China is committed to letting the yuan trade more freely, but the United States must realise that the exchange rate is a matter of national sovereignty, a senior central bank official said on Monday.
China would take domestic and international economic considerations into account when charting the yuan's course, but an adjustment to the currency alone would not correct the economic imbalances that are irritating Washington, People's Bank of China Assistant Governor Yi Gang said.
"The exchange rate issue is A) a sovereign issue and this is our principle. B) We will take internal and external balances into account when making decisions on the yuan," Yi told reporters on the sidelines of a financial forum.
His comments staked out China's position ahead of a visit to Beijing this week by a high-powered U.S. delegation led by Treasury Secretary Henry Paulson.
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The U.S. officials are expected to cajole China to let the yuan rise more swiftly for its own good and to keep liberalising its financial and product markets.
"We can't rely on adjustment of one factor, say the yuan appreciation, to address the economic imbalances," Yi told the forum.
As he was speaking, China reported a trade surplus of $22.9 billion for November, just shy of October's record $23.8 billion and more than double the November 2005 figure of $10.5 billion.
China has let the yuan rise by around 3.45 percent since it revalued the currency by 2.1 percent in July 2005, but U.S. critics maintain that the yuan remains vastly undervalued, giving Chinese exports an unfair advantage in global markets.
"We will keep the yuan exchange rate basically stable at a reasonable and balanced level and increase flexibility in the exchange rate system," Yi said.
WORKING WELL
One of the principal arguments made by economists for a stronger yuan, which would crimp exports and spur imports, is that the cash spun off by bumper trade surpluses makes it hard for the central bank to control the money supply.
That is because, rather than letting the yuan's exchange rate rise, the central bank buys huge amounts of dollars and prints yuan in exchange. It then tries to stop banks from lending the yuan out, and so further fuelling an investment boom, by requiring banks to buy large quantities of central bank bills.
In its latest such operation, the central bank on Monday sold 120 billion yuan ($15.3 billion) of one-year special bills to selected banks at a yield of 2.7961 percent, traders said.
Critics say such mopping-up operations are unsustainable. But Yi struck a positive note, saying liquidity in the banking system was still controllable.
"The operations aimed at soaking up liquidity are proving effective and the cost of such operations is relatively low compared with other countries like South Korea," Yi said.
What's more, the gap between Chinese and U.S. interest rates was in the "comfort zone" for the central bank at the moment.
While it was impossible either in theory or practice for the PBOC to target a particular yield gap, Yi said speculators would be encouraged to bring money into China, betting on a stronger exchange rate, if yuan interest rates were high enough.
To that end, economists say the central bank has tried to ensure a yield gap of about 3 percentage points -- roughly the rate at which the yuan has been appreciating.
But with one-year dollar deposits around 5.20 percent, that gap is now down to around 2.4 percentage points, giving speculators on paper more of an incentive to move money into China.
China has raised interest rates twice in 2006 as part of a tightening of monetary policy. Asked whether another increase was on the cards this year or next, Yi said he could not answer the question.
"But I can only say that the current levels of CPI and interest rates are in harmony," he added.
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