Emerging Markets Consider Capital Controls To Combat “Hot Money” Inflows

Concerned with accelerating inflows of so-called “hot money,” more emerging market nations are considering new capital controls to keep their currencies from appreciating and prevent asset bubbles from becoming a problem.

Loose monetary policy in the United States and Europe has flooded fast-growing Asian economies where Western investors are seeking higher yields. India, Taiwan, South Korea, Hong Kong, and Indonesia are among the regions investigating options to combat the rapid inflows of foreign capital that are driving up stock prices, and threatening their export sectors by forcing their currencies to appreciate.

“With interest rates exceptionally low and with abundant liquidity around the world, Hong Kong faces the potential risk next year that asset prices may go up sharply and become increasingly disconnected from economic fundamentals,” the Hong Kong Monetary Authority said on its Web site.

Hong Kong attracted a record $73 billion (HK$567.5 billion) in foreign inflows between Oct. 1, 2008 and Nov. 13, 2009, according to the Hong Kong Monetary Authority (HKMA). That has driven a 57% surge in Hong Kong stock prices and a near-30% in property values.

Foreign investors have plowed more than $15.5 billion (732.5 billion rupees) into India’s stock market this year, helping push it 75% higher. The rupee has surged about 4.7% against the dollar as a result and further increases could stymie the nation’s exports.

Meanwhile about $15.5 billion (NT$500 billion) in foreign funds has poured into Taiwan dollar accounts - five times more than what the nation’s central bank considers acceptable.

Some emerging market nations have already taken action. Brazil last month imposed a 2% tax on foreign investment in the country’s stocks and bonds, hoping to halt the appreciation of its currency, the real.

Additionally, Brazil’s Finance Ministry said Tuesday that it will soon start taxing the issuance of depositary receipts in international markets, in a bid to prevent companies from selling shares abroad instead of locally. The Bovespa Index has surged 136% this year in dollar terms.

China, too, has taken measures to alleviate the pressure hot money has put on its currency. In October, the central government - for the first time in 17 months - allowed mutual fund companies to resume purchases of foreign assets through its Qualified Domestic Institutional Investors (QDII) program.

E Fund Management Co. Ltd., China’s fifth-largest mutual fund company, and the smaller China Merchants Fund Management Co. Ltd. both obtained investment quotas from the State Administration of Foreign Exchange (SAFE). SAFE approved $1 billion in investment for E Fund and $500 million for China Merchants. That means both funds are now free to invest in offshore markets such as stocks and bonds.

And on Friday, SAFE issued another $1 billion quota to Bosera Fund Management Co. under the QDII program.

While the quotas aren’t particularly large they provide an outlet for hot money inflows as well as the government’s massive trade imbalance.

China’s foreign exchange reserves rose by $141 billion in the third quarter to $2.27 trillion in September. Combined with the trail of hot money that has followed the economy’s recovery, China’s forex holdings are pressuring the yuan to rise.

Analysts say that measures like the ones taken by Brazil and China are just the beginning.

“I think this is going to be one of the big trends in Asia… There is a very strong risk that other countries start to jump on the bandwagon and try these things out,” Richard Kelly, a senior economist at TD Securities Inc., told The Globe and Mail .

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