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China favours stronger yuan to fight inflation
Published on: 2011-05-09
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Confronted with fresh US pressure over its currency policy, China appears more willing to let the yuan strengthen at a faster pace to control inflation, its new primary concern, analysts say.

China has let the currency appreciate five percent against the dollar since vowing greater flexibility last June and Beijing has signalled the exchange rate will be used to curb rising prices and growing foreign exchange reserves.

As the world's two biggest economies meet in Washington from Monday for annual high-level talks, Washington will demand faster appreciation but experts say Beijing will go at its own speed and is prepared to change course if exports stall.

"There has been a real shift in the last couple of months," Alistair Thornton, an economist for IHS Global Insight in Beijing, told AFP.

"There's more public acceptance of what is driving inflation -- the exchange rate peg, which generates a lot of domestic liquidity in the economy."

Patrick Chovanec, an economics professor at Tsinghua University in Beijing, agreed.

China's leaders are "trying to put out fires and the fire of the day is inflation, and they are willing to allow currency appreciation if that fights inflation -- but only moderately," Chovanec told AFP.

"They are still concerned about the impact it will have on the export sector (and) if they felt they got inflation under control, then their willingness to allow currency appreciation could taper off quite a bit."

The United States has been a strident critic of China's exchange rate policy, which it claims keeps the yuan grossly undervalued against the greenback and artificially cheapens Chinese exports at the cost of US jobs.

On Monday, the central bank set the yuan central parity rate -- the midpoint of an allowed trading band -- at 6.4988 to the dollar, the strongest rate since last June's promise for greater flexibility.

But David Loevinger, a senior Treasury Department official, said Thursday we "absolutely see a change in tone" from China as it confronts inflation.

"Eighteen months ago, the Chinese exchange rate was frozen. Today it's moving," Loevinger told reporters ahead of the two-day Strategic and Economic Dialogue.

Beijing, anxious about inflation's potential to spark social unrest in the country of more than 1.3 billion people, has made tackling soaring food and housing costs its number one priority this year.

But multiple interest rate hikes, tighter lending restrictions and price controls have had little impact. Inflation remained stubbornly high at 5.4 percent in March -- the highest annual rate since July 2008.

Premier Wen Jiabao last month made a rare pledge to increase the flexibility of the yuan's exchange rate to ease price pressures, suggesting top leaders were willing to accept a stronger currency to bring down domestic prices.

In a further sign that Beijing had shifted its stance, People's Bank of China governor Zhou Xiaochuan said last month that the size of China's foreign exchange reserves "exceeds our reasonable requirements".

Central vice governor Yi Gang was quoted by the state-run China Daily on Thursday as saying foreign exchange accumulation was the main source of excess liquidity in China.

For Thornton, those comments were "a real signal that the only way they can cap it (foreign exchange reserves) is by using the yuan appreciation a bit more aggressively".

Foreign currencies used to pay for Chinese exports are snapped up by the central bank in return for yuan, enabling authorities to control the value of the local unit.

The practice adds to China's world-beating foreign exchange stockpile, which soared past $3 trillion at the end of March, and increases the amount of yuan in the domestic economy, fuelling inflation.

Despite the recent gains in the Chinese currency, Loevinger said the United States would press China "to let its exchange rate adjust at a faster pace to correct its still substantial undervaluation".

China made clear on Friday that while it was willing to talk about currency policy, it would not be pushed on the pace of appreciation.

"On these issues, to be frank with you, we have different views that make discussions necessary," Vice Finance Minister Zhu Guangyao told reporters.

Beijing was right to be concerned about inflation but a stronger currency was not "a perfect solution" to the problem, said Ben Simpfendorfer, managing director of economic consultancy firm China Insider.

"Capital inflows might rise, for instance, as the currency strengthens, creating even bigger liquidity and asset bubbles," he told AFP.

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