The first 10 months of this year witnessed a US$7.5 billion deficit in general trade.

"China is highly likely to find itself in a situation with consecutive years of trade deficits, around the end of the grace period of its World Trade Organization (WTO) membership," Dai told the China Finance and Capital Markets Conference, an event organized by Euro Events Management Co Ltd.

Upon its WTO accession, China was given a five-year transition period that finishes at the end of 2006, when it will fully open up the banking sector and other markets. "Therefore, our maintaining renminbi exchange rate stability at present is a wise choice," said Dai, who left his post as the PBOC's monetary policy chief earlier this month after a six-year tenure.

Chinese banks reported far heftier dollar purchases this year than the nation's trade situation would usually suggest, which many see as an indication of speculative capital inflows betting that China may succumb to foreign pressures to allow the yuan to appreciate.

Dai said a major reason for the discrepancy was that more Chinese businesses are shifting their foreign exchange holdings left outside the country during past years back home. He said this is evident by adding up numbers from 1998 to this year.

"Overall, it's basically balanced," he said.

A second reason is the increasing number of overseas Chinese citizens remitting forex back to invest in the booming real estate sector and financial markets, the official said.

A third reason, Dai said, is inflows under capital accounts as a result of "improper" expectations for yuan appreciation.

"When people realize the scenario of consecutive years of trade deficits, I think market expectations will change," he said. "So we need to be prepared for a possible reversal in the forex market over the medium term."

But the upward pressure on renmibi remains strong in the marketplace at present.

As the PBOC purchases excess dollars in the market to enforce its range of the renminbi exchange rate, China's forex reserves soared by 34 per cent year on year to US$383.9 billion at the end of September.

To mop up the excessive liquidity created in that process and ensure reasonable levels of credit growth, the central bank started to issue PBOC bills in April after running out of bond holdings it previously relied on for contractive open market operations.

Some economists are skeptical about the sustainability of the new tool, citing the shorter maturities of PBOC bills, mostly under one year, in comparison with the forex reserves that are largely held in long-term investments, as well as the relatively high interest rates on such bills.

Dai dismissed those worries, insisting that the issuance of PBOC bills will continue. The central bank was intentionally focusing on short-term maturities to fill a hiatus of short-term instruments in the bond market, and the central bank's high credibility has no problem in ensuring continuous issuance operations, he said.

And the cost is lower than what the bills' interest rates suggest, as the central bank still pays interest on excess bank reserves if they are not used to buy PBOC bills, he said. The yield on proceeds from PBOC bills equals that on China's forex reserves, a large part of which is held in US government bonds.

"From this perspective, the issuance of PBOC bills has a lot of room in terms of volume," Dai said.

The outstanding volume of PBOC bills now stands above 400 billion yuan (US$48 billion), but given the "multiplier effect," they have reduced the lending capacity of commercial banks by a far greater margin.

Renminbi bank loans registered their first annualized decline this year in October after months of high growth that worried many, a sign the central bank said its monetary policy operations are working.

(China Daily November 28, 2003)