- The Washington Times - Tuesday, June 14, 2005

SHANGHAI (AP) — China has stepped up its efforts to set up a more flexible foreign exchange regime, fearing that capital being kept overseas could flood back into the country, the central bank said yesterday in its annual report.

The central bank’s comments did not suggest any imminent, sudden change in policy. However, they appear to make a case for urgent reform of Beijing’s rigid foreign exchange policies, which keep the Chinese currency, the yuan, trading within a narrow range around 8.28 yuan per U.S. dollar.

Some of the capital that has left the country in the past decade is ?unstable,? and could shift back into China ?at any time, putting pressure on the yuan exchange rate mechanism, buffeting domestic financial markets and insidiously affecting financial stability,? the report said.

The central bank did not say how much money it believed could potentially flow back into the country. However, it said China recorded net capital outflows each year from 1994 to 2003. The accumulated net outflow for those years was 1.72 trillion yuan ($208 billion), the annual report showed.

The bank said it had intensified studies on setting up a more flexible foreign exchange system to handle a ?reasonable? level of foreign exchange from companies and individuals.

The United States and other trading partners have lobbied China to let the yuan’s value rise. It has been fixed for the past 11 years. They contend the yuan is undervalued by as much as 40 percent, giving Chinese exporters an artificial price advantage overseas.

Beijing has balked at allowing the yuan to trade freely, saying its developing economy and fragile financial institutions are not ready for significant currency fluctuations. But it has begun slowly loosening some controls.

Some economists argue that the greatest pressure for change is coming from within the financial system itself.

Speculation that the yuan’s value might rise already has attracted large inflows of capital that would normally push the currency’s value higher if it were allowed to trade more freely.

Instead, the central bank keeps the yuan’s value fixed by buying many of the dollars that flood into the country. The result has been a massive buildup of foreign exchange reserves.

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