Hot Money - Sources and Causes

Sources and Causes

Hot money is usually originated from the capital rich, developed countries that have lower GDP growth rate and lower interest rates compared to the GDP growth rate and interest rate of emerging market economies such as India, Brazil, China, Turkey, Malaysia etc. Although the specific causes of hot money flow is somewhat different from period to period, but generally, the following could be considered as the causes of hot money flow:

• Sustained decline of interest rates in the highly industrialized, developed countries. The lower interest rates in the developed nations attract investors to the high investment yields and improving economics prospects in Asia and Latin America.
• General trend toward international diversification of investments in major financial centers and toward growing integration of world capital markets.
• Emerging market countries began to adopt sound monetary and fiscal policies as well as market-oriented reforms including trade and capital market liberalization. Such policy reforms, among others, have resulted in credible increase in the rate of return on investments.

As described above, hot money can be in different forms. Hedge funds, other portfolio investment funds and international borrowing of domestic financial institutations are generally considered as the vehicles of hot money. In the 1997 East Asian Financial Crisis and in the 1998 Russian Financial Crises, the “hot money” chiefly came from banks, not portfolio investors.