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Hot money

Hot money Definition

Hot money is used in economics to refer to funds which flow into a country to take advantage of a favourable interest rate, and therefore obtain higher returns. They influence the balance of payments and strengthen the exchange rate of the recipient country while weakening the currency of the country losing the money. These funds are highly volatile and will be shifted to another foreign-exchange market when relative interest rates make this more profitable. It is money held in currency markets by speculators as opposed to national banks or domestic investors.

Hot money is a major factor in capital flight and the ability of developing nations to finance their debt. As large sums of money can move very quickly to take advantage of small fluctuations in interest rates and currency values, countries which have difficulty raising money through the sale of long term bonds are particularly succeptible to short term interest rate pressure, particularly during periods of rapid inflation. These types of transactions were largely responsible for the currency crises in Mexico and Asia during the 1990s.

In part to reduce the influence of hot money on a nation's economy, a few nations have minimum time requirements for investment. For example, Chile requires all foreign investments to be put in a one year locked account. Although this sort of control reduces investment in a country, it also makes it less succeptible to currency flight.

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