BEIJING, CHINA: Faced with spiraling inflation and a stock market and real estate bubble, China has been moving over the last month to tighten regulations on short-term speculative funds from overseas, known as hot money.

The money, betting on gains in the yuan, often flows into China via underground banks and other illegal financial entities, or through the padding of trade and investment bills that disguise legitimate business transactions.

However, one downside is that the regulations have also affected legitimate businesses, a development that has worried some Japanese companies operating in the country.

When a Japanese bank's Chinese subsidiary organised an urgent seminar in Shanghai following a change in the regulation last month over payment methods, representatives of more than 1,000 companies--mainly Japanese--flocked to hear the procedural changes explained.

Attendees were full of questions such as "Can you accept foreign currency paid out based on estimates?" and "Our clients won't change the way they pay after the change. What should we do?"

Under a new rule that took effect 14 July, the foreign currency that firms based in China receive is supposed to be sent to bank accounts designated by the authorities for checks. Until the authorities have consulted export records to verify the actual exchange of goods, the companies cannot exchange the currency with the yuan.

On 6 Aug, the government revised regulations on currency exchanges. The changes, the first in 11 years, emphasise controls on the inflow of speculative capital.

An official at a Shanghai-based firm exporting food to Japan said: "We've always engaged in these types of transactions, but suddenly found we couldn't exchange the money. We've tried to call the (State Administration of Foreign Exchange), but it's always busy."

Meanwhile, the government has also cracked down on the underground banks that have handled the hot money that passes through the system.

Since the crackdown began late last year, some of these banks reportedly have closed.

In Shenzhen, Guangdong Province, which neighbours Hong Kong and where many Japanese companies have offices, thousands of underground banks are said to be operating. Many such places are disguised as everyday stores, with signs placed in windows offering money exchange and transfer services.

Such signs, once common around the city, are gone now.

But such underground businesses still exist. When this reporter asked an underground bank operator if he could exchange US dollars, he immediately produced a calculator displaying a better rate than that being offered by banks.

"I can't make it obvious what I'm doing, which makes it harder to do the business. Many of my friends have changed jobs," he said.

Reversing the trend

It is believed the hot money started to flow into China around the time the country revalued the yuan higher against the dollar in July 2005. The inflow of currency accelerated in late 2007, when dollar denominated assets became less attractive following the US subprime crisis. Chinese research institutes estimate as much as US$1.75 trillion flowed into the country.

The hot money has created real estate and stock bubbles while contributing to a glut of money, increasing inflationary pressures on China. If the Chinese economy takes a downturn, the hot money likely would quickly flow out of the country and could disrupt the country's financial system.

The effects of the tighter regulations are already being seen. The yuan has dropped nearly 1% over the past month--the first fall since the yuan was revalued.

The outflow of hot money may already have begun, with some dealers saying one reason the yuan may be declining is the outflow of hot money.

One Beijing-based economist attributed the recent stock market slump and slight dip in real estate prices to the possible outflow of speculative funds.

"The amount of money that has entered China has been overwhelming," the bank operator said. "But these days, the amounts being sent out of China are sometimes quite high as well." (By AKIHITO TERAMURA/ The Yomiuri Shimbun/ ANN)