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China is not expected to take any drastic action to change its currency value, as the current yuan fluctuations, which are both market-regulated and cautiously administered by the central bank, serves the economy of China and the neighboring countries well, analysts said.

A bank clerk exchanges Chinese yuan for an equivalent amount of U.S. dollars in a bank in Liaocheng, east China's Shandong province in this February 28, 2006 photo. [newsphoto]
Wu Xiaoling, a deputy governor of the People's Bank of China, said recently that Beijing was doing its best and that it would trust market forces to gradually let the currency move more freely.

"There will be no wide fluctuation of foreign exchange rates, because it may harm the steady development of Chinese economy," Wu said. "The yuan's flexibility is increasing gradually and we will allow supply and demand to play its role in forming the exchange rate."

And, China has noticed the negative impacts brought by its huge foreign exchange reserves, at more than US$870 billion, and is taking steps to relieve the pressure.

The State Administration of Foreign Exchange has started to free up the country's foreign exchange regime with a shift from stockpiling foreign exchange reserves in State coffers to letting businesses and individuals hold more foreign currency. Some qualified commercial banks are also encouraged to invest in overseas market.

The huge foreign exchange reserves, fuelled by China's trade surplus and surging direct foreign investment, indeed influenced China's economic growth, and limited the independence of the country's currency policy, analysts have acknowledged.

Some forecast that 15 or 20 years later, when China enters middle stage of aging society, with an increased production cost and lower saving rate, China¡¯s trade surplus may then be reduced, and a balance of payments achieved.

Chinese President Hu Jintao deflected U.S. pressures to allow the yuan to appreciate during last week's visit to Washington, while saying China would gradually establish a more flexible exchange rate system.

Qu Hongbin, chief China economist for the HSBC, said China had already made a significant move on April 14 when it announced plans to allow Chinese banks and institutions to invest private capital overseas for the first time.

"This measure will lead to fundamental changes by opening an official channel for foreign exchange outflows and allowing Chinese retail investors and corporate sectors to invest in overseas markets," Qu said. "We believe there is huge pent up demand for Chinese savers to diversify their 31 trillion yuan (US$3.87 trillion) in accumulated savings into foreign assets."

The move is designed to free the central bank from having to purchase overseas government securities -- mostly US bonds -- to offset growing foreign reserves that have piled up with China's huge investment inflows and growing trade surpluses, he said.

Let the yuan rise gradually - adviser

China should let the yuan rise gradually and diversify its fast-growing foreign exchange reserves away from the dollar to reduce concentration risks, an adviser to the central bank said in remarks published on Thursday.

The government should also act to abolish its long-standing preferential tax treatment for foreign investors, the China Business News quoted Yu Yongding, a prominent economist who sits on the central bank's monetary policy committee, as saying.

"We should let the yuan appreciate, but only through a gradualist approach," the newspaper quoted Yu as saying.

"The pressure on the yuan to appreciate is growing, but it can't rise too fast because that will hit export-oriented firms, including textile companies," he said.

China's growing trade surplus and inflows of foreign direct investment had pushed up its foreign exchange reserves, generated upward pressure on the yuan and made it harder for the central bank to manage monetary policy, Yu said.

China's foreign exchange reserves, which reached a world record $875.1 billion at the end of March, were on track to hit $1 trillion by the end of this year, Yu said.

"The foreign exchange reserves will continue growing for a relatively long period and a large part of the reserves are being held in the form of U.S. dollar assets," he said.

"The assets are likely to lose their value if the dollar weakens or inflation picks up in the United States. So we must make early preparations to prevent possible trouble."

Analysts suspect China has been gradually reducing the share of dollars in its reserves, but fears of a collapse in the U.S. currency will prevent it from making any dramatic shift.

The rapid build-up of foreign exchange reserves meant the central bank, in order to control the money supply, had to issue more bills to mop up, or sterilise, the yuan it issued when buying dollars flowing into China, Yu said.

"My personal view is that such a sterilisation policy is unlikely to continue forever, because the return on commercial banks' assets will be affected if it persists," Yu said.

The central bank buys dollars to ensure the yuan does not rise too sharply against the dollar despite the landmark 2.1 percent currency revaluation in July.

Critics in the United States say the yuan remains undervalued, giving Chinese exporters an unfair edge.



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