The central bank governor noted that from the point of view of discouraging hot money speculation, "it is good to emphasize that the exchange rate of the yuan would be kept steady".

Despite increasing calls by some countries to revalue the yuan, the Chinese Government has made clear its determination to defend the stability of its currency.

The strong Chinese statement was believed to be a clear warning to international currency speculators, who channeled up to US$25 billion into China during the first half of this year.

China's forex reserves rose by a hefty US$60.1 billion in the first six months of this year, outstripping by more than US$25 billion the combined US$4.5 billion trade surplus and US$30.3 billion in actual foreign-direct investment.

That discrepancy, many economists suspect, is a result of inflows of hot money in a bet on currency appreciation as Japan and the United States step up pressure for a stronger yuan.

Such speculative capital sneaked into China mainly through trading, foreign direct investment, the qualified foreign institutional investor (QFII) programme and individual flow from overseas Chinese to relatives living on the mainland, according to experts.

They warned that besides exerting considerable pressure on yuan revaluation, the massive inflows of hot money also add to the difficulty for the government in curbing over-capitalization and inflation through monetary policy.

Professor Peng Yun'e with Shanghai-based Tongji University blamed the huge influx of hot money for an excessively rapid rise in the country's broad money supply, which may ignite inflation.

The speculative money may go into bonds and bank accounts, raising the amount available for lending.

As the end of July, the county's M2 - a key measure of money supply including cash in circulation and deposits - was up by 20.7 percent from the same period of last year, higher than the central bank's planned growth of 18 percent.

New loans by commercial banks between January and July soared to 1.9 trillion yuan (US$228.8 billion), more than the 1.8 trillion yuan (US$223 billion) that they lent in all of 2002.

To ease mounting pressure from the acceleration in money supply expansion, the PBOC had issued central bank bills worth a total of 60 billion yuan (US$7.3 billion) in a bid to whittle down base money, according to Professor Peng.

The central bank even took the drastic step of raising the ratio of deposits required by commercial banks - the percentage of deposits that banks must hold as reserves will be raised to 7 percent from the current 6 percent, which is aimed at mopping up about 150 billion yuan (US$18.2 billion).

A change in the reserve requirement is considered one of the most blunt instruments a central bank can use to reduce money in circulation.

Zhang Xiaoji, director of the Research Department of Foreign Economic Relations under the Development Research Center of the State Council, cautions that the rush of short-term capital tends to cause economic fluctuations.

Quite a large amount of speculative money is estimated to have gone into lucrative sectors such as real estate, bonds and futures.

"When facing poor profit prospects, hot money, because of its speculative nature, will leave the market soon and trigger upheavals in the overall economy," Zhang said.

To guard against possible risks, regulators have launched a probe into forex acceptance and settlement operations by commercial banks, which the State Administration of Foreign Exchange said it would clamp down on illegal cross-border capital flows.

But experts expect an effective mechanism to more closely monitor the flow of speculative capital in and out of the country.

(China Daily September 10, 2003)