Hot money refers to short term funds coming from other countries to peforming economies like India. In the context of international capital flows, hot money indicate funds from one country entering into the financial markets of other countries for a short term; expecting high returns. A major feature of hot money is that they are very short term. They are quickly moving from one market to the other according to changes in risk and opportunities. New generation money transfer facilities have promoted the flow of hot money over the last two decades.
The danger from hot monety is that they are extremely volatile. This volatility creates instability in receiving countries like India. Inflows and outflows of hot money in large quantity produces exchange rate fluctuations and stock market boom and crashes. If hot money is into banks, the quick withdrawal may led the bank into a crisis.
If you are searching for the meaning of hot money, you may identify short term bank deposit as hot money. Traditionally, short term deposit in banks was the typical hot money because in the past bank deposit was the most mobile form of foreign capital from one country to the other. Deposit options like certificate of deposit offers investors to park money for a short period of time, availing high interest rate. Here, movement of money from one country to the other may be based on interest rate differential. A higher interest rate country will get higher foreign capital in the form of bank deposits.
But now, with the opening up of debt and equity markets (stock market) of EMEs to foreign portfolio investors, the FPI (Foreign Portfolio Investment) has emerged as the leading form of quick money flows globally. Stocks can be purchased and sold quickly and money can be transferred from one country to other within a short span of time. Hence, FPI is the star among hot money flows in this new era of financial globalization.
It is not just quick money transfer and opening of stock market to foreigners that makes FPI as dangerous form of foreign capital. Rather a new breed of investors called flash boys who are active in stock markets that pose more danger.
These investors are genuinely quick in making purchase and sale order and become trend setters in stock prices. Advanced software are used by these groups to find the future price trends and execute quick trade to reap profit. They use computer simulated algorithms to carryout stock trade which is often called as algorithmic trading. When such investors execute big orders, it is known as High Frequency Trading.
A book by the American financial journalist Michael Lewis, ‘Flash Boys: A Wall Street Revolt’ explains how investors sells and buys shares at lightning speed to make short term profit, using advanced computer based technique known as algorithmic trading.
Flash boys according to Lewis, is the investment class using advanced technologies to make swift high frequency trading. Such high frequency trade (HFT) by big investors at rapid pace will create fluctuations in Indian financial markets including the equity market and the foreign exchange market. In this respect, the FPI becomes the most feared hot money in the era of financial globalization.
Recently, the US regulators have named Navinder Singh Sarao, an Indian origin British citizen for the flash crash of May, 06, 2010 that caused a stock market crash of nearly one trillion dollars in the US stock market.
India’s hot money data card 2014
The year 2014 was an extra ordinary year for the Indian stock market. Both the Nifty and Sensex have reached new highs even though the economy has not recovered that much. Main factor that pulled the market upwards was the hectic investment made by Foreign Portfolio Investors amidst positive political and business sentiments in the country. With unknown data from China, India was the largest foreign portfolio investment receiving country during the year.
Total net investment by the FPIs into the equity and debt market was an all time yearly high of $43.4 billion according to SEBI estimates. Of these, approximately $24 billion was invested in the debt market. Substantial FPI inflows have also increased RBI’s foreign exchange reserve. Similarly, the rupee also remained stable, compared to the steep fall recorded in the previous year. But the risk factor is that the FPI flows may be retrieved at any time if some negative news happens either in India or in abroad. In the last few days, (May Second week of 2015), the stock indices have lost values in big amount due to the pull out of the FPIs. This has also weakened the Rupee, indicated by the depreciation pressure.