A GROWING number of top Chinese economists are advising their Government to consider a currency revaluation to fight persistent inflation and destabilising "hot money" capital inflows.
"The Chinese currency should be revalued as China's productivity is increasing," Professor Fan Gang, a member of the central bank's monetary committee, wrote in a paper that he was to present to the China Update conference in Canberra before being held back for a last-minute meeting with the Prime Minister, Wen Jiabao.
In recent years currency revaluation has been a taboo topic among Chinese policy makers.
However, the costs of maintaining the yuan's "crawling peg" against the falling US dollar are now hard to ignore, as inflation pressures rise and speculators place huge bets on breaking the currency peg.
A surge in unexplained capital inflows pushed China's stock of foreign exchange to an unprecedented $US1.8 trillion ($1.86 trillion) at the end of May, Xinhua news agency said.
The inflows have in effect emasculated Chinese monetary policy at a time when consumer prices rose 7.1 per cent in the year to last month and factory gate price inflation accelerated to 8.2 per cent.
Some advisers are advocating a one-off appreciation, and others are urging an "undeclared float".
"[The Governor of the People's Bank of China] Zhou Xiaochuan can have a vacation for two weeks to see what happens," He Fan, the assistant director of the influential Institute of World Economics and Politics at the Chinese Academy of Social Sciences, told the Herald yesterday.
"They don't need to say they are floating the exchange rate but they can at least test the market's view. With a one-off appreciation by 10 or 15 per cent, maybe the market will believe that's the end of the story.
"But maybe the market will still not be satisfied."
Professor Fan Gang said the currency's equilibrium value might not be as high as many feared because the market for the yuan was dominated by the People's Bank of China and the state-controlled banks - who were unlikely to dump all their foreign currency holdings.
The People's Bank of China has attempted to mop-up excess liquidity by directing state-owned commercial banks to buy low-interest Government bonds.
Mr He said the main state-owned commercial banks were already devoting between 30 per cent and 40 per cent of their assets to such loss-making endeavours. This was creating "ugly" bank balance sheets and encouraging the banks to recoup profits with "dangerous" lending policies that might ultimately jeopardise financial stability and the Government's efforts to clean up non-performing loans.
In his paper, Professor Fan writes that analysts have "correctly and convincingly" highlighted "structural distortions caused by repressed interest rates and an undervalued currency" which "may also lead to economic, financial and social problems".
His comments are significant because Professor Fan was previously a staunch defender of the status quo. Nevertheless, a one-off revaluation is unlikely in the near term because China's export sector is suffering from a downturn in their major developed-world markets and struggling to cope with rapidly rising input costs.
The export industry has strong political support within the Ministry of Commerce and less so from the powerful National Development & Reform Commission.
"There is a thing called 'Chinese domestic politics'," writes Professor Fan. "Such domestic politics constrain policy makers from making a move when they are facing high pressure to ease social disparities with more job opportunities."
Professor Fan also warns that China's "immature and fragile financial system" may not be able to bare a large shock caused by a revaluation in the order of 30 or 40 per cent as demanded by some US congressmen. "In summary, in the view of Chinese policy makers, the costs or risks associated with a 'quick revaluation' may be larger and less predictable and manageable than the costs associated with the current gradual approach."