Statistics indicate that China's net foreign exchange reserves in the first quarter of 2008 grew by more than US$ 80 billion. What are the factors behind the rapid increase? Is it the inflow of hot money or are there other reasons?

China''s foreign exchange reserves in the first quarter of 2008 grew by US$ 153.9 billion, and the trade surplus and applied foreign capital over the same period hit US$ 70 billion, according to the latest statistics. The margin of more than US$ 80 billion is believed by some to be an influx of hot money.

As China has not opened its capital market, the investment of foreign funds calculated under the Qualified Foreign Institutional Investor (QFII) scheme is inaccurate, according to Hu Zuliu, managing director of Goldman Sachs (Asia) Ltd. "Although the margin is closely related to the inflows of hot money into China, which reflects a potential pressure of surplus money, the amount is not exact," said Ding Zhijie, vice president of the School of Banking and Finance of the University of International Business and Finance.

Some believe that the level of hot money in China has been underestimated. Hot money can flow into China through transfer pricing, or through fake trading and investment, as well as through misappropriated capital funds. China has now accumulated at least US$ 500 billion of hot money, claims Dr. Zhang Ming from the Chinese Academy of Social Sciences.

Financial authorities in all open economies have to deal with cross-border capital flows. The main sources of China's growth in foreign exchange reserves and trade surplus are legal trade and investment activities. But the possibility of clandestine inflows of hot money cannot be ruled out, insiders from the State Administration of Foreign Exchange told the People’s Daily.

It is not easy to determine China's exact accrual of hot money because of a lack of clarity in the definition and the sourcing of funds. But it is generally acknowledged that hot money has been flooding into the country as the result of the appreciation of RMB, and in the expectation of a rise in China's real estate and stock markets.

The hot money risk deserves close attention, and more foreign investment channels should be developed.