China's central bank governor argued in comments published on Saturday that Beijing does not control the yuan's flow across borders as tightly as some think and that it is natural for the currency's trading band to be widened over time.
Zhou Xiaochuan said in an interview with Chinese magazine Caixin that China did not fare badly on an International Monetary Fund measure of currencies' convertibility under the capital account.
But he stopped short of calling for a fully convertible currency.
"If the highest standard of measurement is to have wholly unrestricted convertibility, then so many developed countries have not achieved 100 percent full convertibility," Zhou told the magazine.
Investors increasingly expect that China will give them more freedom to trade the tightly controlled yuan.
While the currency is already convertible under China's current account, the broadest measure of trade in goods and services, the capital account, which measures inflows and outflows of different types of capital, is still closely managed by Beijing as it worries about capital flight and hot money inflows.
Countries with convertible currencies under their capital account let their currencies trade with few restrictions for investment purposes.
Zhou noted China must regulate levels of foreign debt incurred by private and public sectors to reduce currency risks, monitor cross-border deals to guard against illegal activities such as money laundering, and combat speculative capital flows.
"Excluding the above three factors and judging from the 40 sub-items set by the IMF, you may find that actually China is not that far from capital account convertibility," Zhou said.
Still, he said Beijing would keep improving the exchange rate regime to make it more flexible, adding it is natural for the currency to fluctuate in a bigger trading band in future.
"The yuan's trading band will be widened," he said.
China currently lets the yuan trade in a 0.5 percent range, and moves to increase that band would show Beijing is gradually relaxing its control over the currency.
"Compared with international markets, you may know that the 0.5 percent (daily trading band) is quite a small floating band," Zhou said.
INFLATION CONCERNS WANING
Investors had speculated earlier this year when China was fighting three-year high inflation that Beijing would widen the yuan's trading band to accelerate its rise and combat price pressures.
Instead, Beijing raised interest rates three times, moves that have produced some tentative success: Inflation eased to 4.2 percent in November, down from a 6.5 percent high in July.
Zhou acknowledged that price pressures are easing and that the job of fighting inflation is not as urgent as before. But he warned against complacency.
"Inflationary pressure is easing, and curbing inflation is not as urgent as in 2011," he said. "But we should not lower our guard against inflation and must appropriately manage inflation expectations."
He said that it is difficult for China to achieve the government's annual inflation ceiling of 4 percent this year and he expects inflation to be around 5 percent this year.
"China has been always having relatively big scope to adjust its monetary policy," Zhou said when asked whether a drop in China's foreign exchange purchases in recent months has given the central bank more room to adjust monetary policy.
President Hu Jintao in his televised New Year's address on Saturday, said the government would continue to maintain relatively fast economic growth and manage inflationary expectations in the year ahead.
But he also warned that "uncertainty about the global economic recovery is on the rise".
The yuan closed at a record high against the dollar on Friday, passing through resistance at 6.30 and ending 2011 with an appreciation of 4.7 percent, with traders citing signs of central bank intervention to push the yuan up at the end of the year.
The yuan's gains for the year are in line with the 4 to 5 percent traders in the onshore market had expected at the start of the year.
Traders still see the yuan appreciating in 2012 as China faces U.S. pressure to do more to rebalance bilateral and world trade, while it continues to record trade surpluses.
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