TARGETING FOOD: Zhengzhou Grain Futures Exchange (pictured) is the biggest exchange of its kind in China. Recently, grains and other agricultural products become major targets of speculation for hot money (ZHAO PENG)

The benchmark Shanghai Composite Index was plagued by dips, climbs and dives as the stock market slumped from 3,186 to 2,838 points in four days, beginning November 12. Sharp fluctuations occurred on the index in the following days.

Figures from Wind Information Co. Ltd. said 250 billion yuan ($37.61 billion) vacated the Chinese stock market in November, while a substantial amount of money invested in the market under the qualified foreign institutional investor (QFII) scheme also pulled out.

Commodity prices in the futures market also fell sharply—zinc and aluminum prices decreased more than 10 percent over the course of two weeks last month.

Analysts believe the stock market surge in the first few months of this year was actually pushed up by hot money, while the recent plunge of the stock and futures market demonstrated the effectiveness of government measures to combat hot money that has been speculated to have been working its way into China.

Striking hot money

There are many reasons for the spike in hot money in China. For instance, some speculators are betting on the appreciation of the yuan, China's currency; some are relying on the fast economic rally in China; and others are taking advantage of China's flawed financial supervision.

The U.S. Federal Reserve's decision to print and release $600 billion into the market aroused concerns from emerging markets currently involved in fighting inflation and excess liquidity.

But the United States has its reasons for taking this action. "At the rate we're going, it could be four, maybe five years before we are back to a more normal unemployment rate of about 5 percent to 6 percent," U.S. Federal Reserve Chairman Ben Bernanke told CBS News. The purchase of more bonds than planned is "certainly possible," he said. "It depends on the efficacy of the program" and the outlook for inflation and the economy.

The program, known as quantitative easing (QE), has been criticized by officials around the world, including those in China and Germany. Their primary concern is that this round of QE, known as QE2, would drive down the value of the dollar and cause a surge of capital abroad that would create asset-price bubbles.

China, as the major driver of the post-crisis economic recovery, will be most affected by the greenback flood.

While the Chinese Government has been addressing the problem since the second half of this year, harsher measures were launched in November to clamp down on hot money.

On November 9, the State Administration of Foreign Exchange (SAFE), the foreign exchange watchdog, issued a notice on strengthening foreign exchange administration and preventing hot money influxes by standardizing trade, foreign direct investment, return investment and overseas public offerings. The notice required banks and other financial institutions, which bear the full brunt of hot money, to strictly manage their position in sales and exchange settlements. SAFE will also closely watch the short-term debt quota and the banks' outstanding guarantee for foreign institutions and monitor domestic companies' overseas initial public offerings (IPO) to ensure that money raised from overseas markets is used for standard economic practices, such as trade and business transactions. The exchange watchdog will enhance management on domestic institutions and personnel who set up special-purpose overseas companies and will punish illegal activities.

Later, on November 15, the Ministry of Housing and Urban-Rural Development and SAFE issued a notice on managing housing purchases by overseas institutions and individuals. Yao Jian, spokesman of the Ministry of Commerce, said the ministry has been keeping a close eye on foreign investment in the domestic property market.

On November 29, the Shanghai Futures Exchange raised the transaction deposit for copper, aluminum and zinc futures from 5 percent to 10 percent, that for wire rod, gold and deformed steel bars from 7 percent to 12 percent, and that for natural rubber futures from 11 percent to 13 percent. Those measures increased the cost of transaction and curbed speculation to some extent.

Stricter controls

Although some SAFE officials do not believe there's large-scale hot money flowing into China, the government will not relax its supervision. Moreover, the current international capital flow does not allow emerging markets, like China, much leeway to function when facing hot money.