A widespread expectation that the yuan will keep rising is at the root of China's monetary problems, a central bank report said yesterday, urging a reform of the current exchange rate regime.
Controls on the capital account are "virtually ineffective" and speculative funds keep pouring in, betting on the yuan's appreciation, Guo Jianwei (
These inflows dent the efficiency of monetary policy measures such as interest rate hikes and moves to soak up liquidity, he said in the paper, which was distributed at a financial conference in the Chinese capital.
"China should enhance the monitoring of capital inflows," he said.
It was unclear what impact, if any, Guo's report would have on either central bank or Chinese government policy.
But its public release reinforces evidence of a growing debate within the government about how to manage the yuan exchange rate in the face of billions of dollars of capital pouring in.
"The trade surplus and yuan appreciation expectations are reinforcing each other and worsening the situation, and continued yuan appreciation expectations have made exchange rate controls lose their anchor," Guo said.
"Because foreign exchange controls are virtually ineffective, there is a lack of uniform and transparent monitoring of inflows and outflows [and] hot money continues to flow in."
China freed the yuan from a long-standing peg of about 8.3 to the dollar in favor of a trade-weighted basket of currencies in July 2005, and has since allowed it to appreciate slowly, but steadily.
The rate, set yesterday at a record high of 7.4476 to the US dollar, has appreciated faster in recent weeks, adding to already entrenched speculation that the yuan is a one-way bet.
Guo further said hot-money inflows combined with the yuan appreciation expectations are in large part responsible for rising price pressures.
"The fundamental reason for high prices is sustained yuan appreciation expectations, which are pushing up asset prices."
"Worries that a narrowing US-China interest rate gap will exacerbate speculative capital inflows have limited the room for raising Chinese interest rates and have curtailed the strength of sterilization operations," he said.
The process of using interest rates to manage the economy has also become "ineffective" because of the sharp inflow of hot money and because of limitations in the interest rate regime itself, the report said.
One possibility for discouraging capital inflows is to further restrict the ability to take money out of the country, he said, a view that runs counter to suggestions that China needs to relax capital controls.
"We have to maintain capital controls if we want independent monetary policy and a floating exchange rate regime," the report said.