China's economy is strengthening even as all the world's major regions are slowing down, giving the country a chance to phase out government control over the exchange rate, the IMF said.
China's economy will grow 7.5 percent this year, a 0.5-percentage-point increase from the IMF's projection in April, the fund said in its annual review of the economy.
"A gradual move toward greater flexibility would facilitate China's growing integration into the world economy," the IMF said. Ultimately, the yuan should be linked to a basket of currencies, it said.
China's central bank has fixed the yuan at 8.28 to the dollar and allows the currency to fluctuate within a narrow range.
Domestic spending is propelling growth in China this year, as exports slow to the country's two biggest markets, the US and Japan. Spending at home, however, is at risk of slowing if the economy slows as the government is forecasting.
China's economy grew 7.8 percent in the second quarter from a year earlier, down from 8.1 percent in the first three months. The economy, Asia's fastest-growing this year, expanded 8 percent last year, according to Chinese government and IMF estimates.
"With slower exports and a slower economy, they are better off with a more flexible exchange rate," said Ku Shin, director of Asian analysis at Banc One Capital Market in Chicago. "They can make prices of their goods more competitive by allowing the currency to depreciate."
Pent-up demand for yuan among exporters would delay any depreciation that could result from a more flexible exchange rate, he said.
China doesn't allow trading of its currency for anything other than trade, a restriction Shin said is likely to stay in place for at least a decade.
The band should be widened gradually, the IMF said.
The IMF also forecast that Chinese inflation would speed up to 1 percent this year from 0.4 percent in 2000.
China's current account surplus, the broadest measure of a country's trade in goods and services would narrow to about 1 percent of gross domestic product, from 1.9 percent last year, the fund said.
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