Hot Money

Subject: Economy

Section: External Sector

Context: India to stay alert for ‘hot money’ after bond index inclusion: official

Concept:

Hot money refers to the currency that quickly and regularly moves between financial markets and is invested for short-term.
In this investors lock in the highest available short-term interest rates for large gains.
It is less flexible and bring in volatility in economy (Ex- FPI is often referred to as “hot money” because of its tendency to flee at the first signs of trouble in an economy.).
Banks usually attract “hot money” by offering relatively short-term certificates of deposit (CD) that have above-average interest rates. As soon as the institution reduces interest rates or another institution offers higher rates, investors with “hot money” withdraw their funds and move them to another institution with higher rates.