign Exchange (SAFE) in China solicited opinion from all social sectors on the issue of administration of domestic foreign exchange accounts of foreign institutions. SAFE stated that these accounts of some foreign institutions tend to be a hotbed of illegal practices because of the absence of unified regulations. SAFE will reinforce the management of these accounts in domestic non-offshore banking sectors.

I believe that there are several key points here. First, SAFE will regulate the opening and operation of foreign institutions' domestic foreign exchange accounts, in order to keep track of cross-border capital flows. Second, it wants to prevent these accounts from being used for money laundering. Third, it intends to prevent the large-scale illegal flow of cross-border capital in these accounts from adversely impacting China's financial market. Fourth, it wants to avoid these accounts becoming the main channel for the escape of international hot money.

In recent years, with the increasing opening up of China, more and more foreign institutions have opened foreign exchange accounts in domestic banks. The volume of business keeps increasing rapidly. According to incomplete statistics, such accounts opened by foreign institutions within China exceeded 100,000 at the end of 2008.

A few years ago, when RMB was appreciating fast and domestic asset prices increasing in leaps and bounds, a large number of foreign institutions frequently opened accounts in domestic banks. This made a huge a mount of international hot money rush into China. The total volume of international hot money in China at that time was estimated to be $500-600 billion equivalent to 5 trillion yuan. After the financial crisis broke out, due to the reflux of the US dollar and the depreciation of RMB, the net outflow of the balance of payments accounts in China is estimated to be between $20 billion to $200 billion in the fourth quarter of 2008.

The trend of RMB exchange rate and the development of Chinese economy in the future will determine the direction of international hot money flow. Considering the fact that China's economy will recover earlier than other countries, if RMB exchange rate can be kept stable or even allowed to rise slightly, there is little chance of a massive outflow of international hot money from China, no matter how turbulent international financial markets are. If the flow of international hot money can be limited to a controllable range, we don't need to worry about it too much.

However, if China doesn't accelerate the pace of economic reform for dealing with key problems, China's economy will face many difficulties when the US and European economies revive after the crisis. By that time if the RMB is depreciated because of a slowdown of China's economic growth rate, it is possible that there would be huge amounts of international hot money outflow from China.

China should tighten the administration of the cross-border flow of capital. But it is unnecessary to strictly control the outflow of oversea capitals. The key to this issue is whether China's economy can keep sustained and steady growth.

The author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Science.

(China Daily May 19, 2009)