The PeopleÆs Bank of China reported an all-time record rise in foreign reserves in the month of April, and analysts expect May to be even bigger. The main source of this inflow, however, may not be foreign-direct investment (FDI) or related to ChinaÆs trade surplus.

Lehman Brothers says the discrepancy between FDI and inflows due to ChinaÆs trade surplus, versus the rapid growth of its foreign-exchange reserves, suggests that æhot moneyÆ is now accounting for the majority of FX inflows.

ôThe trade surplus and FDI inflows explain only 33% of the surge in FX reserves in April,ö says Ron Subbaraman, analyst at Lehman in Hong Kong.

He has charted the increase in Chinese FX reserves over the past five years versus its trade surplus and its FDI. It is common for FX reserves to grow more quickly than the surplus and FDI combined can explain.

The gap grew particularly large in early 2007, perhaps explained by portfolio investors buying renminbi assets to participate in the currencyÆs appreciation. But the gap closed in the second half of the year.

Now the gap is back û and bigger than ever. In April, foreign reserves grew by $74.5 billion, to a total of $1.8 trillion. This follows what had been the record in January, when reserves grew by $61.8 billion. FDI and the trade surplus could account for only $24.3 billion of this rise, Lehman calculates, suggesting $50.2 billion of the reserve increase canÆt be readily explained.

Subbaraman says there is no public data that fully explains why FX reserves are growing so far out of proportion, or where this excess money is going. Some of it can be credited to mainland corporations borrowing more overseas. In the past, it was explained by foreign speculating in mainland real estate.

Other factors could include interest earned by Chinese companies on overseas assets, FDI outflows and the valuation effect on renminbi assets as the dollar depreciates. But Lehman suspects this is only part of the story, and that speculators are taking positions on rising Chinese interest rates and a strengthening renminbi.

Lumped together, this so-called æhot moneyÆ is likely to head for riskier investments, and in the past has been destabilising to other countries because it can surge and then disappear quickly û as happened to other Asian countries in 1997-98 (although by no means is Lehman Brothers suggesting an impending crisis).

ôThis is the biggest such gap on record, and the biggest rise in ChinaÆs foreign reserves on record,ö Subbaraman says. ôItÆs interesting that even as ChinaÆs trade surplus is narrowing, the pace of its accumulating foreign reserves has picked up.ö

Last weekend the central bank raised interest rates by 100 basis points û a move designed to buy up liquidity stemming from the countryÆs balance-of-payments surplus, but one that is also likely to have attracted even more portfolio inflows.