China economist calls for yuan stability

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Official media report adds to suggestions yuan appreciation could slow

By Lisa Twaronite & Moming Zhou, MarketWatch

Last update: 4:50 p.m. EDT April 28, 2008

SAN FRANCISCO (MarketWatch) -- A Chinese government economist called for stability in the country's tightly-controlled foreign exchange market, according to an official Chinese media report, adding more evidence to suggest the yuan's recently rapid pace of appreciation could slow.

"(We should) take the adjustment of foreign exchange policies as an important task, stabilizing market expectation of the exchange rate, sending a relatively stable exchange-rate signal to the market, and ensuring the stable growth of the economy," Xia Bin, an economist at the Development Research Center, told China Securities Journal in a report on the official publication's Web site Monday.

"(We) shouldn't adjust the exchange rate according to a range that the market has imagined. (We) should consider the economic development of the past few years and give the yuan a relatively stable level," Xia said.

Earlier this month, a different Chinese government economist warned that China's efforts to rein in inflation by allowing its yuan to strengthen could be undermined by inflows of speculative funds. Zhu Baoliang, the chief economic analyst of the prediction department of the State Information Center, said such inflows were exerting pressure on the central bank to increase the money supply, which could further fuel inflation.

In March, China's consumer prices rose 8.3% compared with the same month last year, after rising at 12-year high rate of 8.7% in February.
China used the peg the yuan to the dollar, but stopped doing so in July 2005. It now permits its currency to trade in a band of 0.5% on either side of the official parity rate it sets daily.

The yuan has gained about 18% since 2005, and China stepped up the pace of appreciation in recent months, in a bid to control inflation. The yuan rose at an annualized rate of about 17% in the first three months of 2008.

Spread adds to pressure

Speculative funds poured into China on bets that the yuan will keep appreciating, and also that the spread between Chinese bank bills and overseas rates will continue to widen.

As the U.S. Federal Reserve eased rates to stave off a U.S. recession, China has raised interest rates six times since early 2007 to damp inflation and cool double-digit growth. China's one-year certificate of deposit rate is 4.14%, compared with the U.S. federal funds target rate of 2.25%.

"Although the Fed lowered its interest rates, China is still under increasing pressure to raise its interest rates," Xia was quoted as saying. "The interest-rate spread between China and the U.S. is creating increasing pressure for China to raise the yuan rate."

In order to maintain the yuan's trading band, China has to intervene in foreign exchange markets. It then sterilizes its intervention, which means it absorbs an equal amount of liquidity in the market to make up for the heavy foreign exchange purchases used to keep its currency within its tight range.

"China should never give up monetary policy independence. Control is better than no control," Xia said.