For years, China's economy was short on, but now, China's monetary policymakers face the problem of too much "hot money" or speculative capital in the marketplace.

According to a research report by the investment bank Credit Suisse First Boston (CSFB), up to US$25 billion in short-term speculative funds sneaked into China in the year's first half as investors bet on possible sharp appreciation of the local currency renminbi.

"This money will not lead to immediate impacts on China's economy," Gao Huiqing, a senior analyst with the State Information Centre, told China Business Weekly.

"But the government needs to take heed of the longer-term fallout from speculation."

Capital influx adds to monetary pressures

According to Gao, the hot money will mostly flow into areas with high liquidity such as the securities and bonds market as it is a short-term investment.

The speculative capital, since it is seldom invested in industries, is unlikely to damage the overall economy once it is withdrawn.

Experts said the government's repeated emphasis on the renminbi's stability in the near future will help divert speculators' attention from the renminbi.

"The sharp inflow of hot money may gradually trail off," Tan Yaling, a senior researcher with the Bank of China's Institute of International Finance, told China Business Weekly.

In the first half of this year, China's foreign reserves increased US$60 billion and the nation's trade surplus and foreign direct investment (FDI) grew by around US$35 billion.

The gap between the two figures - about US$25 billion - is likely to have arisen from the inflow of speculative capital, according to Tao Dong, a Hong Kong-based chief analyst with CSFB.

Experts said the increase in hot money this year is also reflected in the nation's international balance of payments, released by the State Administration of Foreign Exchange in May.

The most noticeable change last year was a rare shift of US$7.8 billion into positive territory under the errors and omissions column, an item in the balance of payments which often reflects unreported and irregular money flows.

Gao said there is a link between that shift and the surge in hot money in China.

Despite minor impacts on China's economy in the short term, speculative foreign currencies will further pressure the central People's Bank of China to increase renminbi supply, which is already high, according to experts.

The nation's money supply picked up pace in June, up 20.8 percent from a year earlier and edging out end-May growth, which was the fastest in five years.

Economists have warned of an overheating economy, fanning fears that inflationary pressures will grow.

Since early this year, calls for China to revalue its currency have escalated.

However, experts strongly believe any appreciation now would damage the economy in terms of exports, employment and financial stability.

Taking one step towards currency appreciation may intensify pressure from the international community for even greater appreciation.

Tao suggested alternative measures are better policy options than direct appreciation at the moment.

He said one measure under intense consideration is changing the currency repatriation requirement.

So far, all but a small proportion of foreign currency export earnings must be repatriated and sold to the central bank. The new measures would allow Chinese companies and individuals to hold foreign currencies, onshore or offshore. This would reduce pressure on the central bank to pile up foreign reserves and to slow money supply growth.

Tao said the government is considering abandoning the VAT (value-added tax) rebate scheme as well.

The plan would reduce average tax rebates from 15 per cent to 11 per cent and effectively appreciate the renminbi without altering the exchange rate, according to Tao.

It would also ease the government's fiscal burden, as VAT rebate requests increased by 16 per cent year-on-year in the first six months of this year.

Gao said Chinese companies would also be encouraged to go global, investing overseas or buying overseas assets.

He said pressure for an appreciation of the renminbi will lessen in the third quarter of this year.

The inflow of FDI to China is likely to slow down as the world's economy gets back on track and investments rise in other parts of world.

Some investments may shift away from China because its share markets have been in the doldrums for months, while global markets are more upbeat.

"The government should stay cool-headed, alert to any potential hazards ahead," said Tan.

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