China should accelerate exchange rate reform by temporarily allowing the yuan exchange rate to be fully decided by the market in order to ease current inflationary pressures said two government think tank economists in an article published in Friday’s China Securities Journal.

The priority given to the stability of the yuan has meant that the People’s Bank of China (PBOC) has lost some of its independence in deciding monetary policy, according to the authors of the article, He Fan and Zhang Yue from the Chinese Academy of Social Sciences (CASS).

They said that excess liquidity continues to be at the root of current inflation. China’s foreign exchange reserves had reached nearly US$1.7 trillion by the end of March 2008 and PBOC is having a difficult time using sterilization measures to drain off excess liquidity, leading to an inevitable increase in the basic money supply.

Massive inflows of hot money have worsened the situation; the authors pointed out that China will face a real financial crisis once the hot money retreats.

Therefore, although the timing is not ideal for an exchange rate adjustment, the authors still believe that an acceleration of exchange rate reform is the best policy choice in the circumstances.

"A floating yuan would break market expectations of a one-way appreciation of the yuan, free up monetary policy and ease inflationary pressure” He and Zhang wrote.

For more details, please read the full story in Chinese

(http://paper.cs.com.cn/html/2008-07/04/content_15947345.htm).

(China.org.cn by Yan Pei July 4, 2008)