In a rare, stern warning, China's foreign exchange chief Guo Shuqing told local governments yesterday to avoid encouraging "hot-money" investments from foreign sources.
Regulators have been playing down the effects of speculative inflows, but Guo said the country might see "no end of trouble" unless local governments understand the risks of soaking up foreign funds "haphazardly."
"China is paying great attention to speculative funds," Guo, director of the State Administration of Foreign Exchange, said in an interview on the sidelines of the annual session of the National Committee of the Chinese People's Political Consultative Conference, China's top advisory body.
"Foreign exchange administration departments and other macroeconomic agencies are investigating the issue and will punish illegal activities severely."
Foreign exchange reserves jumped by US$206.7 billion last year alone. Guo said the overall inflow of capital is "normal and legal" and reflects the "market scenario," but he also pointed to the existence of some "worrisome" problems.
He said improper foreign investment has been used to purchase renminbi-denominated assets and commercial housing for speculative purposes, anticipating that China will eventually bow to international pressure and allow its currency to appreciate.
The foreign exchange administration found that some overseas people have bought dozens of apartments in China's coastal cities - "obviously not for their own residential purposes," he said.
The "hot money" pushed housing prices to very high levels, making the cities look "prosperous" but actually harming the investment climate by creating higher living and business costs.
The cash inflow presents a serious threat, in Guo's view. Should the situation lead to a real estate bubble that bursts, financial institutions, enterprises and even individuals will suffer from huge losses, he explained.
Guo emphasized that every locality and foreign-funded enterprise is obliged to abide by the rules of the foreign exchange administration.
"Capital inflow is an important part of China's overseas economy. We hope everyone involved will join hands with us to restrain speculative capital," he said.
Guo also reported that outstanding foreign debts surged 18 percent year-on-year to US$228.6 billion dollars at the end of last year. He said the country's foreign exchange reserves, which reached U$609.9 billion at the end of 2004, second only to Japan - are sufficient to pay the debts.
A massive foreign exchange reserve has long been an excuse used by some countries, especially the United States, to demand appreciation of the yuan, which now floats against the US dollar within a narrow band, according to economists.
Premier wen Jiabao reiterated in his government work report on Saturday that China, however, will keep the yuan "basically stable"  while pledging to improve the exchange rate mechanism.
Also yesterday, a deputy to the National People's Congress, which is also in annual session, said China should map out special regulations to prevent money laundering as soon as possible.
"The fight against dirty money will advance economic development and social stability," said Zhao Peng, director of the Gansu Province branch of the Industrial and Commercial Bank of China, China's biggest commercial bank.
China's central bank is giving priority to collecting and analyzing information on suspicious bank transactions.
"The inspection covers a narrow area and has not proven effective," Zhao said.
China badly needs a supervision system that covers all three leading financial sectors - banking, securities and insurance, he said.