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China must beware dollar fall - bank adviser

(Reuters)
Updated: 2005-12-30 13:05

China is on track for robust growth next year but a drop in the dollar could fuel pressure on the yuan and erode the country's foreign currency reserves, an adviser to the central bank said in remarks seen on Friday.

The economy should be able to grow around 9 percent in 2006, considering the government's ability to spur demand with its budget to offset slowing export and investment growth, Yu Yongding was quoted as saying by the China Securities Journal.

"Because China's fiscal situation is relatively sound, the government has relatively great leeway to use expansionary fiscal policy," said Yu, a prominent academic who sits on the central bank's monetary policy committee.

The government would probably raise salaries for its employees next year, which would help push up wages nationwide and boost household consumption, he said.

But Yu warned that the United States might stop raising interest rates in 2006 and start guiding the dollar downward, putting upward pressure on the yuan.

"More seriously, China's economy would take a big hit if the U.S. dollar weakened sharply due to such factors as a bursting of the U.S. property bubble," he said. "The loss for China's foreign exchange reserves would be extremely serious."

At the end of September China had $769 billion in foreign exchange reserves, the world's largest after Japan's.

Yu has previously said the dollar, which has strengthened on global markets in recent months, would be vulnerable as long as the United States ran a huge current account deficit.

The yuan has appreciated a further 0.48 precent against the dollar since a landmark 2.1 percent revaluation on July 21.

Officials have ruled out another one-off revaluation but have pledged to introduce more flexibility into the currency through market-based reforms.

Yu said the central bank should not alter the basically stable trend of monetary policy. Merely expanding money supply would not help companies get more loans, because lenders had been under pressure to shore up risk controls, he said.

"Some firms feel that bank credit is tight, but that's resulted from banks' efforts to tighten up risk controls rather than monetary policy, and we cannot resolve the tight credit problem by expanding money supply," Yu was quoted as saying.

Economists have said stringent government requirements on capital adequacy ratios had forced banks to slow down lending.

Yu said the central bank's deliberate efforts to keep money market interest rates low since the revaluation had helped deter speculation on the currency, but low market rates had also burdened banks' profits.

Commercial banks should be allowed to lower deposit and lending rates and step up lending to small companies, he said.

In fact, market rates have risen a little since vice central bank governor Wu Xiaoling seemed to acknowledge the problem by saying on Oct. 21 that she hoped rates would not stay as low they they were.