China is unlikely to act quickly to relax its control over the foreign exchange system, given the rampant market uncertainties, suggest experts.

Movements, if any, towards a more flexible foreign exchange system must be gradual, experts contend.

"As the global financial market is still full of uncertainties, it is not wise now to change China's currency policy,?Tan Yaling, a senior researcher with the Bank of China's Institute of International Finance, told China Business Weekly last week.

Moreover, that would pose too big a risk to the nation's fragile banking and financial sector, she said.

"China is still a developing country, with a huge, but immature, banking and financial sector,?Tan said.

"Before success in the banking reform is achieved, the nation's banks might not be capable of taking the risks caused by policy changes in the foreign exchange system.?

While the US dollar has been sliding to new lows against the euro and Japan's yen, the renminbi's fixed foreign exchange rate to the greenback has been coping with great upward pressure.

China's trade surplus, a key target by critics of China's yuan policy, actually has little direct link with the exchange rate, experts said.

"China's recent export performance has been truly enticing, but it is primarily driven by the country's decade-long trade reforms, dynamic private enterprises and abundance of cheap labour,?Tao Dong, chief regional economist with Credit Suisse First Boston (CSFB), told China Business Weekly last week.

China's exports have consistently outperformed imports throughout the highs and lows of the yuan, and the export boom has even persisted during turbulent years that included the Asian financial crisis.

During the financial crisis, many other countries urged China to devalue the renminbi.

In a recent report, CSFB said, "The major uncertainty in China's case is the time frame and the cost of recapitalizing a banking system that continues to have a very high level of non-performing loans. It is unlikely that full liberalization of the renminbi will occur until this sector is in a more stable position.

"On the foreign exchange side, we maintain our view there will not be a revaluation of the renminbi until after another round of efforts at bank restructuring, (and hence most likely in the 2006-08 period).?

According to officials, pressure on China to appreciate the renminbi has been relieved by the government's recent injection of US$45 billion of its massive foreign exchange reserves into two large State banks.

People's Bank of China Governor Zhou Xiaochuan was quoted as saying upward pressure on the currency has also been eased by signs of an economic recovery in the United States, and recent Chinese purchases of big-ticket items from US manufacturers.

Tan said: "In fact, I don't think the foreign exchange reserves are overloaded. For a huge country like China, in the early stages of development, the current bulging foreign exchange reserves are reasonable."

Hot money

According to a research report released by CSFB in the middle of last year, short-term speculative money, about US$20 billion, sneaked into China in the first half of the year, used by speculators to bet on a sharp appreciation of the renminbi.

The volume of hot money continues to rise, Tao said.

Tan said much of the hot money is now parked in Hong Kong, and the sharp rise in Hong Kong's stock indices, particularly H shares, proves that is the case.

Financial reforms ?including the banking and foreign exchange systems ?are part of a systematic reform, experts said.

These reforms must be studied comprehensively, they added.

China, which is expected to keep its foreign exchange rate stable in the new year, might inch towards a more flexible foreign exchange system, experts suggested.

The timing is gradually becoming mature for a more flexible, market-oriented foreign exchange system, Tao said.

The Hongkong and Shanghai Banking Corporation (HSBC) predicts there is a greater chance this year for China to make its currency more flexible.

"By the middle of this year, there should be a window of opportunity to introduce greater flexibility into the exchange rate policy,?said Geoffrey Barker, HSBC's chief economist for the Asia-Pacific region.

Local media have reported China is considering moving to a trade-weighted basket of currencies to set its exchange rate in the future.

Tao said he does not expect any bold action in the near future.

The renminbi's rate will not be changed much even if it is linked to a basket of currencies, Tao added.

(Business Weekly 01/20/2004 page1)