Hot money flows and production uncertainty: Evidence from China

Common wisdom generally associates hot money (short-term international capital) with risk in the financial market, while its impact on the uncertainty of the real economy outputs is ignored. Using the Chinese data from 2000 to 2016, we document the aggressive hot money inflows by 2010 and a sudden slow-down afterwards. We find the unidirectional causality from hot money to the industry output, and the bidirectional causality between hot money and the service output. Specifically, with a 1% increase in hot money inflow, there is a 0.29% increase in the industry output and a 0.25% increase in the service output. We further reveal that the short-run variation in hot money flows is the Granger cause of variation in the industry and service outputs, a source of production uncertainty. Moreover, the investigation of six capital-concentrated subsectors provides additional cross-sectional evidence of hot money's heterogeneous effects. Overall, we provide the first empirical evidence on the impact of hot money on the real economy output in China, pointing to a significant risk that volatile hot money flows escalates production uncertainty. These findings lend regulatory insights into risk management and capital control in China.