Hot money or short-term portfolio inflows refers to short-term investments in negotiable and liquid shares, bills, and bonds.
There are two ways to manage hot money flows. Here’s a simplified example to explain the two methods.
1. The CIB owns a portfolio of treasury bills within its assets = EGP 100
2. The exchange rate of the dollar = EGP 10
The First Method
(also the cause of most of the financial crises in emerging markets in the nineties)
1.. $10 was transferred to the CIB in exchange for the purchase of T-bills by an investor in the US
2. The CIB sells the $10 to the central bank for EGP 100
3. The CIB uses the EGP 100 in lending
4. There is a boom in domestic demand and a rise in imports
5. The deficit in the current account balance worsens, leading to pressures on the exchange rate and eventually to a mass exit of foreign capital and pressure on the central reserve.
The Second Method
Conservative management of flows
1. $10 is transferred to the CIB in exchange for the bills
2. The CIB reinvests the $10 in a deposit in London instead of selling it to the Central Bank and classifies it in its balance sheet as a foreign asset.
In this scenario, the CIB is fully prepared to save $10 and buy treasury bills again if the foreign investor wants to exit.
In addition, the flows do not lead to the printing of banknotes, the growth in domestic demand, and the widening of the current account deficit.
The problem with the second method, which was used in Egypt to a large extent, is that it puts pressure on banks’ profits because the return on the dollar deposited in London is less than the return on Egyptian treasury bills.
Hot Money Management
