Zhu Jianfang, chief economist with CITIC Securities Co. Ltd., said that global funds are seeking higher returns in emerging markets, and that capital flows into China have been increasing since the end of last year. Currently, the benchmark interest rate for one-year deposits in China is 3 percent, 2.5 percent higher than the United States. "Counting in the expected annual yuan appreciation of 3 percent, the profit margin of hot money will be at least 5.5 percent," said Xiao Lei, a forex researcher with Beijing-based Tianyi Precious Metal Business Co.

"Funds seeking new investment opportunities have been returning to China since the second half of last year, as the U.S. economy entered a slow recovery, with the end of the financial de-leveraging process, as well as a defused euro-zone debt crisis," said Liu Yuanchun, Assistant Dean of the School of Economics at the Renmin University of China.

Saying no

Experts warn that speculative investments from abroad may harm the country's financial stability and threaten economic growth. The continuing inflow could push up inflation and the value of the yuan. As a result of excessive liquidity by hot money inflows, soaring investment in the Chinese currency will surely drive up prices, worsening an already hot inflation situation. "Chinese exports are suffering from shrinking profits and devastating losses. If renminbi appreciation continues, it will further squeeze exporters' profit margins," said Tan Yaling, Director of the China Forex Investment Research Institute. "It will add woes to the Chinese economy in deceleration. Exports are the major engine propelling the Chinese economy."

Over-expectation for the appreciation of the Chinese currency would bring in more inflows of hot money and worsen the bubble in the housing market.

According to a report released by Great Wall Securities, real estate in big cities is a secure haven from risks for hot money.

"Real estate has become the most favorite investment in China for hot money. Those who buy property can enjoy a double profit from a housing price increase and a rise in the renminbi rate," said the report.

"Housing and some local construction projects are most attractive investment for hot money. The urbanization underway across the country has produced a huge demand for money and overseas capital has become coveted," said Lian Ping, chief economist at the Bank of Communications. Other experts say that the current round of hot money funneled toward housing in first-tier cities will counter the Central Government's efforts to tame housing prices. Although some big cities limit the number of homes a family can own, purchases under a company name are allowed. "The pathway for hot money to speculate in China's housing market is still accessible," said Li.

The SAFE said in a recent statement that it would hand down warnings within 10 days if it finds that a firm's capital flows do not match its shipments of physical goods, or if the firm is channeling unusually large amounts of money into China. Such companies will then be placed on its "B list" of closely monitored companies for three months and will only be moved back to the "A list" if good behavior is observed. The SAFE said it will require banks to report suspicious transactions and take affirmative measures to prevent abnormal cross-border capital inflows as well as maintain a reasonable growth of trade financing. "Banks are not allowed to assist customers to evade foreign exchange regulations," the statement said.

The rules tighten limits on long yuan positions that banks can hold for their own accounts and ask banks to peg limits of their open positions to the foreign currency deposit/loan ratio, restricting their capacity to lend in the U.S. dollars. Banks have been accumulating long yuan positions in an effort to profit from yuan appreciation. Companies and banks that break the regulations face fines or even shutdowns, with their practices exposed to the public. The tightened regulatory measures will take effect starting on June 1.

Analysts said the announcement may indicate that the practice of faking trade data has already aroused concerns of the authorities. "With the SAFE's new measures, distorted trade data will drop in May," Li said. While the impact of capital inflow on trade data has drawn attention from regulators, China's exports are expected to slow down, said Cao Shuishui, a researcher at the China Securities Journal.

Although the Central Government has shown its determination to curb speculative capital, its efforts may not pay off as expected. "A large sum of hot money has come in. The new rules have come too late," Li said. "Bankers and exporters are all the beneficiaries of phony trade. A rule on paper is not powerful enough to stop them."

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