US Federal Reserve Chairman Alan Greenspan said China's currency may be undervalued and it's in the Asian country's "interest" to move to a more flexible exchange rate policy.
The yuan has been fixed at a rate of 8.2770 to the dollar since 1995 and Beijing is under increasing pressure to allow it to trade more freely. The dollar's drop against the euro and the yen has led to calls from South Korea, Japan, the EU and industry representatives in the US for China to allow the yuan to rise.
"If the exchange rate is significantly undervalued, and indeed a reflection of that would be their accumulation of dollar assets, the accumulation of dollar assets will expand their money supply to the point that it will create problems in monetary policy and it will be to their interest to change," Greenspan said during his semi-annual testimony to the House Finance Services Committee.
China is enjoying record trade surpluses, a surge in foreign direct investment and the second-biggest foreign-currency holdings in the world after Japan. Reserves rose to US$346.5 billion last month from US$340 billion a month earlier.
"Greenspan comments keep the issue alive for the potential of revaluation of the peg in China," said Tim Stewart, chief currency strategist at Morgan Stanley in New York.
"Nothing that he said in his comment said it was imminent," Stewart said.
China is considering ways to alleviate pressure from overseas to allow the yuan to appreciate against the dollar, the state-owned China Daily newspaper reported on Tuesday, citing an unidentified person at the central bank.
Letting the yuan trade more freely will probably mean an increase in its value, said Fred Hu, China strategist at Goldman Sachs Group Inc. The currency may be undervalued by as much as 15 percent, he said.
China had a US$2.1 billion trade surplus last month and last year overtook the US to become the world's top recipient of foreign direct investment.
In the first half, China attracted US$30.3 billion of foreign investment, about a third more than a year earlier and 11 times the amount South Korea received.
US Secretary of the Treasury John Snow last month said China is considering widening the trading band for its currency. Japanese Finance Minister Masajuro Shiokawa said in February that Tokyo wants China to abandon its currency peg.
Greenspan "had every opportunity to say nothing and he chose to say something," said Stewart. "It continues to foster the idea in the market that some adjustment to the peg is probable over the next few quarters."
China's central bank ruled out any immediate change. The nation needs to "maintain the stability of the yuan, which will provide the foundation to continuously improve the exchange-rate mechanism," the People's Bank of China said in a statement on Monday.