China will be "more active" in draining funds from the financial system to give the market a bigger role in setting the yuan's exchange rate, the central bank said.
The People's Bank of China will "strengthen coordination between domestic and foreign currency policy," according to a statement posted on its Web site yesterday after a quarterly meeting of the monetary policy committee. The central bank reiterated that it would "further curb excessive loan growth'' and control "rapid investment growth."
"This is a sign that the central bank is getting ready do more on yuan reform, possibly widening the trading band," said Huang Haizhou (黃海洲), head of Greater China research at Barclays Capital Asia Ltd in Hong Kong.
"They've done a lot on domestic policy such as raising lending rates and banks' reserve ratio, but we haven't seen any measures on the exchange rate," Huand said.
China is stepping up efforts to cool the economy after reports showed investment, money supply and production accelerated last month. The central bank on Friday raised the required reserve ratio for commercial lenders by half a percentage point to 8 percent, less than two months after increasing interest rates for the first time since October 2004.
Domestic policies "need to be coordinated with the exchange rate policy, which lets demand and supply play a basic role in determining the yuan exchange rate," Yu Yongding (
Yu, who is also the director of the Institute of World Economics and Politics at the Beijing-based Chinese Academy of Social Sciences, said this was his personal understanding of the central bank's statement.
China will continue improving the exchange rate system, giving the market a "fundamental" role in setting the value of the yuan while keeping the exchange rate at a reasonable and balanced level, the statement said.
Economists including Barclays' Huang and Qing Wang say government measures taken so far to cool credit and investment growth will not be enough to solve the cause of the problem -- surging inflows of foreign currency reserves that are flooding the financial system with liquidity.
A widening trade surplus, which reached a record US$13 billion last month, rising foreign investment and capital inflows betting on further yuan appreciation are boosting China's foreign exchange reserves. The nation's holdings rose 32.8 percent from a year earlier to US$875.1 billion at the end of March, and overtook Japan's as the world's largest in February.
"To effectively cut off the source of liquidity, China needs a more flexible exchange rate to sever the link between foreign currency inflows and money creation," said Wang, a currency strategist with Bank of America in Hong Kong.
"Faster appreciation of the exchange rate will help narrow the trade surplus," which is the main source of the foreign currency inflows," he said.
Huang says he expects the central bank will widen the yuan's daily trading band against the US dollar to as much as 1.5 percent either side of the daily fixed rate from the current 0.3 percent by the end of the third quarter.
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